With the stock market on the outer last year, could its fortunes change if the property downturn deepens over the coming months?
Last year was a difficult period for a number of different asset classes. Although equities were one of the most publicised underperformers, with growth stocks particularly in the firing line, there were also major losses elsewhere.
One of these areas was the property market. Prices reversed course as central banks began to increase interest rates.
Locally, the RBA’s move to hike interest rates over eight consecutive months was a major driver for the downturn in the housing market.
However, with rates yet to peak, and borrowers facing a fiscal cliff, there is reason to believe that the property market still faces a number of challenges ahead in 2023.
It is our view that said challenges could put further pressure on property prices, increasing the relative appeal of the stock market.
Property in 2022
Before we detail our expectations for the year ahead, it’s worth noting the trends we witnessed last year.
Across the calendar year, national property prices finished a little over 5% lower. This was the first time since 2018 where national home values declined in a calendar year.
Whereas Sydney and Melbourne led the drop, other markets such as Adelaide and Perth actually recorded gains in 2022. Gains were, for the most part, a consistent sight across all sub-markets until the Reserve Bank of Australia began to raise interest rates.
With the RBA hiking rates at the fastest rate we’ve ever seen, the pull-back kicked into overdrive from that point onwards. In fact, from the peak of the cycle, national home values ended 2022 about 8% down, albeit once again, different cities performed differently.
Interest rates in 2023
With inflation still likely to sit well above the RBA’s target range of between 2% to 3%, we see the nation’s central bank raising interest rates at least two more times over the coming months, and potentially even three times.
The reason why inflation is likely to remain sticky is because many of the challenges contributing to higher consumer prices remain unresolved.
With the exception of easing energy prices, which will help, other inflationary inputs remain affected by factors such as supply chain bottlenecks, labour shortages, inclement weather and the like.
On this basis, as interest rates continue to rise, we anticipate property prices to continue trending lower. It is plausible that the sub-markets that have been shielded from the worst of the decline thus far play catch-up with the laggards.
This may be the case because of a broader concern at play. There is great uncertainty ahead regarding mortgage serviceability that threatens to extend the magnitude of the downturn in property prices.
Fixed-rate cliff
Unlike property markets such as the US, UK, New Zealand, and even Canada, where at least 70%, or even more than 90% of all home loans are fixed-rate mortgages, it is a different story down under.
Historically, less than 20% of all mortgages have been fixed-rate loans. Given pandemic-era monetary policy, which saw borrowers load up at ultra-low rates, the portion of fixed-rate loans has reached as much as 35-40% of all mortgages. This is equivalent to an estimated $750 billion.
Focusing on the near-term outlook, the RBA believes that around 23% of all mortgages - or two-thirds of fixed-rate loans - will roll over to variable rates this year. That accounts for nearly $500 billion worth of borrowings.
The impact of this roll-over cannot be understated. Borrowers will face steep increases on their home loan repayments, which could be in the vicinity of four percentage points higher.
Mortgage rates could be as much as 40% above the levels at which they were stress tested for a worst-case scenario. This is an unprecedented scenario that has never been a concern in Australia.
At face value, this should be enough to weigh on sentiment for the property market. However, if this translates into a higher level of mortgage stress, and then an increase in forced sales, there is a risk that not only prices continue to tumble, but the rate of the decline may accelerate.
Debt levels are already at record values, which means that a sudden jump in mortgage rates will instantly re-rate total mortgage payments to record highs relative to household income.
Will equities be a beneficiary?
Typically, a property downturn lags what we might see in the stock market. On account of the outlook for the housing market over the coming months, we expect to see less investment in property.
This could encourage would-be property investors to look at alternative asset classes. As we believe the stock market is already trading at ‘cheap’ levels, it is our belief that the market stands to gain from redirected money flow.
Our view is based on the notion that the lag in the property market suggests there may still be a larger downside to come for the asset class, at least relative to the stock market, which is more likely to be closer to, or has already reached a bottom.
In other words, stocks have already been discounted by a significant haircut. The downturn in property only started in April, whereas equities faced selling pressure throughout the entirety of 2022.
Furthermore, share market investors have factored in expectations for further rate hikes to come. On the contrary, property vendors are less likely to have done so, there is less liquidity in the housing market, and some owners may be forced to sell their property amid mortgage stress.
Taking these factors into account, we believe investors may preempt a recovery in the stock market before there are gains to be made by investing in property.
Of course, this momentum may not necessarily be realised across every sector of the stock market. But on the whole, we believe the asset class offers a strong possibility for outperformance in 2023.