The performance of the Australian economy over 2017 to date can best be described as mediocre. The end of the mining investment downturn is near, the consumer environment is challenging while there are ongoing concerns around a build-up of risks in the housing sector.
Overall GDP growth has been below trend at 1.7% for the year to March 2017 and is likely to be little changed around this level in the year to June 2017 (data due 6 September), but is then expected to pick up to around 2.5% by year end. There has however been two key surprises in the economic landscape so far this year; the strength of the labour market and the stellar improvement in the NAB Business Conditions Index . The labour market has added 200,000 jobs so far this year, partly making up for weakness seen in 2016. Perhaps more impressively, 75% of the job created have been in full-time positions, a great achievement and suggests some real underlying strength in the economy. However, wages growth have remained at record low levels, leading to weak household income growth and subdued consumer spending.
The strength of business conditions and confidence, as shown by the NAB survey, has also been a key highlight. The NAB Business Conditions Index as at July was +15, which was the highest level for the series since early 2008 and three times its long-run average. Indeed, by this measure business conditions have been consistently above their long-run average through-out 2017. However, this impressive headline number has hidden renewed divergence across industries and states. While most industries are reporting positive business conditions, mining has been in a clear upward trend and has recovered from the weakness evident in 2015 and 2016. Retail in contrast has been the weakest sector. On a state basis, NSW is recording the strongest Business Conditions, while Queensland, South Australia and Victoria are also performing. In contrast, Western Australia is the weakest of the states.
As reporting season wraps up in Australia, how do the profit results and outlook statements from Australian companies compare with the broader economic landscape as outlined above? This earnings season could be described as ‘patchy’, with less positive revisions to earnings than February 2017 and quite divergent results between different sectors of the market. However, this result could have been skewed from a small number of companies that had much worse than expected results.
As the chart below from Citi Research shows, there is normally a correlation between the NAB Business Conditions Index and the ASX 200 earnings revisions ration (% upgrades less downgrades). However recently there has been a growing divergence between the two. Historically when the NAB Business Conditions Index reached 10, there is an improvement in net upgrades, but this hasn’t occurred yet. The question is, will it in time?
Earnings revisions and Business Conditions
Source: IBES, NAB, Datastream, Citi Research. NAB Business Conditions till July 2017, IBES earnings revisions ratio to 30 August 2017. *3 month moving average apart from last data point. **Upgrades less downgrades are as a percent of all stocks in the index.
The strongest earnings results have emerged from the mining and energy sector, reflecting favourable commodity prices and cost cutting programs. Continued solid demand for commodities has also helped, driven by better-than-expected economic growth in China and the synchronised pick-up in the global economy. This sector has also benefited from reducing debt and improved cash flow generation, which has led to increased dividend payouts for the sector.
Beyond the resources sector, earnings growth was more subdued and more reflective of the modest momentum in the Australian economy. Much of the improvement in earnings has come from cost cutting, lower interest costs and some margin improvement, rather than revenue growth. The weaker results have been focused in insurance, food retailing and transport companies, while there actually have been some positive results in utilities, housing and some parts of the consumer market. One clear trend has been a growing concern over energy costs from a range of companies and sectors. Some companies have expressed a need to invest in renewable energies such as solar to secure cheaper energy supply going forward given a lack of overarching government policy on this important issue.
One other key thematic that emerged from earnings season was strength in company balance sheets. There has been a focus on de-gearing, with some companies now holding onto excess cash. The key question, which could impact the economy going forward, is how will this cash be used? Some companies, in the absence of investment intentions, are returning this cash to shareholders through buybacks - boosting household income. While other companies have recently refocussed intentions to invest to both grow organically or through acquisition. If this does occur it could be the start of a pick-up in non-mining investment that has been desperately missing from the Australian economic landscape and could help return Australian economic growth closer to trend.
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