The Warning Signs for Australia’s Economy

Now’s not the time to buy, but it’s certainly a time to do your research and work out who will continue to perform well in a more subdued spending environment. The question is though, just how subdued will the spending environment become as the China rebalancing story plays out over the next few years?

Well, Ross Garnaut, Australia’s well-known China watcher, is vying with your editor to be the biggest China bear. He reckons mining investment as a percentage of GDP in Australia’s economy will fall from the current 8% all the way back to 2%. And if that happens without consumption or housing or business investment taking up the slack, come 2014 Australia could be looking at its first recession in 23 years…

We’ve been making the same argument. We’ve been saying this recent rally in shares and house prices is a trap…a trap to make you think everything is as it’s always been.

But the point of our (and Garnaut’s) warnings is that Australia’s economic future will be very much unlike its past. Our largest trading partner is undergoing a dangerous economic rebalancing which will mean much less demand for our raw materials.

The profit warnings from all the mining services companies are simply a warning for Australia’s economy. Times are changing!

But if the action from the mining services sector portends a different, more austere future for Australia’s economy, no one is telling Commonwealth Bank investors. Yesterday, the stock hit an all-time high. On a price-to-book value basis, it’s the most expensive bank stock in the world, according to analysis from UBS.

‘Price-to-book’ simply tells you how much of a premium a company’s share price has to its equity, or ‘book’ value. According to UBS, Comm Bank trades at 3.6x its tangible equity value. That’s high, and reflects the banks’ very strong competitive positioning and high return on equity.

But you would have to question how long Comm Bank, and Australian banks in general, can maintain world-beating levels of return on equity as the economy faces a mining induced slowdown. Don’t forget, banks are highly leveraged entities. They do very well in good times due to this leverage. But as the Australian economy slows and unemployment picks up, the leverage works the other way.

The recent reporting period for the banks showed profit growth on the back of cost cutting and lower bad debt levels. Top line growth was flat at best. And as the Australian economy slows, you would expect to see bad debt levels pick up again. This is not an environment that appears to justify record high share prices for the sector.

If Australia’s outlook is changing, then the banks are yet to admit it…

Regards,
Greg Canavan
for Markets and Money

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From the Archives…

Multinationals vs. the Nation State
17-05-13 – Sam Volkering

The Federal Reserve Will Panic and Climb Even Higher
16-05-13 – Bill Bonner

Survival of the Most Capital Efficient
15-05-13 ­– Dan Denning

New Australian Home Buyers Aren’t Convinced
14-05-13 – Dan Denning

What Happens When Everyone in the World has Zero Interest Rates?
13-05-13 – Dan Denning


Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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