As though there isn't enough bad news on the market today – Morgan Stanley has revised down its housing market outlook and is warning that the upcoming price drop will be the worst since the 1980s!
The news will add to the gloom with the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index down 2.5% at the time of writing and it looks like it will close at or near its intraday low.
This means the market rout could last for several more days, if not for a few weeks unless the ASX 200 benchmark bounces strongly tomorrow to trade back above the 6,000 level.
It's a great time to be a cashed-up bargain hunter but Morgan Stanley's latest forecast only reinforces my view to stay away from anything that's related to the residential market.
The broker's proprietary housing indicator, MSHAUS, has slumped to a new low and prompting Morgan Stanley to change its forecast for house prices to drop by between 10% and 15% compared to its earlier prediction of 5% to 10%.
"This suggests that the recent decline in prices will likely continue at a similar pace into 2Q19," said the broker.
"All housing market drivers remain a drag, but Supply-Demand Balance was the main driver of this quarter's decline, adding to the drag in previous quarters from tightening credit supply."
A fall of 10%-15% would mark the biggest drop in house prices since the early 1980s, although households are two times more leveraged to housing now than back then.
The forecast change comes on the heels of the release of National Australia Bank Ltd.'s (ASX: NAB) residential property index, which showed a big drop in sentiment among property professionals.
Morgan Stanley struggles to see improvements over the next year with a looming oversupply of dwellings, tighter lending standards and restrictions in credit flows. The risk of the scrapping of negative gearing benefits if Labor wins the next election could be another drag on the market.
This paints a bearish picture for our largest mortgage lenders like Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), while those exposed to housing construction like CSR Limited (ASX: CSR) and Mirvac Group (ASX: MGR) could be facing more challenging times ahead.
Investors aren't concerned about developers like Mirvac and Stockland Corporation Ltd (ASX: SGP) though as most of their 2019 developments have been pre-sold (assuming most buyers can complete settlement).
But if the property correction were to persist into 2020 as some experts are predicting, their earnings would be vulnerable to a downgrade.
What's more, Morgan Stanley reckons there is a 30% chance of a hard landing where property prices fall circa 20% to 25% from peak to trough.
Under this bearish scenario, Mirvac's and Stockland's earnings per share in FY20 will need to be downgraded by 15%, according to the broker.
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