The key ingredient for a deep Australian recession is missing, but it’s not gone away
Australia is close to recession.
Gross domestic product (GDP) for the March quarter grew at 0.1 per cent.
Surprising strength in the household sector and increased government spending hauled the economy over the first quarter finishing line.
Being on the edge of a recession is concerning because extended periods of economic contraction are nothing short of brutal.
Technical recessions — defined as two consecutive quarters of negative economic growth — are associated with surging unemployment and plummeting asset values (including property and shares).
In some cases, superannuation nest eggs can be wiped out, pushing retirees from a comfortable retirement to one reliant on government subsidies.
While the Australian economy is clearly weak, Reserve Bank and Treasury forecasts have economic growth accelerating later this year.
So, that’s that, then.
Not quite, and I’ll explain why.
Households are the key
The Australian economy is in a funk.
The pandemic, and the supply constraints and stimulus that came with it, produced higher inflation.
The Reserve Bank responded with tighter monetary policy (higher interest rates) and the federal government with spending “restraint”.
The business community has since shown some resilience but pulled back in the first three months of this year with private investment falling by 0.8 per cent, “driven by a decline of 4.3 per cent in non-dwelling investment”, the ABS noted Wednesday.
Australia is also importing more than it’s exporting, which is a negative for economic growth.
It’s the household sector that’s shown unexpected strength, expanding by 0.4 per cent in the quarter, helped by consumers saving less and, in some cases, dipping into their savings to help pay for essentials.
And this is where we hit a key point.
Federal government tax cuts, energy rebates, and real wage growth (helped by an increase in the minimum wage by Fair Work), will provide households will the support they’ll likely need to, well, keep spending on essentials.
It’s hoped by the end of the year inflation will have further subsided and the Reserve Bank will be able to ease monetary policy, freeing up households to spend further.
You can see why few, if any economists, are forecasting a recession.
But an obvious threat is missing from the commentary.
Enter the financial markets panic
The Great Depression was preceded by the 1929 Wall Street crash.
Australia’s 1991 recession was preceded by the October 19, 1987, stock market crash — known as Black Monday.
The economy was running well in 1987, growing at 2.6 per cent per annum.
But in the years prior, too much money flooded into the stock market.
Is there too much flowing into financial markets today?
The ASX200 Financial Sector is up 10 per cent over the past 12 months.
It’s also up more than 12 per cent in 2024, “confounding the analyst community, which overwhelmingly have ‘sell’ or ‘underweight’ calls on the big banks”, according to IG’s Tony Sycamore.
Westpac Bank’s stock price is up 17.3 per in the year to date.
The US stock market also continues to simmer around boiling point.
Wall Street hit its 25th record high for the year this week.
AI chip maker Nvidia also took over Apple as the world’s second-most valuable company, worth $US3.01 trillion.
But analysts seem unphased by all of this.
“The number of [stock market] record highs doesn’t really matter,” stock market newsletter founder Marcus Padley says.
And he’s not concerned about the stratospheric rise in Nvidia’s valutation.
“The price earnings ratio of Nvidia is actually lower now than it was a year ago because earnings forecasts have outstripped the share price,” he says.
Padley says global financial markets, including Australia’s stock market, are not showing signs of any mania.
“The reason the dam breaks is because there’s a build-up of pressure over a long period of time,” he says.
“For our market to be a 1987-type of problem, you would need a pre-1987 build-up, which happened in 1985 and 1986, and we certainly haven’t had that at this point.”
For example, from the low in July 1986 to the peak in September 1987, the Australian All Ordinaries index went up 110 per cent.
Compare that to today when the All Ordinaries is up 12.3 per cent from a year ago.
Padley argues the market’s recent rise has been orderly.
“The big tops and the big bottoms — they have different elements every time,” he says.
“And you just have to be aware about what the market’s obsessing over at those particular points.
“At the moment we’re obsessing about inflation, interest rates and big tech earnings … all the indicators are quite benign. The bull market seems set.”
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Let’s not be caught off guard
It all sounds very positive, but the mood, for want of a better word, is often positive before a major financial markets collapse.
That’s the point.
Investors are taken off guard and panic when sell-orders skyrocket.
“You have Goldman Sachs saying there is a wall of money that is going to, say, a three-to five-year bull market,” Padley says.
“That’s the sort of thing people say at the top.”
The question then becomes: what happens if the stock markets does fall over?
Veteran economist Alan Oster says it’s not actually the financial markets chaos that brings about a recession, it’s the knee-jerk policy responses that often come with it.
The 1987 policy response was swift but, arguably, also led to the 1991 Australian recession, where the economy contracted 0.4 per cent.
“So what happened then was central banks cut their [interest] rates because they were worried that 1987 [economic growth] was going to be awful and then the economy recovered and of course they increased interest rates,” Oster says.
“And [interest rates] went basically from something like 13 per cent to 18 per cent.”
Again though, Australian corporations were highly leveraged in the late 1980s, which caused widespread insolvencies.
That’s not an issue today, and investors also have plenty of spare cash to buy companies with strong earnings, according to FNArena’s Danielle Ecuyer.
She says she’s not “nervous” about the prospect of a financial markets crash, but she is on the alert for volatility.
The reaction will be the real test
To that end, we still haven’t solved the problem of an unexpected, and dramatic, shift in market sentiment.
The last time we experienced anything like a financial markets contagion was the 2023 United States banking crisis.
Over the course of five days in March 2023, three small-to-mid-sized US banks failed.
This was arrested by swift and sizeable central bank intervention.
But, as Padley points out, central banks cannot rescue entire markets.
“Sentiment,” he says, is “very volatile”.
“You can’t time the market on fundamentals. You just wait for sentiment to change, and then react.”
And it’s that reaction that determines how deep any financial markets correction becomes.
Australians have $3.5 trillion tied up in superannuation, so any stock market crash would swiftly end the retirement plans of hundreds of thousands of Australians.
It’s also many of those households holding up demand in the economy.
A sudden drop in demand would then bring about a surge in unemployment and therefore a recession.
The data shows there’s no cause for economic alarm right now.
The problem is that, often, the data’s not showing us the real threat.
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