Weighing an Australian Downturn

I am going to start today’s comment in an unusual way by quoting the deposit rates of some of our largest banks. The aim is not necessarily to entice you to take up bank deposits – although it might be part of a risk reduction strategy given the tougher economic times ahead – but rather to underline the change in the banking industry which threatens the current level of bank profits and perhaps dividends.

The Commonwealth Bank and Westpac are both offering 4.35 per cent for 12-month deposits. Bendigo Bank, which was slow to grasp what was happening in the marketplace so lost deposit market share, is offering 4.5 per cent.

It is possible that NAB and ANZ have similar rates, but they make it hard to discover their real rates. NAB and ANZ customers need to make sure they are not being chiselled. In the call area, the Macquarie accelerated account is offering 3.6 per cent for deposits of up to $2 million.

Token Interest Rates

If we go back to May 2022 when the Reserve Bank started to raise interest rates, banks were offering almost token interest rates and in the following months made a fortune out of the suffering of depositors. The rates currently being offered are obviously less that inflation, but the rise has been spectacular because overseas rates went higher and groups like Macquarie broke the low deposit rate ranks.

An ACCC enquiry into bank deposits may also have been a factor. Mortgage rate competition has intensified and, of course, expenses are up. The bottom line is lower margins and profits that will threaten dividend rates in some banks. 

Australian banks are well-capitalised and the housing shortage is keeping house prices high so the normal sharp fall in dwelling prices that takes place when interest rates rise has not happened. This means that if a borrower falls over, losses will be minimal. What is hard to determine is just how severe the fall in the economy is going to be.

Restraint in Equities

Federal Treasurer Jim Chalmers’s budget estimates duplicate the forecasts that the Commonwealth Bank is making – i.e., a sharp downturn starting in the first half of 2023-24 which will see interest rates fall before 31 December. There is great division in the economic community as to whether CBA and Chalmers are right.

The common analogy that market people are using is that the Reserve Bank has the brakes on while the treasurer has put the foot down hard on the accelerator. With wages rising, those that believe that there will not be a sharp downturn are now forecasting interest rates could take longer to fall and may even rise if wages break out and/or inflation fails to fall significantly.

People I trust in this area are giving me different messages. So, my bottom line is that this is a time to show restraint in your equity exposure because the risks are greater than normal.

Spending Study

And, to underline this, there are strange things happening in consumer land. This is revealed in a remarkable study conducted on the Commonwealth Bank customer base by the CBA itself and the Quantium analytical group.

Normally when there is stress in the mortgage sphere, people cut back on cafes and takeaway foods and similar items. There have been reductions, particularly after adjusting for inflation, but they are not as big as you would normally expect.

Big reductions have taken place in items like appliances, building products and, of course, apparel. There has been a dramatic rise in travel. Part of this is the built-up desires of older people who are not involved in the mortgage stress area and couldn’t travel during COVID. They are now spending this money big time.

Even those under stress are finding money for travel as they prefer experiences over physical goods. That means that retailers are going to have to be very smart and know the customer areas where they are still spending and promote in that area. 

Media outlets that have older, affluent audiences are enjoying heavy advertising, particularly from travel groups. The ABC once had a huge part of this audience but more recently has been broadcasting programs with limited appeal to the older age brackets so audiences have dropped and the commercial sector has benefited.

Home Depot Disappoints

If the downturn takes place as the Commonwealth Bank and Treasury is expecting, then I think the café and restaurant area – which so far has held its ground – will be impacted. I haven’t seen in the US a similar detailed study in spending patterns for those under stress, but this week profits of Home Depot (a US retailer that taps similar customers to Bunnings) fell below expectations, which impacted Wall Street.

US inflation has crept into the wages system and is holding up much more strongly and that makes it possible that there will be even further rate rises. 

But just as in Australia under the CBA/budget predictions, in the US there could also be a sharp downturn which Wall Street share markets are not factoring in. And then of course in the US there is the problem with the Congress which threatens to erupt.

Our Treasury is predicting token growth rates in the US, Europe and Japan. Accordingly, if our treasurer is right, then fasten the seatbelts for a nasty US economy which will threaten share values on Wall Street and that will spread to Australia. 

China Bright Spot

The bright area looks to be China where higher growth rates are being predicted and that is, of course, good news for Australia. In theory that should benefit our miners, but it is now very difficult to develop gas and coal and is suspected that the same will happen to iron ore as Indigenous and environmental objections hit the growth rate. 

If our mining industry cannot take advantage of the markets in Asia because of these local factors, then Australia will be a very different place. That is not a forecast but an alert. Meanwhile it is the time to have an equity level you are comfortable with, keeping in mind the risk factors involved.