It’s official. The Reserve Bank of Australia said yesterday that the Aussie economy would enter recession in 2009. “There are limits on how much we can insulate ourselves from what is happening abroad, and therefore there are probably still some difficult times ahead,” said Deputy Governor Ric Battelino. Two months ago, the RBA reckoned GDP would expand by 0.25% this year.
What’s changed? Well for one, rising layoffs are having an effect on the real economy. Today’s papers report that mortgage delinquencies are on the rise. Delinquencies on full-documentation loans are still relatively low. Just 1.75% of full-doc loans are more than thirty days past due, according to a story in the Sydney Morning Herald.
It’s the non-conforming, low doc, dare we say subprime-esque loans that are even more delinquent. Nearly twenty percent of low-doc non-conforming loans are more than thirty days past due according to ratings agency Fitch. Fitch says that lower rates haven’t helped folks with non-conforming low-doc loans because borrowers can’t refinance now that most of the non-traditional non-bank lenders who were making the loans a few years ago have vanished in the credit crunch or been swallowed up by the Big Four.
“Fitch expects delinquencies to deteriorate further during the March quarter and a gulf to develop throughout 2009 between struggling borrowers and those feeling relief from the Reserve Bank of Australia’s five interest rate cuts since September. The key factor will be each borrower’s ability to retain full employment during the economic downturn, Fitch said.”
What else had changed that would cause the RBA to revise its forecast? GDP growth for Australian trading partners has fallen off a cliff. Fourth quarter GDP figures in Japan showed in contracting at a 12.1% annual pace (easily making it the Biggest Loser). American GDP shrank by 6.3% in Q4. Overnight we learned that house prices in the United States have fallen 29% from their peak and 19% in the last twelve months alone, according to the Case-Shiller index, which measures house prices in twenty U.S. cities.
Of course this could get worse later this year if the Option ARM problem we wrote about recently gets worse. The entire current round of stimuli and bailouts assumes no further deterioration in bank loan books. That’s a big assumption. The only good news was that Chinese GDP expanded by 6.8% in Q4, although as the chart below shows that’s a lot lower than the heady days of 2007, when GDP grew by an almost unbelievable 14%.
But March wasn’t all bad, was it? Did you see that the ASX Small Ordinaries had its best month in sixteen years in March? By yesterday’s close the ASX Small Ordinaries was up nearly 10% for the month. It hasn’t had a big month out like that since December of 1993. The chart below tells the tale.
Small Caps Rally
The energy sub sector of the small caps was the big star in March, up 26.01%. Financials stormed home second, with a 25.29% gain. What a contrast though! Small cap rallies almost always lead broader rallies in the market. And rallies in the market tend to lead recoveries in the economy. Kris Sayce has more on why this is the case in his essay.
We’re not prepared to say that one month of good small cap returns heralds a reversal of the major trend in the market. But if you’re a punter, it certainly has been good news. And we have always had a soft spot in our heart (and perhaps our head) for the small cap market. It’s the small businessmen who lead economies out of recessions by taking risks. This is why the entrepreneur and not the capitalist is the real protagonist of Austrian Economics.
You wouldn’t think the best way to beat a recession is to take more risk. But entrepreneurs take advantage of the lack of competition in recessions to find long-term customers. What’s more, you have to be a low-cost producer of anything to make it in a recession. And you have to do better with capital than competing firms or investors punish you.
It also depends on the kind of risk you’re taking. There are some risks inherent to some businesses, while other risks are more general. Some businesses are more like tightropes and some are more like the trapeze. Small cap finance? Tightrope walking with no net. You might make some money. You could easily break your neck.
Small cap energy? You could break your neck if the firm’s management fails to execute its business strategy. But entrepreneurial risk is a different animal entirely than being in something that is by its nature a dangerous business. Taking a punt on finance stocks in the middle of a bear market in credit seems…well…insane. Energy stocks? Not as insane, especially if you’re early.
Speaking of energy, the New York Times is reporting that as many as 35 new exploration and production projects from OPEC member nations could be delayed over the coming years, thanks to the oil price crash. Don’t mistake dollar strength via competitive currency devaluation with long-term oil weakness.
Yes, oil is going to be a proxy for the strength of the global economy. But over the coming years, a lot of people in the industry are saying that the oil price crash virtually locked in future shortages. The only question is how soon.
Saudi oil minister Ali al-Naimi told the Times, “I have often described unsustainably low oil prices as carrying the seeds of future spikes and volatility. In a low-price environment, the trend is often to focus on survival instead of expansion…If we place a low priority on preparing for the future, that lack of action can come back to haunt us through supply shortages and another round of high prices.”
Both the International Energy Agency and the International Monetary Fund agree. IMF deputy managing director John Lipsky says, “The lower that oil prices drop now and the longer they stay low, the greater the negative impact on future supply…In other words, today’s low prices could be setting the stage for another price run-up in the future.”
No one is interested in the oil story from an investment angle right now. That’s what makes us so interested. Industry insiders couldn’t be more clear about what they think is coming. And we think that means a big move in oil and oil stocks.
Houston based oil man Matt Simmons says, “We are three, six, maybe nine months away from [an oil] price shock…We are not talking about three to five years away — it will be much sooner…These prices now are dangerously low. The lower prices fall, the less oil will be produced and the greater the chance of an oil spike.”
“Unless oil demand falls by 10% or 15% per annum, which it is not going to do, then we don’t need to wait for oil demand to come back before we have a supply crunch. Within a few months, we are going to realize our visible inventories are really tight — squeaky tight — and what would really be inconvenient is to see a recovery in the economy.”
A lot of people would probably disagree with Simmons that a recovery in the economy would be “inconvenient.” But it doesn’t look he has much to worry about anyway. In fact, the size and scope of the various plans to end the recession are nearly bigger than the economy itself in America.
“The U.S. government and the Federal Reserve have spent, lent or guaranteed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s,” reports Bloomberg. That number is up 74% since Bloomberg first researched in November of last year. It tallies up to about $42k per American.
Now do you wonder why Russia and China are getting serious about getting out of the dollar? Those commitments by the U.S. authorities are nearly 100% of US GDP (US$14.2 trillion in 2008. Investments like Hunan Valin Iron and Steel’s $1.2 billion, which Treasurer Wayne Swan approved last night, make a lot of sense given the unhappy days ahead for the dollar. Tomorrow, more on the “alternative risk scenario of dollar collapse,” as presented by the Economist Intelligence Unit.
for Markets and Money