Has the Australian stockmarket just had a month of mayhem, or something more?


There’s nothing like losses to focus an investor’s mind.

ASX winners and losers – a snapshot


The unknown recession

Australia may have enjoyed more than 25 years without a recession, but as Peter Martin explains, it’s been a close run thing.

So as the 200 largest Australian listed companies shed $56.1 billion in market capitalisation over May, the warnings about the state of the local economy found some receptive ears.

It’s not unusual for sharemarkets to fall in May.

This is when dividends are paid and investors who have been hanging on will take that opportunity to cash out.

It is also summer in the northern hemisphere. Northern traders one way or another control most of the world’s money and this is when they take long holidays. This means they aren’t around to opportunistically snap up any declines, hence the saying, “sell in May and go away”.

It’s an axiom perhaps uttered often enough to leave most investors in a jittery frame of mind in the fifth month of the year.

But the S&P/ASX200’s 3.4 per cent decline, while by no means the largest in recent memory, seemed to signal something broader than a mere May selloff to a lot of Australia’s professional investment class.

The declines were for one unusual – Australia’s equity markets went backwards as most Asian markets soared, and as European and US markets hit record highs.

And on the ASX, the sectors to fall the most were ones unusually attuned to the broader growth of the Australian economy.

The big banks – which overwhelmingly rely on residential mortgages for their profits and account for over a quarter of the index by market capitalisation – fell steeply. None were spared as Commonwealth Bank of Australia (down 8.87 per cent in the month), Australia and New Zealand Banking Group (12.21 per cent), Westpac Banking Corp (10.39 per cent) and National Australia Bank (8.64 per cent).

It’s like when you ride a bike slowly. The more slowly you ride it, the more likely you are to topple.

Industry Super’s Stephen Anthony.

This is far larger than the impact of the federal government’s controversial 6 basis point levy on bank liabilities, which analysts have estimated could wipe 3 to 6 per cent off their profits.

In retail, the big names on the ASX300 shed, on average, 9.3 per cent, while several smaller names collapsed – declining retail spending finally biting into investor profits. Those particularly hammered included Myer (down 22 per cent over May), Automotive Holdings (down 21 per cent), Super Retail Group (down 18.5 per cent) and Harvey Norman (down 10 per cent).

And the big miners, who are closely tied to China’s fortunes and thus a key indicator of Australia’s export growth, mostly tread water, kept from recording strong gains by a plummeting iron ore price as well as a cyclone disrupting production in Queensland.

The markets and the broader economy are not always perfectly attuned in their performances. But the particular spread of losses in May points to something concerning for those worried about the strength of our particular market.

Australia, wrote a team of Morgan Stanley analysts last week, is “decoupling from global growth”.

This isn’t so much a sudden or dramatic event – more a slow downturn, as economic indicators head slowly south, recover somewhat, then head lower again.

“The unnerving feeling capturing client attention is that no real shock or inflection point is apparent, yet the risks continue to build and the downgrades continue to flow, with negative earnings revisions a returning feature,” Morgan Stanley equities strategist Chris Nicol wrote.

One fund manager, Altair Asset Management’s Philip Parker, went so far as to sensationally liquidate his Australian shareholdings and return the money to investors, proclaiming that the risks to trading in Australia are too grave due to a housing downturn, slowing growth from China, an overheated sharemarket and rising geopolitical tension.

The assessment was controversial, perhaps unsurprisingly: fund managers pride themselves on being able to beat the market, and charge hefty fees for trying, with varying levels of success, to do so.

But quietly, Australia’s professional investors are preparing for any adverse turn. Disclosures to clients show they’re beefing up the portion of their portfolios kept in cash, turning away from ASX heavyweights in favour of small-cap stocks less affected by the overall cycle, and those that can are increasingly looking offshore for investment opportunities. And Europe is the fashionable place to invest money these days, for the first time in a decade.

Riding a bike slowly

Illustration: Simon Bosch

Illustration: Simon Bosch

The Australian economy, stresses Industry Super economist and former Treasury forecaster Stephen Anthony, is still growing, but slowly.

Mr Anthony has in past years been one of the most accurate forecasters polled in the annual BusinessDay Scope surveys, which ask leading economists for their forecasts on a range of yearly economic indicators. At the start of this year, Mr Anthony was one of the most pessimistic.

He told BusinessDay this week that things were going about as he expected, or perhaps a little bit worse.

“The way I’ve been describing it the economy is, it’s like when you ride a bike slowly,” said Mr Anthony.

“The more slowly you ride it, the more likely you are to topple.”

He expects Australian economic growth to end the year under 2 per cent, which is below the government’s estimates. GDP shrunk in the September quarter of 2016 before rebounding strongly in the next three months.

Views on where it will go next are mostly positive, but one bank chief economist – NAB’s Alan Oster – believes there’s a small chance it may be negative in the first two quarters of 2017, which would plunge the economy into a technical recession.

This is largely, he argued on Thursday, because of the impact of Cyclone Debbie, which reduced coal exports dramatically at a time the economy couldn’t easily pick up extra growth elsewhere.

“While some of the contraction has undoubtedly been driven by the weather and other one-offs (as in Q3 last year), the question for next week will be whether the slowdown includes signal as well as noise, and implies a more fundamental economic slowdown,” Mr Oster wrotes in a note to clients.

Swimming our own race

To understand why Australia’s economy appears to be slowing, at a time of surging international growth particularly in the US, Europe and parts of Asia, it helps to go back to 2008, when the global financial crisis shook the world’s major developed economies.

At the time, the Australian economy was in rude health. It had favourable terms of trade, low unemployment, strong GDP growth. Asset prices fell, as they did around the world, but for the most part, they recovered.

This had a lot to do with China, said Mr Anthony.

“What made Australia unusual was that the Chinese decided to use the lower commodity prices as an opportunity for restocking. Australian producers just sailed on the back of that.

“We got lucky. We had a slow pause, but growth recovered. And then, all of a sudden, terms of trade recovered around the world, and peaked towards the end of 2011. And we were still sending incredible volumes overseas. Since then, we’ve faced largely declining terms of trade.

“With China slowing, the terms of trade windfall we had from mid-last-year onwards likely to subside again.

“We no longer are flavour of the month in terms of our exports. We’re not getting windfall price gains. We haven’t done any reform, effectively since 2000. We’re not particularly working hard, or innovating. And we’ve got an ageing population.”

Professional investors have been increasingly factoring in risk to their portfolios, particularly around retail, which was one of the worst-hit sectors in May’s sharemarket rout.

Companies exposed to the property market are also being downgraded as debate rages about the presence or otherwise of a housing bubble and whether a crash looms.

Institutional investment fund JCP Investment Partners, based in Melbourne, said high-risk mortgage loans to over-extended borrowers could constitute “Australia’s sub-prime”, a reference to a similar phenomenon that kicked off the financial crisis in the US.

If some of these loans went sour, the Melbourne-based fund warned, it could wipe 20 per cent off the bank’s major equity base.

Even companies you wouldn’t expect to be closely tied to real estate are being re-evaluated for higher risk. For example, analysts at Citi downgraded SEEK this week over fears the end of the housing construction boom could lead to fewer blue-collar jobs being advertised.

Aside from housing construction, the strong property price growth is another risk to the Australian economy, one international observers are increasingly focussing on.

Australia has a “spectacular housing bubble” waiting to pop, Citi’s chief economist Willem Buiter declared in Sydney over the week.

“That mess was never cleaned up and in fact you have added to it,” he said.

Australian regulators have begun to act, with APRA imposing limits on no-interest mortgages.

These seem to be having some effect – house prices declined 1.3 per cent in Sydney and 1.8 per cent in Melbourne in May, CoreLogic figures released this past week showed.

But were house prices to fall, it would likely only add to the uneasiness caused by low wage growth. Two-thirds of Australians own residential property, with around half of those still paying off a mortgage.

The bulls and the bears

Not everyone agrees there’s much to be disgruntled about with the state of the Australian economy.

Even those measuring consumer sentiment – one of the most dour indicators – point to an odd duality beneath the headline figures.

Broker CSLA, in a biannual gauge of consumer sentiment based on a qualitative survey of 1400 Australians, pointed to the lack of a single conclusion from its figures.

“Consumers are both spending and saving; both sanguine and ‘bone-rattling’ petrified. Surging house prices have created a euphoric ‘wealth effect’ that is seeing consumers contemplate greater spending, while at the same time, disposable incomes are falling, with spending funded out of savings achieved elsewhere.

“Beneath the surface lurks uncertainty, even fear. Being careful with money is the main sentiment.”

Consumer spending makes up more than half of GDP, which is why it tends to be central to discussions of broader economic conditions.

But outside the consumer sector, business confidence is very strong. The unemployment rate is nowhere near the levels typically seen in recessions. And in a surprising result well above economist’s expectations on Thursday, ABS data showed retail sales grew 1.0 per cent in April – after falling in three of the previous four months.

ANZ senior economist Felicity Emmett said there was “no consistency across different indicators to suggest a broad-based loss of momentum across the economy,” she says, a factor that makes her wary of bold predictions.

“The economy doesn’t really feel like it’s deteriorating quickly. You look at the business surveys, and they suggest that business conditions, trading conditions, and profitability are still really quite strong.

“We have seen quite a slide in consumer confidence. From our perspective, we see that as a realisation by consumers that low wage growth is here to stay. And that’s quite difficult for the household sector when they have very high levels of debt. In terms of the atmospherics, the business surveys do suggest things are quite positive, but the decline in consumer spending is quite worrying.”

Another factor stopping many economists from expecting the worst is the greater and greater share of household spending in the services sector.

Between 1986 and 2013, according to the RBA, the proportion of household spending spent on services surged from half to two-thirds of total household spending. But unlike retail trade, there are few concrete measures of spending on services.

One of the ways economists gauge how the sector is doing is by looking at employment growth in things like healthcare, education, hospitality and entertainment.

“When you look at the employment figures, you see strong growth,” said Westpac senior economist Michael Workman.

“We know that households have got income growth – it’s not that flat. The money’s obviously going somewhere. It’s not going into retail the way it used to, and you can see that with the plight of retailers.”

But maybe consumers are still spending, just elsewhere.

This coming Wednesday will see the release of the GDP figures for the first quarter of 2017. Most expect a small but positive figure, which if delivered would go some way to reassuring the bears that things aren’t as bad as they seem.

But until the economy manages to do more than slowly pedal along, the risks remain.

“If you combine with record household indebtedness, combine that with public indebtedness that is rising, and at this stage, uncontrolled, and if you combine with risks in the banking sector, then you’ve got enough tinder there to start a nice big fire,” said Mr Anthony.

“So what you don’t want then is some sort of fuse.”

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