These sectors are in the firing line as Middle Australia suffers

I still believe the Australian economy looks to be heading for a big slowdown/recession, as I’ve been highlighting for the last month. 

I think it will be in real trouble in the second half of 2023 and as a result, retail stocks here will be crucified, with falls of between 30% and 40% before it's all over. On top of this, additional pressure will be felt by banks, domestic cyclicals and anyone exposed to the housing sector.

The CPI we saw this week is just another indicator that the RBA is not finished. The next one or two rate hikes could be the match that finally breaks the camel’s back.

The market has been shell-shocked since last RBA bombshell rate hike (combined with its “hawkish rhetoric that more hikes could still be in the pipeline) and after the latest inflation figure, that is not going to suddenly go away.

RBA rate hikes will come after the inflation data, despite weak building approvals and employment numbers a few weeks ago (jobs were down -4,300 versus market +25,000), with unemployment increasing from 3.5% to 3.7%.

As we know, once the “worm turns” it keeps going. Throw in 400,000 new immigrants coming into Australia in the next year and we’ll see the unemployment rate rise to 4.5%, maybe even 5%. That may be good at first, in containing wage rise demands wage inflation, but the negatives will weigh heavily:

• sticky inflation,
• increasing unemployment,
• weak retail sales numbers,
• a mortgage cliff about to hit,
• energy prices are about to be hiked another +25%,
• building approvals collapsing.

These factors will be accompanied by huge wage rises (+7% in some cases) that are about to hit. And with inflation up, they will not accept anything less than that now, all with little productivity growth. So, I see more rate hikes at the same time as the economy slows – not a good combination.

"It's looking dire"

I recently heard from someone who manages a water heater production line, that as residential construction slows, heater orders are declining 15% and more. With consumer confidence its lowest since 1990, it's looking dire out there.

Confidence is a massive driver of consumers. As soon as we start to feel things have really turned, we stop spending. The RBA will like that but the government (which is more concerned with non-economic issues) is about to get a massive shock.

Albo has not been “tested” once in 12 months – he’s had the best first year of any PM in living memory – not one Black Swan problem (no major floods, drought, bushfires, COVID outbreak or other catastrophes). So, he had better start concentrating on how to avert a recession or minimise the danger. If not, he’ll lose a lot of his rock star popularity very quickly. Then we may suddenly see a lot more of the ”Missing Minister” Tanya Pilbersek – who Albo regards as a “clear and present danger.”

Governments often get thrown out of office when a recession hits. So, even though Albo is trying to set up for his second and third terms, it will all be in vain if the government is at the steering wheel and Australia goes into a recession.

“Rising unemployment is what really kills a government”

When you lose your job, you’re often looking for someone to blame. Something I observed back in March 1996, when I was working for one of the major parties in a very marginal Labor electorate on election day, left a deep impression

During the day, many people complained to me they had lost their job as the unemployment rate (due to the 1990 recession) had surged from 5.8% to 11%. The comments were “I’ve been a Labor voter all my life and would never vote anything else, but I lost my job (one, two or three years ago) and it’s the fault of the Labor Government (Keating was PM at the time) – so I’m voting Liberal for the first time ever.”

As we know, John Howard won in March 1996 with a huge 5% swing, winning 44 seats in the second-biggest margin ever. The three biggest margins where a government has been thrown out all occurred after economic disasters.

One was when the above government was thrown out after 1996, the other two are:

• 1975: Gough Whitlam took inflation (with big wage rises – sound familiar?) from 2% to 16% and unemployment from 0.3% to 2.6%. Fraser won the December 1975 election with a majority of 55 – still the biggest ever.

• 1983: The Coalition Government under Fraser saw the economy go into recession, with unemployment rising to 9.7% from 5.7%. He lost to Bob Hawke, who grabbed a 25-seat majority.

The following chart shows the long-term unemployment rate. The yellow highlights indicate when the Fraser and then Keating Government were each “swept from power”.

Even though my Teal friends say the Coalition will be out of power for the next 10 to 15 years (yes they do really honestly believe that), history says that:

• Opposition parties fix up their messes and improve, and
• Governments that cannot run the economy smoothly WILL be thrown out.

The current economic problems

Just four weeks ago, the Commonwealth Bank of Australia noted declining discretionary consumer spending on household goods, down -5.7% over the year to March, the weakest annual growth in 19 months.

Retail Sales in April were 1% which followed weak gains in March and February when they were up just 0.4% and 0.2% – on the cusp of going negative.

The last RBA rate hike and threats of more to come, does NOT bode well for the Australian economy in the second half of 2023.

Many recently argued that inflation has already peaked and that the RBA is out of touch with reality. But the central bank has acknowledged that “price push inflation” or “services inflation” – seen on everyday goods – has declined, in part because supply chains are reopening. It is concerned by sticky wage inflation – the current level of wage growth is the highest in around a decade, up from extremely low levels – but further rises will worry the RBA.

Throw in the possibility of more wage rises across the economy in many areas, a potential “wages spiral” – and we could see a continuation of “wage push inflation”. This means that anything that is “leveraged to the Australian economy or consumer” will come under pressure.

House prices could be under pressure later this year if we see unemployment go up quickly. Combining this with higher interest rates, we could see housing defaults – for the first time since the 1990’s recession.

Retailers and other Australian businesses exposed to housing demand would get torched.

I’ve heard talk of sharp downturns in many areas of the economy in recent weeks. So, I was particularly interested to read several very relevant points made by respected journalist Robert Gottliebsen:

• The dam has burst. Suddenly, in the last two weeks, large areas of retail trade have turned down sharply.
• In some areas, the decline is between -15% to -20%.
• Combined with the latest catastrophic fall in building approvals, the long-awaited acceleration in the downturn is now fully underway.

In the last few months, there have been small falls in the food sector, though inflation masked larger but manageable falls in other retail areas, including appliances and clothing. That won’t be easy for the RBA to address because inflation is well and truly embedded in the economy.

As in the US, inflation is being driven by the impact of higher wage growth on services costs and prices. That wage pressure will continue until it's broken by a severe downturn.

Meanwhile, many service companies are still able to raise prices – efficiency becomes secondary. But the game will change in the coming months.

I was first alerted to the downturn acceleration by people in the transport industry. Then I checked with the network of floor people. These are the same people who, three years ago, told me sales were booming when the official figures said there was a slump.

The Reserve Bank ignored comments made by myself and others at the time, refusing to look outside its Martin Place bunker. The RBA relied on out-of-date official figures, leaving rates too low for too long.

Now, because the 2023 downturn acceleration has occurred in the last two weeks of May, the fall may not be seen in official figures for another month or so. But the ANZ-Roy Morgan Consumer Confidence index has now spent 13 straight weeks below the 80 mark – a clear warning of trouble ahead. The last time anything like this occurred was during the 1990-91 recession, which was infamously described by Paul Keating as “the recession we had to have”.

The May 2023 retail downturn was triggered by a combination of events:

• Adjusting for inflation, Australian wages have fallen 3.2% over the last year and 7.2% since their peak. There have been only a few instances of such big falls in real wages. Middle Australia is hurting.

• The vast number of heavily mortgaged householders who received their interest bill as they converted from fixed low-rate borrowing terms to today’s rates. They knew it was coming but the receipt was still a deep shock.

• Volleys of misleading statements about what politicians are going to do to reduce energy prices, which was all nonsense. Disastrous policies over the last two years are exploding power bills, which really hit middle-income Australia. Any relief was delivered to the lower income areas, not middle Australia.

• The Reserve Bank further increased interest rates in May, and there was speculation of more to come. Whether the speculation was right or wrong was irrelevant. It increased fear.

• The fall in consumer demand has been delayed by unexpected stabilisation and even an increase in house prices despite higher interest rates. Meanwhile, potential buyers of new houses are too scared of builder failures to place orders, so the shortages will continue.

When the Federal Budget landed, a series of low-income people were given aid. But those in middle Australia, the wealth creators, were given nothing and told to suffer because “you are affluent”. It was a cruel blow.

Australians coming to the supermarkets are met with regular price rises, which are being offset by people buying cheaper goods. The trend towards buying lower-priced goods is spreading in all retail markets.

During COVID-19, people did not travel overseas and spent much of that money locally, including home improvements. Now among the affluent, that “local” spending money is being outlaid on overseas travel.

Skills shortage, labour shedding

At the moment there is a shortage of skills, but as workers in retailers and their suppliers see sales fall sharply, they know that the survival of their enterprise will depend on labour shedding.

Many under mortgage stress are meeting their repayments via the gig economy, often in the retail sector, and so are very vulnerable to this downturn. And those who study the Canberra political manoeuvrings know that the government wants to hit them harder, restricting the gig economy to make it more difficult to supplement extra income.

“The one thing the Budget got right…”

At this stage, because the fall has been sudden and only for about two weeks, naturally retailers want more time before pronouncing a downturn. 

But the one thing the budget got right was forecasting a sharp fall in the Australian economy in 2023-24, which has started a little earlier than expected, despite strong mining and agriculture,

The stock market has been driven by interest rate trends, so the accelerated downturn is good news because it will curb rate rises. But in terms of the looming profit blows for many enterprises, the market has ignored the budget predictions and is not priced for this downturn.