Part2: A big-short scenario for Australia has been getting a lot of attention this week. John Hempton, Bronte Capital‘s chief investment officer (a hedge fund) and Jonathan Tepper, an economist and founder of Variant Perception (an Independent Global Macroeconomic Research that presents itself as “contrarian investment analysis”) believe that Australia is heading to a scenario eponymous to the book and movie, which describe how the 2007 sub-prime crisis originated and how a few people saw it coming and made money betting on it. After their thesis copied from the Australian Financial Review, here is the opposite view from JP Morgan that says such a big-short scenario “will take years”, and that there is no way house prices will crash 50 per cent. There is also another piece from the regulator ASIC who claims it’s got the Big Aussie short covered.
Who’s right? Only history will tell. So capturing all of this on the blog to have forensic reference if/when it happens/or not.
A widow-maker is what hedge funds refer to as a risky trade that leads to huge losses.
Short positions in the Big Four banks increased following an explosive report by Jonathan Tepper, an economist at Variant Perception, and Bronte Capital chief investment officer John Hempton.
Mr Tepper argued that Australia’s banks are lending money into a housing bubble and foreshadowed up to a 50 per cent plunge in property prices. For hedge funds, the most obvious way to play the trade is to bet the price of bank stocks will fall.
Mr Tepper and Mr Hempton’s research struck a chord with investors, causing a sell-off that would reward short-sellers. On Wednesday, banks rebounded with the strongest gains this year after a surprise windfall for the Australian economy: it is growing faster than anyone thought, at 3 per cent a year.
There were other factors at work too, as global markets flipped to “risk-on” mode, supporting a rally in bank stocks which are still in bear territory.
And another take on the housing bet did the rounds via a report titled Debunking the Australian Housing Bubble View by JPMorgan’s head of hedge fund sales in Sydney, Sujit Dey.
“The only way house prices crash is if rates go up suddenly and/or unemployment increases materially. Either of these two scenarios will take years,” said Mr Dey.
His report, which is not part of the bank’s equity research and was seen by Fairfax Media, “is a 101 note for those that already live here but I thought it would be of interest to my offshore clients”.
“Shorting the Australian housing market has been a widow-maker trade and I think it will continue to be the case,” he said.
Mr Dey detailed all of the ways in which the Australian financial system is structurally different to other jurisdictions with the aim of restraining a sub-prime style meltdown.
One of Variant Perceptions biggest criticisms was directed at the upswing in interest only loans, the implication being that Australian property is so expensive that borrowers can’t afford to meet repayments on the principal, even at record low interest rates. Well documented angst around housing affordability supported this thinking.
‘I CANNOT SEE A 50PC HOUSE PRICE CRASH’
The counterpoint, in Mr Dey’s view, is that such loans are mostly a byproduct of widespread negative gearing incentivised by the tax system.
“The shorts think interest-only loans are a Ponzi scheme but they don’t understand why people use them. People don’t use them because they cannot afford the principal.
“They use them to get maximum deductibility as well as flexibility,” he said. Capital gains tax exemption on the primary residence is another way the tax system has helped one’s home become “one of the best investments possible in Australia”.
Full recourse loans, no culture of “honeymoon” discount interest rates and the distortive effect of offset accounts on national debt figures were other reasons he cited.
Further, high loan-to-value ratio lending has declined, and “low-doc” lending for troubled borrowers represents only a small part of the market, he said.
Mr Dey referenced Mr Tepper’s highlighting of the experience in Moranbah, a coal town where the median house price is down 66 per cent in three years.
“But what would you expect in a mining town? I’m sure this is the case across all mining towns globally whether it is Western Australia, Texas or Canada. We all know that these mining towns were bubbles but you could argue they have already burst,” he said.
FAITH IN CONSUMER
The broker emphasised his faith in the Australian consumer, saying they are in a strong position, and results from the profit reporting season proved this.
“Now I’m not saying Australia will not see a decline in house prices. All I’m saying is that I cannot see a 50 per cent house price crash. My view is we could see a steady 5 to 10 per cent move down due to the oversupply in apartments and tightening lending standards.”
The Reserve Bank of Australia commands the highest cash rate in the developed world, so “if banks raise rates, I’m sure you will see the RBA cut. Not many developed countries have this luxury”.
Mr Dey is not the only person who disagrees with the theory of the “big short”, though it is no surprise that the property and lending industries have emphatically defended their territory.
Mr Tepper later suggested critics of his view were “brain dead” but denied he was seeking a high profile, just “trying to write things as I see them”.