Investment markets

The forces that may impact a recovery

The Australian stock market extended its winning streak to five consecutive months in July, with the ASX-200 now around 40 per cent above its March low. Stronger than expected economic data and operating profit margin expansion in recent months has helped push the market to levels not seen since early November 2008. The question that all market commentators are now asking is whether the recovery in equity markets we have seen this year is sustainable? Is this simply a bear market rally or a recovery with the legs to overcome any hurdles we will undoubtedly encounter in the short to medium-term? Currently, experts’ opinions are diverse; however their respective rationale can be equally compelling. So who should we believe? In analysing where we’re at, a useful way of assessing this conundrum is to look at both the headwinds; or forces that will limit a recovery, and tailwinds; or forces that will promote growth in our economy. Understanding the forces that are at play is the first step to making a judgment on how the economy is tracking.

Government intervention

In terms of a tailwind, there has been unprecedented action that has been taken by governments around the world to curb the size and length of the recession. Government handouts, tax cuts and lower interest rates have provided a sizeable boost to consumer income.

Importantly, a large proportion of households have variable mortgages which have ensured a rapid pass-through of stimulus. Further, households are benefiting from a significant improvement in their wealth with house prices increasing and their investments recently regaining some of the lost ground. Given that investments (super and non-super) and housing account for about 82 per cent of total household wealth, this growth could potentially provide some strong support for spending.¹

On the other hand however, the boost to income from federal government handouts is beginning to fade. There is no doubt that the government stimulus supported demand, with retail turnover soaring by 6.7 per cent since it bottomed last September.² However, the most recent retail spending figures in June suggest that households are already cutting back on their spending.

Consumer saving rates

These headwinds are already being felt, with household saving rates increasing considerably over the last 12 months. As households rebuild their balance sheets and for many de-leverage, the Government is predicting savings rates to remain at a high level over this financial year. Then there is still the fear of becoming unemployed, and the need to save that little bit more ‘just in case’.

For consumers that do want to spend, there is the potential difficulty of attaining credit as banks become more prudent in whom they lend money to. Whilst also reflective of the demand for credit, personal credit levels fell for a 13^th consecutive month in June.

How businesses are fairing

Another headwind that could potentially inhibit economic growth is the caution being shown by companies. Business fixed investment such as equipment and software has declined sharply, accounting for a little over half of the drop in Gross Domestic Product (GPD) to March; a large proportion given it only accounts for around 10 per cent of the total level of GDP. Companies are being forced to cut expenses and right now are more focused on getting through this crisis with as few wounds as possible. This therefore leaves little in the tank to spend on growth, research and development activities. Although ensuring their immediate survival, this could potentially inhibit future growth for these companies.

A potential tailwind for the economy and markets alike is that, despite company’s troubles, business confidence is increasing. The National Australia Bank (NAB) July Business Survey revealed that businesses are currently more confident about the economy than they were two years ago before the crisis hit. And businesses with positive outlooks on the economy mean a decreased chance of significant job losses.

Consumer confidence

Another potential tailwind is the record surge in consumer confidence, with the Westpac-Melbourne Institute consumer sentiment index also soaring to two-year highs, following its biggest three month gain in the survey’s 34-year history to August. This large and sustained rise is another very strong signal on the positive momentum in the Australian economy and as the mood of business also improves, it seems that confidence in a recovery is building.

Admittedly this is on the back of government handouts, the enhanced first home owners grant and almost a self-reinforcing cycle of positive economic news received recently, so market experts warn that it may be too early for optimism.

Impact of trading partners

One hot topic of late that has seen no shortage of positive news is the China story. Underpinned by a huge infrastructure-led government fiscal stimulus package, China continues to defy the economic downturn and delivered GDP growth in June of 7.9 per cent year on year. Continual growth in China, especially given its resource and materials bias, would be a tailwind for the Australian economy given these two sectors account for over a third of the Australian stock market (by market capitalisation).

Whilst China, our second largest trading partner, continues to grow and offer support for local exporters, a number of our other trading partners are not. Our exports have not responded yet to the collapse in growth of our major trading partners, which provides a future headwind for domestic growth.

Japan was in the midst of their worst recession since World War II earlier this year, with real GDP down by 9.7 per cent over the year to March 2009. Although their economy appears to have rebounded strongly since, a robust recovery may prove elusive with a worsening job market and persistent price falls. This is bad news for the Australian economy given Japan remains Australia’s largest export market, accounting for 24 per cent of our exports.³ When the respective decelerating growth of our other major trading partners: UK, USA, Europe and New Zealand, is considered, it highlights the extent of the headwinds that may potentially be encountered.

Enlisting help from an expert

If you would like to seek advice from an expert in light of the current economic landscape, why not consider enlisting the help of an expert through Momentum Financial Advice. This service offers an initial consultation with a qualified financial adviser, at no cost to you.⁴ You can either discuss your situation over the phone or attend a face-to-face appointment.

For more information on the Momentum Financial Advice service, contact a Member Services Consultant on 1300 55 7586 who can put you in touch with an adviser directly.

¹ Reserve Bank of Australia Bulletin – April 2009, www.rba.gov.au
² Australian Bureau of Statistics – September 2008 to June 2009, turnover has increase by 6.7%
³ ABS, NAB Market Economics
⁴ The financial planning service is delivered by GWM Adviser Services Limited (GWMAS) ABN 96 002 071 749 AFSL 230692. Plum, the Trustee and GWMAS are part of the National Australia Group of companies and do not accept any responsibility or liability whatsoever in relation to any decision made on the basis of this information.