The big risk for Australia's equity market

What would you nominate as the single biggest risk to the local stock market right now? In an interview at a recent event held by IRESS and Livewire, we asked Brad Matthews, who consults to Advisors and Managers on asset allocation, for his view. 

He told us: “In relative terms, we're a little bit more bearish on the Australian outlook. Generally, I think the big risk, and it's the one everyone's talking about, is the housing downturn”.

In this short segment from the discussion with Livewire's James Marlay, Brad outlines his perspective and discusses the drivers and flow-on effects for the market.

Watch the short video, or read the transcript, for the experts' perspective.  

Edited transcript 

"So, in relative terms, we're a little bit more bearish on the Australian outlook. Generally, I think the big risk, and it's the one everyone's talking about, is the housing downturn. And the leverage of the household sector to the housing market is very high.

What we don't have is an example in the past where we've actually been through a period where housing prices have fallen by sort of 15%, 20%. If we do go through that sort of correction it creates uncertainty from a forecasting perspective because we just don't have that experience to draw on. But my sense is that the sensitivity to that sort of correction is probably pretty high. 

We're talking about a household sector that is already approaching 0% from a savings ratio, so there's not a lot of capacity in the household sector to absorb some sort of financial shock, and the wealth effect associated with declining house prices could be regarded as a shock. 

The flow-on effect of reduced construction activity is also a factor. Construction has been a big swing employer within the local economy. If you take away that driver of employment growth you start to look at a scenario where potentially unemployment is on the increase, and that creates a fairly negative outlook, I think, for the Australian economy. 

When you look at the Australian economy, and the Australian share market, over the last 30 years, the financial deregulation effect, the growth in the finance sector really gave it a big boost through the late '80s and 1990s. 

That was then overtaken by the mining boom as a big driver of activity over the early 2000s into 2012.The mining boom was then replaced by the construction boom. 

You don't have that same driver anymore. My sense is there isn't another factor that's really going to keep the growth trajectory in the local economy high. 

And given the extent to which the local share market is housing related, via the banking sector, the banking sector is going to struggle, I think, to maintain earnings at their current level in a serious housing downturn".