Despite numerous forecasts for a recession following the end of the mining boom, the Australian economy has continued to grow. However, recently it seems to have hit a rough patch.
Cyclone Debbie and its aftermath disrupted housing construction and trade in the March-quarter and the weather impact on trade will worsen – as indicated by a 45% collapse in coal exports in April.
Overall, March-quarter growth was just 0.3% quarter-on-quarter and annual growth slowed to 1.7% year-on-year, its slowest since the global financial crisis (GFC). But it’s still growing!
- Consumer spending and confidence is constrained by record low wages growth and high levels of underemployment.
- A slowing housing cycle, with a downtrend in housing construction activity and a likely peak in Sydney and Melbourne property price growth under the weight of bank rate hikes, tighter lending standards, rising supply and poor affordability.
- But then there are some positives supporting growth. First up, the drag from falling mining investment is close to the bottom: While mining investment is still falling rapidly, currently around 2% of GDP, its weight in the economy has collapsed, reducing its drag on growth to around 0.5% for the year ahead.
- Public infrastructure investment is strong, up 9.5% over the last year, in response to state infrastructure spending, financed in large part from the privatisation of existing public assets. This is particularly the case in NSW and Victoria.
- Trade is expected to contribute to growth, as the impact of Cyclone Debbie fades and coal export volumes rebound, resource projects for gas finish and services exports continue to strengthen.
Will the Reserve Bank cut rates?
The chance of an interest rate hike in the next 12 months is very low, whereas the probability of another rate cut is around 40% or so. But with the Reserve Bank of Australia (RBA) remaining reluctant to cut rates again, our best case is for rates to be on hold.
Key things to watch include a softening in jobs data; continued weak consumer spending; another downwards revision in RBA growth and inflation forecasts; significant cooling in the Sydney and Melbourne property markets; and the Australian dollar remaining relatively resilient.
Tips for investors
In the current market environment, Australian-based investors could consider:
- Global over Australian shares: While US and global share indices have hit new record highs, Australian shares remain well below their pre-GFC peak. In fact, Australian shares have been underperforming global shares since October 2009. This reflects higher interest rates and no money printing in Australia, the commodity slump, the lagged impact of the rise in the Australian dollar above parity in 2010, which reduced our global competitiveness. And the fact that our share market had a boom last decade, reaching a much higher peak than US and global shares did just prior to the GFC. We’ll likely see the ASX200 trending higher by year-end, but global shares are still likely to do better.
- Exposure to foreign currency: A simple way to maintain a decent exposure to foreign currency is to leave a proportion of global shares unhedged. Historically, the Australian dollar has tended to fall against the US dollar when interest rates in Australia are falling relative to the US. With the US Federal Reserve likely to continue (gradually) raising rates and the RBA on hold or potentially cutting rates again, there is downside risk for the Australian dollar.
- Commercial property, infrastructure investments and shares offering decent sustainable yield: The return on bank deposits will likely remain depressed, so it makes sense to consider alternatives offering decent sustainable income flows, while at the same time allowing for the greater risk of volatility in the underlying capital value that comes with such investments.
Annual Australian growth slowed to 1.7% in the March quarter, hit by bad weather and weak consumer spending. A declining drag from falling mining investment, strong public infrastructure spending and a likely renewal of trade contributing to growth, should all help keep Australia out of recession.
However, soft consumer spending and a slowing in the housing cycle will act to hamper growth compared to relatively optimistic government forecasts. So there is far more chance of another RBA rate cut than a hike over the next year. Australian shares will likely be higher by year-end, but global shares are likely to continue to outperform.
For more on the new financial year outlook from Dr Shane Oliver, watch this video:
The current pullback in shares has been triggered by a range of things and there may be more downside. Shane Oliver explains what investors should keep in mind.