A Potential Play Against Australia's Declining Economy And Housing Market

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Includes: EWA, FXA
by: Adem Tumerkan
Summary

Australia's export-heavy economy depends on China's continued growth - as well as their capital investment back into the country.

But as China's economy is plagued by problems (especially debt and a relatively strong yuan ), growth is decelerating. And it's already greatly affecting Australia.

Australia home prices (y/o/y) have fallen off a cliff into negative territory - its deepest level since 2008.

Australia's PMI, building approvals, and home-loan values have all collapsed sharply over the last 16 months.

I expect this declining trend in Australia to continue as China further slows - which will put pressure on Australian equities.

The mainstream hasn’t talked much about the serious trouble in the ‘Lucky Country’ - aka Australia.

But I’ve had my eye on it for a while now...

And after the recent slowdown of China’s growth estimates, I think this is a good time to bring it to your attention.

Here’s a brief summary - Australia’s a huge country with an abundance of natural resources and a booming exporting sector.

Basically - Australia is to China what Canada is to the U.S. - a big trading partner for commodities. Especially natural gas, iron ore, copper, and bauxite.

Many aren’t aware of this, but Australia hasn’t had a recession for nearly three decades (meanwhile the U.S. has suffered three in that time span). Even the Great Recession of 2008 didn’t tip Australia into a technical recession.

That’s because Australia has hitched themselves to China’s massive growth. And as China’s done well - so has Australia. Especially with the Chinese investing hundreds of billions into Australia’s economy.

There’s even been jokes that Australia may become the ‘24th province of China’ since the Chinese continue buying up everything in Australia - from natural resource deposits to luxury properties.

But that’s all about to change...

China’s having serious problems in their own economy over the last year. And it’s only getting worse.

Stemming from the excessive dollar denominated debts, a relatively strong yuan (thanks to a USD peg they have), and trade war with the U.S.

But most importantly - China’s slowing economic growth.

And now that their momentum’s decelerating - Australia’s beginning to feel it.

You see, I believe markets are complex systems - meaning that small changes of initial conditions can have huge consequences later-on (known as a non-linear relationship).

That’s why less growth and capital from China will have big trickle-down-effects throughout Australia’s economy.

Putting it simply - the less China grows and profits, the less they have to buy from and invest in Australia.

And we’re already beginning to see this slowdown in Australia.

Take a look at the recently published Australia Composite PMI (Manufacturing Output Index). . .

As Markit Economics highlighted - there was a collapse in Australia’s service sector conditions and slower growth in the manufacturing sector.

And just like the drop in China’s PMI - this contraction in Australia’s output shouldn’t come as a surprise...

But the biggest red flag is the collapsing property values in Australia - effectively ending the multi-year boom in Sydney and Melbourne real estate markets.

Just look at the following chart from Crescat Capital...

These are huge year-over-year drops - and similar to what was seen when the housing bubble popped in 2008.

In my opinion - it looks as if the floor’s dropping out from under the Australian real-estate market.

Year-end growth for housing prices are now negative (keep in mind it hasn’t been this bad since 2008)...

To summarize: I believe Australia’s economy and markets are highly fragile - especially since they’re tied to economic growth in China (which is souring).

Said otherwise - the Lucky Country’s facing a fundamental crisis as China’s debt-fueled growth begins decelerating.

To put things in perspective - if property prices are already collapsing throughout Australia as China’s growth has only slightly slowed down - imagine what it will look like if China’s GDP drops below 5%.

With Chinese demand for Australian commodities in danger - which is a huge headwind for the export-heavy country - I expect capital investment from China to further dry up. Adding strain to the ailing Australian housing market.

The Australian Dollar (AUD) is already relatively weak - but I expect it has further downside.

All this is why I’m looking at opening a position via long dated, out-of-the-money put options on the iShares MSCI Australia ETF (NYSE: EWA) to profit from any sell-off and weakness in Australia’s economy (for instance, the EWA is overweight Australian banks - nearly 30% - which are directly at risk to falling home prices). These put options offer the positive asymmetry (low/fixed risk - high reward) that I look for.

I’m also looking at the same play for the Invesco CurrencyShares Australian Dollar Trust (NYSE: FXA) as a bet against a weakening AUD.

I’m going to wait for more data - as well as the upcoming Royal Bank of Australia (aka RBA - the central bank) meeting to see what they do.

But if/when I decide to act - I’ll let you know. So stay tuned.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in EWA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The piece is from my original write-up at SpeculatorsAnonmyous.com. All ideas expressed and charts are my own.

If I do initiate a short position on the EWA, it will be via buying long dated, out of the money, put options only. This gives me the low/fixed downside with large potential upside (asymmetric opportunity) with the most I can lose are my upfront premiums for the options.