Why house prices should recover in 2012: Craig James

The housing market is constantly in a tug-o-war between two factors – demand and supply. And really it doesn't get simpler than that. If there is a limited number of properties for sale and plenty of keen, cashed-up buyers then prices are almost certainly going to be bid up. Similarly if there is an abundance of property on the market and buyers are cautious – preferring to take time to find the 'right' home – then prices are more likely to ease.

Clearly there is no single "housing market"; rather there are countless markets, even down to street level. But if there is a common characteristic across markets at present it is that the supply of homes is up.

RP Data has data on almost every single property in Australia so it is best placed to describe what's going on. And its latest estimate is that there is 5.8 months of effective housing supply in Australian capital city markets at present. That takes into account the current sales rates as well as the number of homes on the market.

But that figure doesn't mean much without some reference point. RP Data advises that a year ago there was around 4.5 months of supply in capital city markets. Over the past four years, effective supply has ranged between 2.3 and 6.5 months, averaging 3.9 months. So it is clear that housing supply is currently relatively high.

But as always supply conditions vary across the country. RP Data notes that supply is lowest in Canberra while highest in Brisbane. However supply in actually lower than a year ago in one capital city – Perth.

So much for supply – how do you measure demand? In part it is determined by interest rates (cost of finance) but also includes labour market conditions, risk preference (desire to take on debt), rent levels and attractiveness of other asset classes. And then you have to incorporate other elements such as demand being brought forward into earlier periods – as occurred with the global financial crisis when rates were cut and incentives were provided to first home buyers.

It is clear that demand for housing has weakened over the last six to 12 months. The job market has clearly softened; Aussies have become more reluctant to take on debt, while returns on cash-based investments have held up in relation to other asset classes. While interest rates have just been cut, this is a more recent development and the key question is whether the reduction in rates has been enough to offset conservative risk preferences.

Overall it shouldn't be surprising that capital city home prices have fallen by 3.4% over the past year, especially following a period of above-normal demand and price growth in 2009 and early 2010. But with supply arguably peaking, job markets healthy and interest rates down, 2012 should be a year of home price recovery.

The week ahead

Unless the purported "mini budget" is released, the coming week will be a dull affair with little in terms of fresh economic information to provide guidance for investors. And it is a similar story in the US, although Americans are waiting for their politicians to come up with proposals to cut the budget deficit otherwise both sides of politics will have to be content with more unpalatable – and enforced – options.

In Australia, there is little in the way of market-moving events in the coming week. On Monday, Reserve Bank Assistant Governor (Financial) Guy Debelle delivers a speech to the Australian Securitisation Forum Conference. And on Wednesday he follows this up with another speech, this time to the APRA Basel III Implementation Workshop 2011. However given the topic matter, there may not be too many references to the current economic situation or implications for monetary policy.

On Wednesday the State Accounts for the last financial year will be released – effectively the report card for state and territory economies. And on the same day the Bureau of Statistics releases the Construction Work Done publication. This publication not only covers building and engineering work done over the September quarter, but it also contains estimates of work yet to be done and work in the pipeline – more forward-looking construction components.

The construction work done figures are used as an input into the GDP (economic growth) estimates for the September quarter. And if our estimates are close to the mark, construction should provide a solid boost to the economy in the quarter. We expect that construction work done rose by 5% in the September quarter after a more modest 0.7% expansion in the June quarter.

And on Thursday the Reserve Bank governor delivers his annual address to the Australian Business Economists' end-of-year function. This is effectively the business economists' Christmas party, but don't expect wild celebrations and exuberant forecasting. The main reason the economists are there is to hear the RBA Governor and, as is always the case, when the RBA Governor speaks Aussies listen carefully for clues on interest rates.

In the US, the week kicks off with data on existing home sales and the Chicago Fed index on Monday. While sales have followed a zig-zag course in recent months, suggesting a rise is in on the cards, economists actually tip a 1.5% fall in home sales. Broadly home sales are holding near a 5 million annual rate.

On Tuesday the updated (preliminary) estimate of economic growth for the September quarter is released and economists expect little variation from the 2.5% "flash" estimate. The Richmond Fed index is released the same day.

On Wednesday personal income/spending data is released alongside durable goods orders, consumer sentiment and weekly jobless claims. Income probably rose 0.3% in October with spending up 0.2% while analysts expect a flat reading for new orders of long-lasting or durable goods.

Also on Wednesday the "super-committee" is meant to come up with budget measures designed to save $1.2-1.5 trillion over the next decade. If they don't, automatic cuts will be imposed – measures that neither Democrats nor Republicans will be happy with. If the "super committee" is successful it will ensure that all Americans will be able to truly enjoy Thanksgiving Day on Thursday.

Share market

With about six weeks of 2011 left, it is an opportune time to assess how the Australian share market has performed this year. Currently the All Ordinaries is down 11% from the start of the year with the ASX 200 lower by 10.5%. Other major markets are also lower with the Japanese sharemarket lower by 16% with the German market down 14.5% and the UK sharemarket lower by 6.5%. Interestingly the US sharemarkets have out-performed with the Dow Jones up 3% and the S&P 500 and Nasdaq largely unchanged.

Looking across the 22 Australian industry sectors, only three are currently up on the year. The best performer has been the defensive telecommunications sector (up 13%) followed by food, beverages and tobacco (up 9%) and utilities (up 2%).

At the other end of the scale, the consumer durables ande apparel sector has fallen by 39% in 2011, followed by diversified financials (down 28%), retailing (down 25%) and capital goods and software and services (both down around 20%).

Interest rates, currencies and commodities

The Australian dollar started the year just under US102 cents and it's currently only modestly lower. The European debt crisis may have raged over the second half of 2011, adding to risk aversion, but the Aussie has weathered the storm well. A broad measure of commodity prices – the CRB futures index – is down around 5% over 2011 but there have been commodity winners and losers. Gold has lifted 25% with crude oil up 7%. At the other end of the scale, base metal prices have fallen sharply with nickel down 28% with lead, zinc and copper down around 20%. Cotton has also lost 37% while wheat has fallen by 21%.

Craig James is chief economist at CommSec.

This article originally appeared on SmartCompany.