Why Aussie Economic Growth Is Set to Slow Sharply

Economic growth data is so old by the time it hits the headlines, the market usually yawns.

So was the case yesterday.

In the three months to 30 June, the economy expanded 0.7% in seasonally adjusted terms. This was ‘better than expected’, but the market has already priced it in…months ago.

Predictably, business commentators rejoiced because it means we’ll probably avoid a ‘technical recession’, which is two quarters of economic contraction.

With most state premiers locking us down, the current September quarter will show the national economy going backwards. If we’re lucky, things should improve in the December quarter. Hence, no recession.

With the world slowly (maybe) returning to normal, does that mean we’re in the clear? Don’t bet on it…

As far as the stock market goes, it’s more concerned about nominal GDP growth, rather than the headline figure you see widely quoted.

Nominal GDP better reflects the amount of dollars flowing around the economy, which companies claim as revenue and profits.

As you can see below, following the sharp contraction in growth from the first lockdowns, nominal GDP bounced back strongly. Loose fiscal and monetary policy helped domestically. And China helped immensely by boosting our ‘terms of trade’ via record high iron ore prices.

All this contributed to annual nominal GDP growth of 15.5% in the year to 30 June.


Quarterly Growth in Nominal GDP

Source: GDP

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Now, if we ignore the COVID impacted March and June quarters of 2020, what does more normal conditions look like?

In the year to 31 December 2019, nominal GDP expanded just 4.4%. That’s not a disaster by any stretch, but it’s substantially less than what we’ve experienced over the past 12 months.

Getting back to normal, for the stock market at least, might not be all that it’s cracked up to be.

And China might be leading the way. The South China Morning Post reports:

Temporary shocks caused by Delta variant outbreaks may have been to blame for depressing China’s economic sentiments in the past month, but economists warn that the latest falling purchasing managers’ indices signal further problems in the economy.

And they are calling for more loosening of liquidity and increased fiscal spending.

Meanwhile, there is an emerging consensus among analysts who believe that the peak of China’s post-coronavirus economic momentum is already behind it. Banks, too, appear to see the writing on the wall and have begun to slash their economic growth forecasts for China for the year, while Beijing is also taking steps that portend the headwinds facing the nation’s economy in the long run.

China’s official composite purchasing managers’ index (PMI), which gauges sentiment in both manufacturing and the services industry, dropped sharply to 48.9 in August from 52.4 in July, data from the National Bureau of Statistics (NBS) showed on Tuesday. A reading above 50 indicates growth in sector activity, while a reading below the watershed mark represents contraction. The lower the reading is below 50, the faster the pace of contraction.

You’ll probably read excuses that this is mostly about increased restrictions to curb the ‘Delta strain’. Don’t believe it. As Jeff Snider points out in his blog, these economic activity readings are not slowing just because of China’s domestic situation.

The chart below shows both new orders and new export orders for China’s services sector plunging:


China PMI

Source: China PMI

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This next chart shows the same for the manufacturing sector. Again, new export orders are falling sharply:


China PMI

Source: China PMI

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What’s the message here?

China, AND the rest of the world are all slowing. That’s not particularly revealing news. The bond market has been telling you this for months. It’s only really the equity market that is ignoring it.

Oh, the iron ore price is telling you this too. While it’s still high by historical standards, the price has fallen 30% since mid-July. I would expect it to be lower still by the end of the year.

Given iron ore’s contribution to nominal GDP growth via the terms of trade boost, this is clearly going to take the heat out of Aussie nominal GDP this year.


Optuma

Source: Optuma

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The only question in my mind is how will the stock market take it?

Will it ‘look through’ and ‘shrug off’ the weakness, or will it decide to price in more risk via lower prices?

The benchmark index, the ASX 200, is thinking the former rather than the latter. As you can see in the chart below, it’s in a healthy upward trend:


Optuma

Source: Optuma

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In other words, you might need to see a bit more in the way of bad news to slow this market down. Just don’t be surprised when it does.

Regards,

Greg Canavan Signature

Greg Canavan,
Editor, The Rum Rebellion

PS: The Rum Rebellion is a fantastic place to start your investment journey. We talk about the big trends driving the Australian Economy. Learn all about it here.


Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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