Market movements - April 2008

The investment market update

Last month we spoke about the risk of a recession in the US. Well, things move quickly in the financial world and one month can be an awfully long time.

Long enough in fact that the dreaded 'r' word has managed to weave its way to our shores and onto the lips of some of our economists – albeit only as a possibility at this stage.

A recession in Australia? Such a suggestion - even the possibility of one - would have been laughed at a mere six months ago. But if one month is an awfully long time, six months is virtually an eternity, and no one's laughing now.

Technically, recession is defined as two or more consecutive quarters of negative economic growth. What this means in practice is rising unemployment, slowing spending, falling profits, and an increase in bankruptcies. Australia's last recessions were in 1990, 1982, and 1974. ¹

A visible sign of recession is falling asset values, though these can follow or precede a recession. For example, sharemarkets tend to be forward-looking, and with a 25 per cent decline in the value of the Australian sharemarket over recent months, it's a clear statement that tougher conditions (though not necessarily recessionary conditions) for corporate profits have been flagged.

Worryingly, recent consumer and business sentiment surveys have fallen sharply. As lead indicators, these survey results may flag a future slowdown in the economy. While a slowdown is not, under ordinary circumstances, particularly troubling, it is concerning that households are now holding much higher levels of debt as a proportion of total disposable income, than at any time over the past 20 years (45 per cent in 1988 compared to 160 per cent in 2008).²

1 Reserve Bank of Australia (RBA), Speech-Global Influences on the Australian Economy, 2005,
2 Reuters Ecowin, ABS, RBA, nabCapital calculations

One conclusion you could draw from this is that Australians are now more vulnerable to a sustained rise in unemployment. To make matters worse, house prices in Australia are at historically high levels, and concerns are spreading that a decline in property values (as has been experienced in the US, UK and other developed countries) could be replicated here.

But it's not all doom and gloom.

On the positive side, Australia is experiencing its most favourable terms of trade position for more than 50 years. The terms of trade is a measure of the price we receive for our exports relative to the price we pay for our imports. This has been boosted by 44 per cent over just the past five years due to the rapid development of Asian economies, most notably China.

In addition, the unemployment rate is currently at 30-year lows of just 4.1 per cent, a sign of an economy that has been growing - and growing strongly - for the past 17 years.

For what it's worth, the Reserve Bank of Australia (RBA) Governor, Glenn Stevens, indicated at a recent Parliamentary economic committee hearing that he did not expect the economy to fall into recession 'any time soon'.

Dr David Gruen, the Government's chief economic forecaster, supported this view in a recent speech to the Australian Business Economists on 4th April, 2008, indicating that it is within policymaker's abilities to keep inflation in check without crunching the economy, by exercising 'careful judgement'. Dr Gruen pointed out that policymakers had successfully engineered 'soft landings' in Australia on previous occasions (notably in 1994 and 2001) without it leading into recession.

Will the Australian economy slow down? There is much uncertainty surrounding this question, but some believe that it is quite likely. In fact, some commentators have suggested that the RBA intend to engineer a moderate slowdown so as to restrain inflation. If this is successful, it will hopefully place the economy on a more sustainable footing for future economic growth. This should in theory bode well for investment markets in the longer term.

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