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Miners and banks had a good run but it's coming to an end: Editor’s note

Lewis Jackson  |  05 Aug 2022Text size  Decrease  Increase  |  
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Today is my final day at Morningstar and this is my final editor’s note. Thanks to everyone who took the time to read and send through their thoughts over the past few months. Mark Lamonica will take over next week. I hope you enjoy this last note. If you don’t, tell us why in the usual place: editorialAU@morningstar.com. I’m taking a few weeks off to motorcycle around New South Wales before the next stint.

End of the line

Scientists estimate 109 billion people lived and died across human history. One in 150 has been a Chinese migrant moving to cities from the countryside since the 1980s. The houses, roads and factories built to home, transport and occupy this 700-million-person migration fuelled an unprecedented infrastructure binge. What we call the “China boom” was history akin to raising the Pyramids.

This migration coincided with another historic change: the steady decline in interest rates which culminated in a decade of near-zero rates across the developed world. Bank of England chief economist Anthony Haldane said in 2015 that interest rates were the lowest in 5,000 years.

These two tectonic shifts showered Australian shareholders with cash. Banks gorged on a boom in mortgage lending as falling rates boosted house prices. Hungry Chinese steel furnaces revived moribund iron ore miners. Shareholders enjoyed decades of weighty dividends. But the next 20 years are unlikely to be as kind and it is time to reorient portfolios from the mortgage writers and dirt diggers many Australian investors are wedded to.

Safe as houses?

Banks like mortgage lending. Homes and land make good collateral: easy to value and relatively stable. Rising house prices boost mortgage profits in at least three ways. First, as home values rise, so do loan sizes and total interest income. The average New South Wales mortgage hit $800,000 in January 2022, almost triple the size of small business loans made during the pandemic. Second, higher prices lure in eager customers as falling rates create a self-reinforcing cycle of higher prices, bigger loans and more borrowers. And third, the value of bank collateral rises on existing mortgages, making recent mortgage loan losses tiny for our banks.

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Since the 1980s, banks have piled into mortgage lending with gusto. The boom was headiest in the 2000s. The number of households with a mortgage jumped sharply and house prices in real terms increased 6% annually (9% unadjusted for inflation). Commonwealth Bank profits grew at an annualised rate of 16 % over the 2000s, the best decade of performance since it was privatised in 1991.

The next two decades will not be as kind. House prices and debt are at record levels and running out of steam. Unaffordable homes choke off new borrowers, cutting into credit growth and flattening loan sizes. Morningstar bank analyst Nathan Zaia forecast mortgage credit growth to halve in fiscal 2023 compared with today.

What about interest margins, or the difference between what banks charge borrowers and pay depositors? Lower rates boosted credit growth, but surely rising rates should help offset fewer and smaller loans? Maybe not. First, net interest margins shift slowly. Commonwealth Bank reported a net interest margin of 2.1% in fiscal 2012 when the cash rate was 4%. A decade later, margins had only slipped to 1.8% despite a cash rate of zero . Second, fewer loans means more competition for those that remain, limiting the upside from higher rates.

“The issue when you don’t have growth, everyone is competing for a pie that’s not growing, so it might lead to more price competition than when the system is growing,” says Zaia.

Australian banks already trade at a valuation premium to foreign lenders. After a bumper two decades, will the next two be as good? Unlikely.

Iron ore no more

Chinese demand turned iron ore from a commodity sideshow into a nation-building project. It’s a question of when the boom ends, not if.

Iron ore mining was a dismal business for the two decades before 2000. The collapse of the Soviet Union, Japan’s property market implosion and the Asian Financial Crisis slashed global steel demand.

Then came China. The portion of Chinese living in urban areas rose from 20% in 1980 to just over 60% in 2021. This human migration coincided with the biggest building spree in world history. China poured more concrete in two years between 2011 and 2013 than the United States did over the 20th century.

Construction means steel and steel means iron ore. Iron ore prices barely cracked the US$30 per tonne mark in the two decades before the early 2000s. Today prices above US$100 are considered normal.

But just as with mortgages, the next two decades are unlikely to be as kind for iron ore. The rate at which people move from farm to city in China has been declining since the 1980s and is now at levels comparable to Australia (even if the overall urban population is still lower). Investment in roads, hospitals, bridges, apartments and factories remains extraordinarily high but Chinese policymakers from Xi Jinping down are committed to curbing the addiction to debt-fuelled concrete pouring.

Iron ore miners know this and are trying to diversify into what BHP chief executive Mike Henry calls “future facing metals”. But green transition metals like copper and nickel cannot replace the iron ore gravy train. Global iron ore production hit 2.7 billion tonnes last year, roughly a third from Australia. Total copper mined was 19 million tonnes, or 0.7% as much.Even were Australia’s iron ore giants able to capture the total copper market, which they won’t, the volumes are thimble-like.

It won’t be Australia’s first commodity boom bust. Wool prices exploded during the 1940s and 1950s thanks to World War 2 and the Korean war. Prices then fell for six decades. Australia fell off the sheep’s back.

Wool prices over a century (inflation adjusted)

Source

Local investors at risk

Australians are especially at risk from any transition because so many own a highly-concentrated chunk of mortgage and mining stocks.

Roughly a third of all Australians invest outside super and most owned less than three investments, according to a 2020 Australian Securities Exchange survey of investors. Half of all investors who identified as diversified owned shares in two or less companies. It’s likely at least one of those products is a bank or mining share. Morningstar data shows a third of Commonwealth Bank shares are held by small shareholdings , compared to just 5% for Transurban.

As the global mining and mortgage boom winds down, Australians investing for the long view should diversify away from home.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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