Australia 'on verge of recession'
By David Uren
March 10, 2008 03:21am
- Looming economic downturn predicted
- Home and share markets to plummet
- China's growth won't insulate Australia
THE economy is headed for recession next year, with a 50 per cent plunge in share values and a double-digit drop in house prices - that's what one analyst says.
While the Reserve Bank takes a largely benign view of the unfolding credit crisis, believing China's growth will insulate us from its worst consequences, others are less sanguine.
Morgan Stanley's chief market strategist Gerard Minack introduced a brief to clients last week saying: "I'm bearish - really bearish."
He argues that Australia will be dragged into recession by a slowing world economy, the tightening grip of the credit crisis, and the effects of the Reserve Bank's succession of interest rate hikes.
Economists are often trapped by the inertia of the moment, failing to see the magnitude of both booms and busts and being forced into constant revisions of their forecasts.
This makes Minack, who takes a long view, worth listening to.
He argues that the market is coming to the end of its fifth bull run since the beginning of the 20th century.
The bear markets that followed produced falls in the region of 50 per cent and lasted for two to three years.
The problem is not that the market is overvalued, relative to earnings, but rather that earnings are themselves inflated and headed for a fall.
Based on profit figures back to 1970, earnings are 44 per cent above their long-term trend.
In the three recessions since then, real earnings per share fell by between 36 and 65 per cent from peak to trough.
"You've got to argue that earnings do revert to their mean. On almost every measure we've got for earnings, be it profit share of GDP, return on assets or margins, it looks unsustainable," he says.
Earnings have been inflated by spendthrift households running down their savings. While the Reserve Bank has argued that fears about housing debt are without foundation because household balance sheets are strong, Minack says the picture looks a lot worse when you look instead at household cash flow.
The latest annual national accounts show the household sector remains cashflow negative, with the deficit of 3.75 per cent of GDP accounting for half the current - account deficit.
Besides, he says, household balance sheets also looked fantastic in Japan in 1990, before its lost a decade of economic growth.
Minack is not persuaded by the proposition that Australia's housing market is somehow immune from the excesses of the US.
Australians have more leverage, are as reliant upon equity extraction and base their household balance sheet on a housing stock that is far more expensive than their US equivalents.
The household sector is booming at present, but is vulnerable to any reversal in fortune. The moment unemployment starts to rise, people will start defaulting on their housing loans.
The view that Australia will be saved by China and the resources boom underestimates the magnitude of the forces ranged against us.
China's growth may continue to require large flows of commodities, but commodity markets at present are being driven by speculative money that can flee as quickly as it came.
Base metals prices could fall by 40 per cent and bulk commodities by 15 per cent without heralding the end of the Chinese driven "super-cycle".
Commodity markets are facing not only the prospect of a recession in the US, but also the possibility of recessions in Japan and Britain, with a slowdown in Europe.
The long-awaited rise in the volume of mining exports will not save us, with Minack calculating it will raise GDP by, at most, 0.1 or 0.2 percentage points.
The terms of trade, by contrast, has lifted GDP by about 9 per cent, while the increase in business investment caused by the resources boom has added about 3.5 percentage points.
"People react as though there is some injustice. Here we are with the market down 20 per cent, when our economy looks strong and China keeps growing," he said.
"People miss the point that we're hugely wrapped up in the global credit crunch because we are one of the world's largest issuers of capital, with the most over-priced finance sector in the developed world and a rickety housing sector.
"People think we're Teflon coated because of links to China. I don't think that's true."
The point of listening to bears is that they have taken hold of the markets.
Minack says if you took the spreads on credit-default swaps literally, you would be forecasting financial Armageddon. Based on the latest benchmarks for default spreads, 7.8 per cent of investment grade corporate debt in the US is expected to default, more than double the worst actual default rate in the last 40 years.
Credit markets do not expect Australia to remain immune, with default spreads on corporations here rising in line with those in Europe and the US.
Markets overshoot - and Minack believes they have - but he is not convinced they have yet reached their bottom.
It reverses the overshoot when margins were so unrealistically low that investors took on huge leverage so that they could make a return. The point about the panic in credit markets is that it affects the real economy.
"That's why there's no point in asking whether the credit markets or the equity markets have it right," he said.
"Dislocation in credit markets puts a cloud over the economy and over equity."
It is an unfriendly environment for one of the world's largest debtor economies.
Reality ... Investors in the big banks are being hit hard by the credit crunch
AUSTRALIAN shares hit a fresh 2008 low today after bleak US jobs data added to mounting evidence that the US was in a recession, while local banks have plunged on the global financial crisis.
The benchmark S&P/ASX 200 index had fallen 82.7 points to 5181.3 by 12.13pm AEDT, down 1.6 per cent.
In early trade, the benchmark S&P/ASX 200 index fell 99.4 points to 5164.6, its lowest since October 2006 and adding to a 3.2 per cent fall on Friday.
The previous 2008 low of 5186.8 was set on January 22.
All the banks were lower at 12.15pm AEDT, plunging to shock new low levels.
By 2.25pm AEDT, Commonwealth had dropped 75 cents or almost 2 per cent to $38.60, ANZ was down 3 per cent or 60 cents to $19.66, National Australia Bank had lost 55 cents to $26.38 or 2 per cent and Westpac had shed 42 cents to $20.72 or 2 per cent.
At 2.36pm, AEDT Macquarie Group , Australia's biggest investment bank, fell 0.5 per cent to $45.22, after rising as much as 2.4 per cent in early trade.
Survey: Have you been hurt by rising rates? US crisis leads sell-offMore poor US economic data on Friday, this time from a grim jobs report, saw US stock markets fall to their lowest in 19 months.
US employers cut 63,000 non-farm jobs in February, the steepest fall in nearly five years, after having eliminated a revised 22,000 in January. Wall Street economists had forecast 25,000 positions were added in February.
The Australian dollar has also been dumped on financial markets
By 9.34am AEDT, the Aussie was quoted at $US0.9271/74, down from $US0.9288 here late on Friday. It had fallen to a low of 0.9247 in offshore trade as high yeilding currencies and riskier assets were dumped by investors.
Losses across board
At 12 noon, mining giant BHP Billiton had dropped $1.13 to $37.75 while the company it wants to buy, Rio Tinto, jettisoned $3.42 to $127.78.
Elsewhere, in the resources sector, energy stocks were lower with Woodside Petroleum off 38 cents at $56.12, Oil Search down six cents at $4.29 and Santos down four cents at $12.36.
By 12.18pm AEDT, Woolworths was 71 cents lower at $27.99 and the owner of Coles, Wesfarmers, had shed 61 cents to $37.11. David Jones fell 19 cents, or 4.99 per cent, to $3.62.
News Corporation lost lost 30 cents to $19.95, its non-voting scrip shed 17 cents to $19.38 and Consolidated Media declined eight cents to $3.79.
Telstra lost eleven cents to $4.26 and Qantas also lost eleven cents to $3.92.
By 2.38pm AEDT, Babcock & Brown was up 2 cents to $13.98 after falling as much as 7.6 per cent in early trade.
The investment bank and asset manager said it had retired over $250 million of short-term margin loans and has received commitments to refinance all other outstanding margin loans. It also reaffirmed its 2008 group net profit forecast of $750 million.
With Reuters and AAP
