Why rate rises are hurting so much + Guzman y Gomez shares

Hi everyone,

Gee, a big week in terms of the economy and also the sharemarket.

• Take profits if you have Guzman y Gomez shares

• RBA keeps rates on hold but considers a rate rise

• Why rate rises are hurting so much

• Three simple charts show why Australia needs immigration

• Record number of businesses going broke

• Tax Office warning for property investors

• How returns from the Australian sharemarket compare with the rest of the world… you’ll be surprised

But first, this week saw sharemarket history being made.

Over the last couple of months I’ve been keeping you updated about AI computer chip maker Nvidia and how it has become a global phenomenon. The investment world is simply aghast at the share performance of the company.

That chart I shared last week showed how its share surge has seemingly come from nowhere. This week it became the most valuable company in the world. It is staggering. On Tuesday, its share valuation leapt over Microsoft.

Nvidia’s history is fascinating. It started in 1999 – the year Steve Jobs returned as the boss of Apple and Intel was the powerhouse of the computer chip world. After three years it made it into the S&P 500 index of the US’s biggest companies.

Those lucky enough to have invested in the Nvidia float back in 1999 have enjoyed a return of 591,078 per cent over those 25 years. No that is not a misprint… 591,078 per cent return.

The company is now worth about $5 trillion ($US3.34 trillion).

Take profits on Guzman y Gomez share float

“Mexican” (I have a Mexican daughter-in-law who disputes that description 😊) food chain Guzman y Gomez made a stellar debut on the sharemarket yesterday when its share price listed at $30… a 36 per cent rise on day one from its $22 issue price.

It’s the biggest new listing since 2021 and the 18^th largest in the last five years. Over recent years there has been a drought of new listings.

The food chain started in 2006 and is famous for its breakfast burritos and $3 tacos.

Among investment analysts, this company has been very divisive with many believing the $22 IPO price looked inflated and the forecasts hard to believe. They were eating humble pie yesterday.

The company listed on the sharemarket when I was hosting my share investment program, The Call, on the ausbiz streaming network (ausbiz.com.au) with Mark Gardner of MPC Markets and Josh Barker from River X as the expert panel.

Both were absolutely stunned by the $30 listing price and agreed it was great for the sharemarket and encouraging other companies to follow onto the boards.

But both also agreed the company is priced for perfection. Its valuation assumes it will deliver on its growth forecasts which include expanding into the US… yes, taking Mexican food to America.

They pointed out that the company is incredibly well run with a terrific business model and impressive management. But at this valuation nothing can go wrong.

They both agreed that if you managed to get some shares in the float (which were hard to come by) then you should bank some profits and sell 20-30 per cent of your holding at these levels.

Mark and Josh suggested new investors wait and see whether the company delivers on its promises.

RBA keeps rates on hold which means your household budget is still down $18k a year

Every time the Reserve Bank announces that interest rates are on hold, understand that means the average home borrower is $18,000 worse off than they were before rates started to rise.

That’s $18,000 in cold hard cash, after tax. You’d have to be earning at least an extra $25,000 a year in wages to just be financially standing still. That $18,000 in cash is why you can’t afford that family holiday, or the council rates, a new car or a regular night out at a restaurant.

And the RBA this week reinforced yet again that interest rates will stay at this level (or may even go up) until inflation gets down to their 2-3 per cent target band. So you’ll be having to do without that $18,000 in cash for some time to come.

We’ve seen the cash rate climb from a historic low of just 0.1 per cent to its highest level since 2011 at 4.35 per cent. That means someone with an average loan of $610,000 has seen their interest rate increase from 2.2 per cent to 6.45 per cent and is now paying roughly $1,500 more in monthly repayments, or about $18,000 a year.

If your home loan is higher than $610,000 then you’re down a lot more than $18,000 a year. On a million dollar home loan the increase in repayments has been over $31,000.

These higher interest rates are causing a lot of pain. But history tells us the current level of rates aren’t all that high. The reality is rates were arguably too low for too long.

Many central banks lowered their policy interest rates to near-zero levels to stimulate their economies during the pandemic and global financial crisis. If rates weren’t cut and governments didn’t introduce rescue packages, the world could have suffered another Great Depression. No one wants that to happen.

In March 2021, the then Governor of the Reserve Bank, Philip Lowe, told Australians that interest rates would very likely stay at the record low of 0.1 per cent until at least 2024. But he mislead Australians and his forecast was horribly wrong.

What seemed like a good deal at the time has had all kinds of consequences.

Firstly, dropping the cash rate that low allowed many borrowers to enter the property market who otherwise wouldn’t have been in a position to do so.

Those who borrowed close to their maximum amount have either had to sell or are just treading water because the 3 per cent serviceability buffer applied by most banks has been eroded away by higher repayments.

Figures from CoreLogic show a record 16 per cent of sales early this year were properties that had last changed hands less than three years ago. Bought when interest rates were ultra-low.

According to SQM Research, the number of residential properties sold under distressed conditions in Australia has risen to 256,000, a 6.9 per cent increase. Thankfully property values have kept rising so hopefully those distressed sales made a profit.

This comes as Compare the Market (where I am Economic Director) research revealed almost a quarter of homeowners are worried they'll have to sell, or have already sold, due to the rising cost of living. They’re asset rich but cash poor. While values have risen, they simply don’t have the cash to meet rising repayments.

And it could get worse. The RBA actually discussed an interest rate rise at this week’s board meeting but decided against the move. In more bad news for borrowers, money market investors are predicting a one-in-four chance of yet another rate rise by September this year. Hopes of an imminent rate cut have been dashed by stubbornly high inflation.

After Tuesday’s RBA decision to keep rates on hold for the fifth straight time, economists are now 50-50 on whether we’ll even get a rate cut in December and believe it’s more likely to be not until at least April next year.

According to RBA Governor, Michele Bullock, rates may have to stay high for even longer because of economic stimulus from state and federal government. Next month a bunch of energy relief subsidies kick in as well as the Stage 3 tax cuts.

While the RBA has been warning that everyone needs to be tightening their financial belts to fight inflation, politicians have been splashing the cash with these energy subsidies and tax cuts to win voter support and be the good guys.

The RBA made a very pointed comment about this in its rate announcement: “Recent budget outcomes may also have an impact on demand, although federal and state energy rebates will temporarily reduce headline inflation.” While conceding that “the persistence of services price inflation is a key uncertainty.”

The recent Federal Budget forecast a series of deficits over the next couple of years. In other words, the government will be spending more than they’re earning and adding to government debt. Completely the opposite to what we’re being asked to do with our household budgets.

You sense that Bullock is fed up with doing the heavy lifting in the inflation fight and is ready to call out the actions of government.

Interest rate cuts have already started around the world

Just to give you a global perspective, we were one of the slowest countries to increase interest rates coming out of the pandemic. Some would say too slow and that’s the reason why inflation quickly got out of control. We didn’t move fast enough.

The downside seems to be that while other countries have put the inflation genie back in the bottle, they have the luxury of starting their rate cutting cycle before us.

While Switzerland cut in March, Sweden was the first country in this cycle to cut interest rates following very high inflation. Then on 5 June, Canada cut interest rates and then the next day the European Central Bank cut.

I’ve pointed this out before, but look at Japan. Its economy has been dire for years. Zero, or negative, interest rates reflecting an economy stagnating through deflation, falling asset prices, ageing population and terrible competitiveness.

No, or negative, inflation can be just as damaging to an economy as high inflation.

Why interest rate rises are so devastating in Australia

The power of interest rises on average Australian families is so much more devastating than it is in other countries. When our rates go up there is an immediate flow through to household budgets because the vast majority of home loans are variable.

When official rates go up it immediately flows through to loans and repayments.

Look at this chart from Ray White chief economist, Nerida Conisbee, where only 15 per cent of home loans are on a fixed rate. Compare that to the global average of 60 per cent and near 100 per cent in the US and Mexico.

In those countries, borrowers don’t feel any rate rise (or fall) until they change properties. In Australia, it’s immediate. That’s why rates are a very powerful tool in boosting or reducing household budgets.

It’s also the reason behind the CoreLogic research which shows mortgage arrears have been rising from their COVID lows of just 1 per cent in September 2022 to 1.6 per cent in this latest March quarter. That is still low but a 60 per cent rise in 18 months.

The upwards trend in arrears has been most influenced by non-performing loans, where the arrears rate has risen to 0.93 per cent. A non-performing loan is one that is at least 90 days past due or where the lender expects it won’t be able to collect the full amount due. The non-performing arrears rate is now slightly higher than it was at the onset of COVID (0.92 per cent) and above the historic average of 0.86 per cent.

A key factor in higher mortgage arrears is, of course, the sharp rise in the cost of debt. With the average variable interest rate on outstanding owner occupier home loans rising from 2.86 per cent in April 2022 to 6.39 per cent in March 2024, a borrower with $750k of debt would be paying nearly $1,600 more each month on their scheduled repayments.

But there are other factors at play as well. Cost of living pressures are consuming a larger portion of household income, households are paying more tax than ever before and household savings are being drawn down, eroding the savings buffer built up through the pandemic.

There is also the fact that households are more sensitive to sharp adjustments in interest rates, given historically high levels of debt, most of which is housing debt. Rising unemployment is also spooking Australians.

Australian households are asset rich and cash poor. Their property’s going up in value but they are finding it tough to meet loan repayments. Thankfully, for homeowners that do fall behind on their repayments, there is a good chance most will be able to sell their asset and clear their debt.

The latest estimates on negative equity from the RBA estimate only around 1 per cent of residential dwellings across Australia would have a debt level that is higher than the value of the home. With housing values continuing to rise, the risk of negative equity is reducing.

Employers are doing it tough

As you know I’m a bit worried that the jobs market is weakening and unemployment could start to pick up pace even though last week’s unemployment figures ticked down slightly to 4 per cent.

It just seems as though all the anecdotal evidence of vacant shops and retrenchments in big banks and mining companies isn’t being reflected in the official figures yet.

Credit reporting bureau, CreditorWatch, has released its Business Risk Index (BRI) for May which shows that insolvencies for Australian businesses are now at a record high as inflation, high interest rates and cost of living are impacting their customers.

CreditorWatch’s data shows an average increase in the rate of insolvencies of 38 per cent over the year to May 2024 across all industries. The total number of insolvencies is up 34 per cent year-on-year and 41 per cent above its pre-COVID maximum.

Remember these are the number of existing business employers going out of business.

Electricity, Gas, Water and Waste Services tops the list of industries by rate of increase in insolvencies, with an 89 per cent increase year-on-year, followed by Education and Training (87 per cent) and Mining (72 per cent).

Three great charts on why we need immigration

Immigration is such a hot political topic at the moment. How many people we need, the pressure they are putting on the housing market, whether they’re taking jobs – these are such electoral hot buttons and often completely misleading.

Then, separately, we talk about the ageing population and low birth rates which have devastated economies like Japan, China and across Europe.

Populations must grow to build the workforce, to underpin a growing economy and protect our high standard of living. That’s why we need migration.

Here are three great charts which paint the picture.

Australia’s birth rate is at record lows. We are not producing enough future workers to replace the ones who leave the workforce. You could argue we need another Peter Costello “baby bonus” which accounts for that blip up in 2005.

So our natural population growth is falling and is at the lowest level in years.

Despite falling birth rates and small natural population growth our actual population growth is rising at a much greater rate than any other advanced economy – and our population is ageing at nowhere near the same level as our major trading partners.

That’s great news. Why?

Immigration levels.

Property investors are big targets of the tax office this year

The Australian Taxation Office (ATO) is warning rental property owners that their tax returns are in the spotlight this tax time.

That’s because the ATO has found the majority of rental property owners are making errors in their tax returns, despite 86 per cent using a registered tax agent.

The most common mistake is not understanding what expenses can be claimed and when. In particular, the difference between what can be claimed for repairs and maintenance versus capital expenses.

Other mistakes on the ATO’s radar include overclaimed deductions and a lack of documentation to substantiate the expenses claimed.

The ATO receives data from a range of sources like banks, land title offices, insurance companies, property managers and sharing economy providers (like Airbnb), and cross checks this data to determine the accuracy of tax returns lodged by rental property owners.

Rental property owners can claim deductions only to the extent they’re incurred in producing income. This means any costs you incur in generating rental income each year, may be claimed for the same period. There are some exceptions.

A repair can usually be claimed straight away but capital items, like dishwashers, curtains or heaters, can only be claimed immediately if they cost $300 or less, otherwise they need to be claimed over time.

One of the most common deductions claimed by rental property owners is interest on mortgages. Based on previous years data, the ATO estimates incorrectly reporting interest expenses account for 42 per cent of the $1.2 billion tax gap associated with rental properties.

A common issue with interest deductions is where taxpayers are redrawing or refinancing a loan for their rental property and using the extra money to pay for private expenses like a new car, school fees or a holiday, then claim the whole amount of interest charged on the investment loan for the year as a deduction.

For example, if you have an $800,000 mortgage for a rental property and then add $50,000 to the loan to upgrade your family car, you can only claim the interest on the initial $800,000, not the interest on $850,000.

A deduction can be claimed for levy payments to body corporate administration funds and general-purpose sinking funds at the time they are incurred, as long as the fees are used for routine maintenance of common property. However, if the body corporate requires payments to a special purpose fund to pay for a particular capital expenditure, like replacing the roof of an apartment building, these levies are not deductible until the capital works are complete and the expense has been billed to the body corporate.

Costs relating to borrowing expenses, including loan establishment fees, lender’s mortgage insurance and title search fees, are also commonly being claimed incorrectly. These costs are generally claimed over a five-year period or the life of the loan, whichever is less. State or territory stamp duty can’t be claimed as a deduction while you rent the property (except in the Australian Capital Territory).

You need to keep these records until you sell, when the amount will be added to your cost base to reduce any capital gain you may have on the sale.

The ATO is also warning rental property owners about incorrect claims for capital expenses.

Repairs such as fixing a dishwasher can generally be claimed immediately but buying a new dishwasher cannot.

Some expenses including improvements and capital works must be claimed over time, for example remodelling the bathroom in your rental property. In most circumstances, capital expenses are claimed at 2.5 per cent over 40 years.

The ATO has an investor toolkit on their website which is a great resource.

Why your investment portfolio must have offshore exposure

Investing in overseas sharemarkets has never been easier with most brokers offering the ability to buy direct shares, plus there’s an enormous range of ETFs which provide global exposure.

If you need any convincing have a look at this rundown of major stock market performances over the last 10 years:

India: +188%
USA: +172%
Japan: +158%
Brazil: +128%
Russia: +117%
Sweden: +86%
Germany: +85%
Bermuda: +76%
France: +75%
Chile: +68%
New Zealand: +67%
South Africa: +57%
China: +52%
Canada: +48%
Australia: +41%
Switzerland: +39%
South Korea: +32%
Mexico: +27%
UK: +20%
Saudi Arabia: +18%
Spain: +5%