Australian recession is certain

Shane Oliver puts lippy on the pig today:

Introduction

Australian economic growth has slowed to the weakest since the GFC. Talk of recession remains all the rage. And economists don’t have a great track record in predicting recessions globally – with an IMF study finding that of 153 recessions seen in 63 countries around the world between 1992 and 2014, economic forecasters only predicted five in April of the year before they started – so why should they pick one this time? As someone who forecast two of the last one recessions in Australia I am a bit wary. Perhaps the best way to predict recessions would be to forecast one every year and then you would have a perfect track record in predicting them! Some actually do this. But they are totally useless because they miss out on the 90% or so of the time that countries are not in recession and the positive lead this provides for share markets and other growth assets.

Recessions come along when there is a shock to the system (usually high interest rates), invariably at a time when the economy is vulnerable after a period of excess (such as rapid growth in spending, debt or inflation). The shock causes a loss of confidence, lots of little spending decisions are delayed and excesses are unwound. But given the natural tendency of most economies to grow given population growth and new innovations, increasing economic diversity, counter cyclical economic policies and the rise of the more stable services sector recessions are relatively rare at around 10-12% of the time globally. In Australia the last one was 28 years ago.

Why there has been no recession for 28 years

The absence of an Australian recession – whether defined by two quarterly GDP contractions in a row or negative annual growth – for 28 years is instructive. Many forecast recessions at the time of the 1997-98 Asian crisis, 2000-2002 tech wreck, the GFC and from around 2012 as the mining investment boom ended. But it didn’t happen. There are seven reasons why:

  • economic reforms made the economy more flexible;
  • the floating of the $A has seen it fall whenever there is a major economic problem providing a shock absorber;
  • desynchronised cycles across industry sectors;
  • strong growth in China that helped through the GFC;
  • strong population growth;
  • counter cyclical economic policy – like stimulus payments and monetary easing that helped in the GFC; and
  • good luck – which can never be ignored lest hubris set in!

But is our luck running out?

June quarter GDP growth was just 0.5%. And annual growth has fallen to 1.4% which is the slowest since the GFC and below population growth of 1.6%. Housing and business investment fell, and consumer spending remains very weak. Were it not for public spending and net exports the economy would have gone backwards in the June quarter.

Graph: Australian real GDP growth
Source: ABS, AMP Capital

Going forward, the housing downturn has further to run with building approvals pointing to a further fall in home building.

Graph: Building approvals are pointing to further falls in home building
Source: ABS, AMP Capital

This is likely to amount to a 0.5-0.6 percentage point pa direct detraction from growth. This along with low property turnover (less people moving) and lagged negative wealth effects from the earlier fall in house prices will all act as drags on consumer spending. In total the housing downturn is likely to detract around 1-1.2 percentage points from growth in the year ahead.

The drought will likely also act as an ongoing drag on growth with a “mild” El Nino hanging around although this may be modest at around a 0.2 percentage point growth detraction. The threats to global growth from trade wars also suggests downside risks to export growth.

The weakness in relation to the economy is clearly evident in soft profit results in the recent June half year profit reporting season. The ratio of upside surprise to downside was the weakest since 2009, only 58% of companies saw profits rise from a year ago and the proportion of companies raising or maintaining their dividends fell to the lowest since 2011 suggesting a lack of confidence. Earnings growth slowed to 1.3% and excluding resources stocks was around -2.4%.

Graph: Proportion of Australian companies seeing profits
Source: AMP Capital

Slow growth but probably not recession

Since last year our view has been less upbeat on growth than the consensus and notably the RBA. This remains the case as the housing construction cycle turns down and weighs on consumer spending. As a result, it’s hard to see much progress in reducing high combined levels of unemployment and underemployment, and hence wages growth and inflation are likely to remain low. But there remains a bunch of positives that should help the economy avoid a recession even though growth will remain weak for a while yet. Here are nine.

  • Rate cuts and tax cuts should provide some growth boost – while July retail sales were disappointing, the experience from the GFC stimulus payments is that the tax cuts will provide some lift to growth in the months ahead and various retailers have expressed optimism about this recently.
  • The threat of crashing property prices looks to be receding – while it’s so far been on low volumes, buyer interest has returned to the Sydney and Melbourne markets and we never saw the much-feared surge in non-performing loans or forced selling. This has helped remove the threat of a debilitating negative wealth effect on consumer spending.
  • Infrastructure spending is booming – recent state budgets saw the projected peak in infrastructure spending pushed out yet another year to 2020. And it’s likely states will seek to take even greater advantage of ultra-low long-term borrowing costs to further push out the peak in infrastructure spending.
  • The low $A is helping to support the economy – the $A is down 39% from its 2011 high and is likely to fall further and this provides a boost to Australian businesses that compete internationally by making them more competitive.
  • The business investment outlook is slowly improving – the big drag on growth as mining investment fell back to more normal levels as a share of GDP is over and mining investment plans are rising. This is driving some pick-up in the outlook for overall business investment.
Graph: Actual and expected capital expenditure
Source: ABS, AMP Capital
  • Australia has a current account surplus – the June quarter saw the first current account surplus since 1975. The slide since then in iron ore and coal prices suggests it may not be sustained, but the reasons for the improvement are more than just commodity prices so the deficit is likely to be well below the norm of recent decades going forward. What’s more there has been a significant improvement in our foreign liabilities with a less short-term debt and a growing net equity position. This all means that our reliance on foreign capital inflow has declined. So much for the boiling frog!
  • There is scope for extra fiscal stimulus – the Federal budget is nearly back in surplus and while we have had a long run of deficits our public finances are in good shape compared to the US, Europe and Japan. As a result, there is scope to provide more fiscal stimulus and this is probably more important than a narrow focus on the surplus.
  • Population growth remains strong – Australia’s population growth at around 1.6% pa remains strong. Of course, strong population growth is not without issues and in terms of living standards it is economic growth per person (or per capita) that matters. But solid population growth also has significant benefits in terms of supporting demand growth, preventing lingering oversupply and keeping the economy dynamic.
  • Finally, cyclical spending (consumer durables, housing and business investment) as a share of GDP remains low – suggesting that apart from bits of the housing market there’s not a lot of excess in the economy that needs to be unwound.
Graph: Australian cyclical spending is actually low
Source: Bloomberg, ABS, AMP Capital

Concluding comment

Our assessment remains that growth will remain soft and that the RBA will have to provide more stimulus – by taking the cash rate to around 0.5% and possibly consider unconventional monetary policy like quantitative easing. Ideally the latter should be combined with fiscal stimulus which would be fairer and more effective. While Australian growth is going through a rough patch with likely further to go, recession remains unlikely barring a significant global downturn.

There is one simple fact that makes all of this a silly parlour game. We’ve been in per capita recession for four quarters, growing just 0.1% over the entire year, and including two consecutive negative quarters. In short, we’ve been in recession for a year, right at the tail end of the global business cycle when it is supposed to be booming.

In the common tongue we are known as a “sitting duck” as the global cycle slides towards its end.

Comments

  1. “Recessions come along when there is a shock to the system (usually high interest rates), invariably at a time when the economy is vulnerable after a period of excess (such as rapid growth in spending, debt or inflation)”.
    – Maybe Shane should start reading up on Balance Sheet Recessions – Japan style. Maybe he should read Richard Koo’s book or watch him on YouTube. When people get scared of the size of their debts – they don’t consume or invest. They just pay the debt down as the CBA has just reported.

  2. While we are objectively in a per capita recession, I think that this is form over substance. The reality is that unemployment is low, bankruptcies are not happening left right and centre, and neither are mortgage foreclosures. Yes, incomes are stagnant for most, and there are issues like underemployment, but I think we need to get a grip here. I realise this site loves bear porn, and people here think that property is about to crash (for now just a temporary rise due to low volumes, right renting bears?) and all that jazz. But sooner or later we need to get real.

      • The Horrible Scott Morrison MP

        The next killer asteroid is coming. That is certain. It is just a matter of when. All those factors you mentioned make us more vulnerable when it hits.

    • Boom times ahead hey. What in gods name are you doing here on this waste of time corner of the internet, go out and get yourself some debt post haste. Plenty of properties to buy Davey, go out and snap yourself up a few.

      • I don’t think there’s an economic boom around the corner, but I think the evidence shows that we are at a time of escalating house prices (at least in Melbourne and Sydney). Not by some super-boom 20% a year amount, but like it or not prices are rising.

        • So, if we are not getting a new mega property boom, where do you think someone should put their money? What kind of property gains per year do you think is realistic and for how long?

          • One doesn’t need mega property rises to make money on real estate. Steady, modest growth (long-term) does the trick. It’s worked in the past for the most part, and it will likely work in the future (no guarantees), especially given population growth — and no, I’m not a fan of large population growth, but it is what it is. The reality is that land in the big capitals will become increasingly scarce. Not a fan of apartments.

    • ChristopherJMEMBER

      Most forecasters are starting to see recession as very possible as the indicators are mostly all there, Davey. Australia has ridden high on a trades and services economy. A lot of trades are going to see their wages gone or very much diminished, leaving quite a few households with insufficient income to pay debts and everyday expenses. The luxuries go first, then a cut back on what expenses can be cut. Credit cards are maxed meeting repayments…. All flows on to the services sector too, including retail, hospitality, businesses that supply materials to the trades.

      A lot more bank sales in my real estate paper, which is thicker than the news and classies, and I am informed anecdotally by banker that there would be more, but the banks don’t want to create panic so their foreclosures are a trickle, at the moment.

      Not many alive have even seen a good recession, let alone the depression that is coming. This government isn’t going to spend like billy o to replace the missing income and consumption in the private sector. They’ve hung themselves on a budget surplus, only hand out cheques to mates and don’t have the brains anyway to see what could be done to avert and contain the gdp shock coming.

      Disclaimer – economist

      • We’re on the bring of a mega recession with double digit unemployment? Maybe, but it’s a prediction without solid evidence. So it’s pretty unclear how it can be made so confidently. For the record, many persons here for many years have been predicting this and been getting it wrong — ditto with predictions regarding Melbourne & Sydney property falls — although at least with the latter there were falls, though now that falls have finished we can say that they were much more limited than predicted.

    • Why I don’t entirely agree is because according to Martin North (I hope I am correct here) the housing debt is held by 30% of all households. Which 30%? That is the big question.

      Why I do agree is if the debt and risks are evenly distributed across the households / workforce.

  3. The problem with analyses like this is the lazy resort to broad brush references that portray the opposite of what is happening.

    Whilst in theory strong population growth is a good thing for the economy, in our case the opposite is true today since:

    – the bulk of our migrants who come to work come from places like India, where there are heavy obligations to send money back to family (not spend it in the local economy)

    – the balance who do not work (elderly, refugees) only produce economic activity in the Government funded services sector i.e. recycling tax dollars with the enormous inefficiencies that that entails, never mind the fiscal hit

    – a not insignificant portion of migrants (maybe not the majority, I do not know) come from cultures where cheating the Government on whatever welfare it is dumb enough to hand out and not paying taxes is considered fair game. This is not to say that locals are not guilty of this – too many are. It is just that all round the average attitude of people is ‘what is in it for me / what can I get my hands on, not what can I contribute to the nation’. So if your concern is the economy, then you really need less people like this, not more. For any economy there is ‘good’ population growth and ‘bad’ population growth. For reasons just explained, Australia has too much of the latter. A subtle point but one that, it seems, is way over Shane’s head.

    – a very small number of migrants involve themselves in very serious crime. That very small number generate disproportionately high costs to the health and justice systems. Those services must be funded from tax dollars, which must be taken from the pockets of others who might otherwise spend them in the local economy.

    Needless to say, Shane Oliver doesn’t have the slightest clue about any of this, and why would he? His reach is limited to the quaint notion that population growth ‘keeps the economy dynamic’. I think the word you are looking for Shane is ‘vibrant’.

    • “– a very small number of migrants involve themselves in very serious crime. That very small number generate disproportionately high costs to the health and justice systems. Those services must be funded from tax dollars, which must be taken from the pockets of others who might otherwise spend them in the local economy.”

      Yes, and the majority of this very small number of immigrants (as far as Melbourne goes) is of African origin because despite Africa being 3.9 times the size of Australia, there just isn’t ANYWHERE ELSE in Africa to send these immigrants/refugees to.
      Instead, we willingly import human garbage.

    • I agree, Indians are cheap, they eat curries with little meat and lots of rice, they rarely eat out, they get paid crap but that’s our import model, good times.

  4. I have watched (from close on in) two public service selection exercises for non-ongoing (6 month, multiple positions) APS 2 (lowest you can go while being sentient) for base grade hauling files about a building in Geelong. Paying low 50s per annum.

    Hundreds of applicants, a disturbing number with single (or even double ) Masters degrees – which i dont think would be paid down for the salary on offer.

    The applicants divide up into two basic types. Type one is the 50+ years of age set. Often had a career making serious decisions, been made redundant, have often sold out of Melbourne and bought cheaper locally, and a low level gig is money for jam with no responsibility, living in vicarious semi retirement by the sea. Quite a lot of these people have nothing more than VCE and a few Cert IVs.

    The other subset is generally much younger – late 20s to mid 40s – who are often profoundly overqualified for the work (a disturbing number of dual masters – IT, Law, Science, Business/Commerce [I kid you not]). They have often been priced out of living in Melbourne (and a surprising number from Sydney). In some cases they are applying straight out of Uni , or never having used their quals while working for 2-10 years in hospitality or retail as casuals/temps. In a couple of situations they are applying for openly stated reasons such as ‘I will at least get entitlements/Super paid’. Often they have made a conscious decision that a low level grunting position is preferable to spending 2-4 hours a day in traffic trying to get to gigs in Melbourne. Some of these guys are parts of couples/families trying to support mortgages and or kids, and of the rest every man and woman jack of them is renting (and being taken to the cleaners) or living with parents. I have seen 3 people with obvious significant IT skills come away from service in the Navy and apply for this type of crud work, tell me ‘It’s all that is available’.

    No wonder wages are going nowhere, no wonder GDP is going nowhere. No wonder consumers arent spending.

    If this type of phenomena is happening on a broad enough scale in a broad enough number of places, the wonder I have is why there hasnt been a revolution yet – combined with wonder about just how ugly things will get if someone or something steps on the trigger.

    • We’ve seen similar things in Sydney for jobs we advertise (in IT). The number and over-qualification of many candidates is shocking.

      >”the wonder I have is why there hasnt been a revolution yet”
      Perhaps Australians are too lazy?
      Perhaps things aren’t bad enough yet?
      Perhaps Australians are too diverse in background and there is not enough of a community feeling to organise dissent?

    • Jeez.. This makes me nervous. I’m looking at leaving my dead end IT job for a while, taking a break and drawing down my savings then looking around for something else — but it does seem there’s a fair bit of competition out there for various roles.

      Even with a fair amount of savings, a willingness to cut costs (move into share accommodation, etc), I’m quite nervous. Not sure how those with a family and financial commitments are feeling..

    • The Horrible Scott Morrison MP

      50k seems overly generous for someone qualified only as an IT monkey. Smart people study marketing and property economics, and then take a masters in tax minimisation strategies (doing a capstone project on negative gearing).

    • reusachtigeMEMBER

      I love IT people. You can walk all over those fckers and they never complain (except behind your back, they’re good at that, but would never have the guts to mobilize… LOLOLOL)

    • I remember London during the GFC.
      There was a short listed line of 30 people standing in the cold at 5.00am applying to be a flower delivery van driver.
      Owner wanted to show what every day would be like hoping some would drop off.
      Everyone stood there with their uni degrees and portfolios begging for the 1 spot.

    • Quantitative Peopling (QP) will do such things.

      But our business leaders still keep claiming there is a major skills shortage that can only be relieved via more QP.

      The Lib/Labs/Greens are trying to stop locals from being able to afford the ability to achieve family formation in a way other than as indentured serfs. The fact that its reducing our capacity to sustainably grow and defend our nation does not bother them since they believe all labour/humanity is interchangeable at a frictionless rate.

  5. Sure. Lets all listen to the guy thats in charge of strategy at a company thats lots billions as people jump ship while their stock price is down 89% as they give a 7.25% dividend yield.

  6. “recession remains unlikely barring a significant global downturn”

    Kinda like saying a leak in my roof is unlikely barring a significant downpour. It’s a matter of when, not if

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