Watch This Level for Australia’s Recession Indicator

It’s not often you see the Commonwealth Bank [ASX:CBA] and Woolworths [ASX:WOW] lose more than 5% of their market value on the same day.

But that’s exactly what happened yesterday as the market reacted to some weak trading updates and a bungled interest rate announcement from the RBA.

I don’t think the outcome could’ve been any worse for the RBA. The decision to cut rates on Tuesday to a record low of 2% came with a statement that seemed relatively sanguine about the state of the economy.

As a result, the RBA signalled it was done with further interest rate cuts for the time being.

But the market completely disagreed. Australian stocks quickly reversed course, finishing slightly lower on the day of a rate cut. The next day, CBA released its third quarter trading update, which showed a slight fall in year-on-year growth and falling margins.

Then, WOW revealed comparable year-on-year sales growth for the three months to 31 March of just 0.2% (adjusted for Easter trading) for its main Food and Liquor business.

These are the retailing giant’s lowest growth numbers in years, and suggest the economy is not recovering at all.

Last August, RBA Governor Glenn Stevens said that there was only so much interest rates can do to generate sustainable economic growth. He said the biggest thing the economy needed to get back on track was a restoration of confidence…good old ‘animal spirits’.

As the Financial Review reported at the time:

Reserve Bank of Australia governor Glenn Stevens has said the single most important driver of the economy, a recovery in confidence, is not something that can be provided by lower official interest rates.’

He’s right of course. Interest rates below a certain level don’t do anything for the real economy. They only benefit the speculators. But if he really thinks that, he’s not exactly in the right job! To a central banker (a modern one, at least) interest rates are like the hand of God. They can do anything.

If Stevens wanted his almost reluctant cut to interest rates on Tuesday to bolster confidence, he’s failed miserably. The evidence is in the market response and the widespread confusion over just what the RBA is thinking.

The Bank is now in damage control. The Financial Review reports today that ‘Reserve Bank officials are expected on Friday to reintroduce an overt "easing bias" for rates into the central bank’s economic outlook.

In other words, the Bank knows it screwed up and is now scrambling to reverse the damage, leaking its next communication to the market as soon as it can.

But it doesn’t really matter. Stevens is right. Lower rates from here will do little for the real economy. You’re already seeing the signs of that judging from the response of the major banks. While ANZ passed on the full rate cut to borrowers, CBA and NAB didn’t.

The banks want to protect their interest margins. They’re also concerned about the quality of borrower they’re getting as rates dip down into record low territory.

Today’s marginal borrower will become tomorrow’s bad debtor. And given bad debts and provisioning for bad debts are near record lows across the banking sector, banks will start to worry about their future credit quality.

So the law of diminishing returns is certainly starting to set in as far as interest rates go.

The only objective for monetary policy now is to join the currency war, lower the dollar, and help the export sector.

The Australian economy needs to adjust to the post mining boom environment. It can do that via a lower dollar, which is a general devaluation and loss of relative wealth for the whole economy.

This is what the RBA wants to achieve. A lower dollar across the board is a loss of relative wealth but it’s also a necessary step to restore international competitiveness.

And despite 10 years of investment designed to increase our resource production capacity, Australia is clearly not internationally competitive.

Just this week, trade figures for the March quarter came out. Despite the big lift in iron ore production, Australia managed to run a trade deficit of around $4 billion for the quarter. Post the commodity/mining boom, we’re still running a current account deficit of around $40 billion a year.

On an international basis, we’re expensive and uncompetitive. Australia needs a lower dollar to help restore some of that competitiveness. It’s just a shame that the RBA bungled its attempt to push the dollar down.

Ironically, it’s the government that perhaps has the best chance of knocking the dollar lower. All they have to do is carry on…

Treasurer Joe Hockey’s post interest rate cut comment was embarrassing. In a sign of how politicians think about economic growth, and the contempt they have for people, he called on individuals and businesses to go out and borrow and invest. Is he not aware that household debt levels in Australia are already amongst the highest in the world?

Of course he knows. He just doesn’t care about it. He only cares about getting another term in power.

Which is why next week’s budget will be soft and only pay lip service to a ‘return to surplus’. That should knock the Australian dollar around a bit.

Slowly but surely, our international creditors will see that politics in Australia is a stinking morass, and that without the mining boom we are as fiscally irresponsible as the best of them.

The threat to Australia’s AAA credit rating, brought about by this fiscal ineptitude, is still a fringe issue. The mainstream doesn’t yet consider it a credible risk. But all real and credible risks start on the periphery and work their way in to the centre.

I don’t know how long it will take to become an immediate threat. But it’s one of the biggest risks to Australia’s debt soaked economy. Loss of the rating will push the cost of credit up for Australia’s whole economy, regardless of what the RBA says or does.

As I’ve often said, for clues on the timing, keep an eye on Australia’s biggest bank, the CBA. The share price damage in recent weeks is not a big deal. As you can see from the weekly chart below, on a longer term basis the stock is still in an uptrend.

But $80 looks like an important level. This is around where the 100-week moving average is, a level that provided important support during the last sharp sell-off in 2014.

Since the interest rate induced bull market got underway in late 2012, CBA’s stock price has not fallen below this level.

So my guess is that you’ll see some buying support come in around $80 in the days and weeks ahead. But if and when it breaks down below this point on a weekly basis, then it’s time to start questioning not only the end of the banking bull market, but also Australia’s 24 year run of economic good times.


Greg Canavan+,
for Markets and Money

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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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