Australia has enjoyed decades of prosperity, but with that has come a higher cost of living and substantial increases in property prices. Are we due for a correction?
The mining boom is no longer and property prices in towns such as Perth and Darwin are showing early signs of a correction. However, Melbourne and Sydney are showing no signs of slowing down. Melbourne was proclaimed the most liveable city in the world, again, and Sydney ranked seventh.
What market correction, where?
Perth also made the list, occupying the ninth position and Adelaide came in fifth. If Perth is facing a possible market correction, are Melbourne and Sydney safe?
Consider the following: Melbourne is the automotive hub of Australia and home to the local arm of car manufacturers Toyota Motor Corp; Holden, owned by General Motors Company; and Ford Motor Company. However, when these companies leave Australia, as they have said they will do by 2017, up to 100,000 jobs in Victoria (and double that nationwide) will go with them. Could this be the Achilles heel of Melbourne?
Dr. Muharem Karamujic, in his book Housing Affordability, rated the affordability of Melbourne suburbs between 2001 and 2010 using the Median Multiple (MM) Indicator. MM is defined as the median house price divided by median household income, with a value below 3.5 indicating a 'affordable' house and a value above 10 indicating a 'severely unaffordable' house. The last suburb to record a MM below 3.5 was Melton, the outermost suburb of Melbourne, back in 2004. The MM continued its upward trajectory, with the high-end suburb of Toorak moving from a MM of 17.67 in 2001 to a whopping MM of 31.0 in 2010.
Sydney, Australia's finance capital, is even more expensive than Melbourne, boasting a median house price of $900,000, on the back of yet another annual price increase of 16.5%. Australian Bureau of Statistics (ABS) reports the April 2015 value of outstanding home loans in Australia at about $1.4 trillion.
Strains on the system, such as a prolonged mining bust or a poor response to the departure of the automotive industry, could trigger a domino effect in an unprepared economy. Yet, Sydney's home buyers seem to think there is nothing to fear.
So which stocks would be most affected?
Real estate stocks such as Devine Limited (ASX: DVN), which mainly operate in the residential building sector, will be in the firing line. The finance industry as a whole would be shaken up and the major four banks such as Commonwealth Bank of Australia (ASX: CBA), which owns the lion's share of the outstanding home loans, will face serious challenges. Smaller players that may not be profitable yet, such as Yellow Brick Road Holdings Ltd (ASX: YBR), could see share prices fall off the cliff. Travel managers, such as Flight Centre Travel Group Ltd (ASX: FLT) and Corporate Travel Management Ltd (ASX: CTD) will feel the pinch.
How to defend yourself?
Keep a healthy cash balance at all times, as the market will be throwing a lot of babies out with the bath water. Maintain exposure to companies that generate good amounts of cash from international operations, such as Integrated Research Limited (ASX: IRI) or fund manager Platinum Asset Management Limited (ASX: PTM). Even though Woolworths is facing margin pressure, the market is likely to regard it as a defensive stock and pile in.
Foolish takeaway
It seems record low interest rates plus an insatiable desire by high net worth foreigners to own Australian property (whatever the true reason may be) continues to encourage a property boom, but for how long? Of course, a market correction may never materialise, but if it does, let's hope it's mild. If hope is not your thing, then make sure to review the defensive elements of your portfolio strategy.