How much will a slowing China affect our banks?
It is a fairly obvious link between a slowing China and our mining companies.
China slows, they use less iron ore, coking coal, thermal coal, copper etc. Our miners are directly affected. The recent weakness in their share prices is reflecting this and I think this is just the tip of the iceberg.
But will a slowdown in China affect our banks?
Our banks are basically leveraged bets on the house prices. Westpac and CBA are 2/3 home loans and so it all depends on house prices.
I think that mining boom towns and cities such as Karatha, Darwin and Perth are likely to have fairly large haircuts on their very elevated house prices over the next few years, but how much this flows into other property areas is difficult to predict.
As the mining boom slows, interest rates will probably fall further. This will cushion many borrowers, but what happens if the Australian dollar does not fall with our terms of trade? Australia’s AAA status is not really under threat for a few years because of our low government debt. This “least worst” position means there is a chance that the Australian dollar could remain elevated and may not cushion the fall in the terms of trade. The counter cyclical areas to the mining boom such as tourism, agriculture and manufacturing sectors may continue to struggle. If this happens unemployment rises may be higher than many are predicting. This will put pressure on borrowers and flow through to banks.
So should the banks prices be going up as the news out of China is suggesting they are running out of steam? I think it is extremely irrational to think that our banks are safe if the mining boom is finishing in the next few years.
The banks may be ok, but then again they may not. I do not believe they are offering enough returns to factor in the quite large downside that may eventuate if Australia’s unemployment rises quickly following the end of the mining boom.
The probability that the banks are ok investments in my opinion is a 50/50 bet. These are terrible odds for investors and at Valor Private Wealth, we look to find investments where we believe we have much higher odds of being right over the long term.