AUSTRALIAN ECONOMIC OUTLOOK Looking for Growth Against Strong Headwinds Dmitry Capel Investment Manager HOSTPLUS
TAA Regional Forum
DISCLAIMER The information in this presentation is general in nature and does not consider any of your objectives, financial situation or needs. Before acting on this information, you should consider obtaining advice from a licensed financial adviser and consider the appropriateness of this information, having regard to your particular investment needs, objectives and financial situation. You should obtain a copy of the HOSTPLUS Product Disclosure Statement and consider the information contained in the Statement before making any decision about whether to acquire an interest in HOSTPLUS. Issued by Host-Plus Pty Limited ABN 79 008 634 704, AFSL No. 244392, RSEL No. L0000093, RSE No. R1000054, MySuper No. 68657495890198. Information in this presentation was sourced from Bridgewater Associates.
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AUSTRALIAN ECONOMIC GROWTH
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Economic growth has been around potential for the past several years.
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The weakening commodity sector was offset by the acceleration by the rest of the economy due to RBA easing.
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Without a renewed round of easing it looks like it will be difficult for the economy to absorb the slowdown from the commodity sector.
DRIVERS OF ECONOMIC GROWTH
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Improvement in the rest of the Australian economy provided an offset to the slowing resource sector.
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The aggressive easing by the RBA reduced debt service payments and supported the housing sector, which in turn supported household wealth and spending.
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Much of that support is now past, and conditions are deteriorating in the noncommodity sector for the first time in several years.
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Domestic demand has slowed in the last few months as confidence weakened, and employment conditions are now worsening.
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Additional easing will likely be necessary to offset the resource sector slowdown and it will need to come through declines in rates.
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Despite large changes in the drivers of economic activity over the past several years, Australia has maintained relatively stable growth rates near potential.
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The current level of activity is roughly neutral as it has been for several years.
COMMODITY SECTOR CYCLE
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Conditions in the Australian commodity sector have reflected a pretty typical commodity cycle over the past decade.
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Rising commodity demand (from China) outpaced supply, which drove up prices.
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Increased profitability for commodity producers triggered investment to meet demand.
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We saw an investment boom in the resources industry - investment ramped up from 5% to 10% of GDP from 2010 to 2012.
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A combination of high prices and stronger production supported the economy, boosting commodity exports from 9% to 15% of GDP.
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Then the cycle started to roll over as global production outpaced demand for iron ore and prices started to fall, decreasing the attractiveness of further investment.
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Australia has already seen a material hit to growth and more is yet to come.
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Income from production remained relatively strong as new production coming online offset price declines, but recent price declines are substantial enough to overwhelm rises in production.
COMMODITY SECTOR INVESTMENT
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AUSTRALIAN COMMODITY EXPORTS (%GDP)
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IRON ORE PRODUCTION VERSUS PRICE
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AUSTRALIAN COMMODITY EXPORTS IMPACT ON GROWTH
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RBA RESPONDED BY DECREASING RATES
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The RBA responded to weak domestic conditions by decreasing rates from 4.75% in 2011 to 2.5% now.
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The bounce in economic conditions was supported by decreasing the cost to take on new debts, reducing existing debt service costs, and boosting asset prices.
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In particular, the easing jump-started the housing sector, supporting home prices and leading to improved household balance sheets and creditworthiness.
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The RBA has been on hold for roughly a year now, and the support from the past easing is starting to fade.
HOUSE PRICES AND HOUSEHOLD DEBT LEVELS
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RISKS ARE BETTER CONTROLLED
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With rates at 2.5%, the RBA still has room to decrease rates further to support the economy, but continued housing appreciation poses certain risks.
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The large proportion of variable-rate debt in Australia provides a mechanism to directly reduce household debt service costs.
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But the continued debt-fuelled appreciation in housing has caused debt levels for Australian households to continue to rise from already high levels to levels much higher than their developed peers.
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While debt levels are high, that doesn’t necessarily mean that there will be a housing crisis on par with that seen in the US and Spain.
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Australian lending standards are not as weak, with much lower loan-to-value ratios than in the US, tighter lending standards, and a greater ability on behalf of the banks to hold borrowers accountable to their debt.
EMPLOYMENT CONDITIONS
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Employment conditions give a good sense of how the current pressures on economic conditions are netting out for the household sector.
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While aggregate growth has remained near potential, employment has deteriorated significantly over the last several years, particularly recently.
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Employment weak in the commodity sector and strong in the housing sector.
WAGE GROWTH
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Weakening employment conditions have been a weight on household incomes for the last several years.
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However, recent stats indicate that spending has declined to the weakest level in several years. Confidence has similarly fallen. Both of these dynamics pose a risk of reinforcing the impact of slowing income growth from the soft labour markets.
CONSUMER CONFIDENCE
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It looks like it will be difficult to maintain the current pace of growth without a further decreasing rates.
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Downward pressures on the economy: – The turn of the commodity cycle; – Reduced government spending; – Weak domestic conditions outside of the housing sector.
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The easing of policy a few years ago by the RBA was critical to maintaining growth, particularly as many other supports to the Australian economy faded.
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With rates at 2.5% the RBA still has some room to continue to ease.
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So, there is pressure to decrease rates further over the next year.
