So far, the economy has toughed it out

02_So far_ the economy has toughed it out

Garry Shilson-Josling, AAP Economist
(Australian Associated Press)

There’s no denying the risks posed by the wave of anxiety sweeping global markets.

So far, the economy has toughed it out.

The National Australia Bank’s latest survey of Australian businesses on Tuesday showed a minor waning of confidence and weakening of conditions but both are still well into positive territory.

NAB’s economists said the weakness was concentrated in Western Australian and South Australia, where the dust from the mining investment slump is continuing to settle.

“This suggests that fundamental conditions in the non-mining economy remain resilient,” they said in their report on the data.

But the mood in the world’s share markets is toxic.

Share prices have fallen 10 per cent in US dollar terms to far this year, and there’s no guarantee they won’t go further.

News that in years gone by might have been seen as positive now seen as negative.

A falling oil price reduces business costs and frees up the household budget for spending on a wider array of goods and services.

And a rising oil price has typically been seen as bad.

The Oil Price Shock of 1973 was a shock because prices rose, not because they fell.

Nowadays, though, a falling crude oil price is seen as a sign that the world economy is slowing, and that inflation might go into reverse and become deflation, giving investors and consumers every reason to delay their spending decisions.

Signs of strength in the US economy – like the nine year low in unemployment recorded last week – used to be seen as a positive for the share market, because more growth means more profits and dividends, but these days it’s just a warning bell for a rate hike from the Federal Reserve.

To some extent, the weakness in equity markets can be explained as a reaction to high prices – stocks in the US S&P 500 index are currently trading at around 20 times their past year’s earnings.

That’s about as high as the price-to-earnings ratio goes in that market, aside from times of temporary weakness in earnings – like the early 1990s or 2008-09 recessions, or periods of truly irrational valuations, like the tech stock boom of the late 1990s.

It’s arguable that the world’s bellwether market should be at least stalling for a while just to allow earnings to catch up with prices.

But further downside, not just for Wall St but other major markets, is possible.

If so, it would inevitably spill over into the Australian market.

And lower share prices mean the cost of raising capital to fund investment is higher, because existing shareholders have to sell a bigger chunk of their business – and forego a bigger chunk of their earnings – to raise the same amount of cash.

So there’s no guarantee that Australia will continue to hold out against the tide of fear currently gripping global markets.

So far, so good, as NAB’s survey shows, but there is plenty of scope for things to go awry.


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