From bad to worse

Results from Westpac's key indices in September while not good, were at least encouraging. Unfortunately much has changed in the December survey.

In last week’s note we looked at the three recessions which Australia has experienced since 1965. We defined a recession as the economy actually contracting over the year, rather than just two consecutive quarters of negative growth. The recessions were all deep and very painful. They were generally characterised by 20-30 per cent contractions in residential building investment; 20 per cent contractions in business investment in the first year followed by a 10 per cent contraction through the second year; and around 0 per cent growth in consumer spending. The recessions were also associated with a 2-3 year period of deteriorating employment conditions with the unemployment rate rising by 4-5 percentage points.

The danger with the current debate on whether Australia will have a recession in 2009/2010 is that the "recessions" we have experienced have been very severe. Australians who remember the three recessions (1974/75, 1982/3 and 1990/1) don't think of a brief period of negative growth. They recall dismal employment conditions, a collapse in housing activity and savage cuts to investment.

The issue is not whether we have a short period of negative growth which would qualify as a recession. The issue is whether we have a repeat of the only recessions Australia has experienced – a brutal collapse in spending and extended period of dismal employment conditions. Westpac's forecast has been for anaemic but nevertheless positive growth in 2009 and 2010.

This outlook has been based on the certainty that there will NOT be another 20-30 per cent collapse in house building since we already have a chronic shortage of housing of around 12 month's of normal production. Further, both fiscal and monetary policy has been remarkably pre-emptive and there is still a long pipeline of investment spending on large infrastructure projects which will maintain some momentum through most of 2009.

However we have consistently emphasised the downside risks associated with the unprecedented drag from the negative wealth and confidence effects associated with the global financial crisis and the resulting world recession.

Those downside risks just got a lot greater!

Westpac and ACCI have just released the December Westpac ACCI survey of Industrial Trends. The remarkable advantage which this survey has over other business surveys is that it has been in existence since the early 1960's. At a time like now, when we are angsting about a repeat of those three painful recessions it is helpful to use a survey where current trends can be compared with the trends of those recessions.

The last survey in September was relatively reassuring that businesses were not anticipating a repeat of the previous recessions. But much has changed in the December Report.

While the levels of the key indices in the December survey were comfortably above the low points of the recession the pace of deterioration was comparable and in some cases more rapid. The Actual Composite Index of overall activity which is modelled on the US's ISM fell by 10 points from 50.8 to 40.4. That compares with recession low points of 27 (1974), 24 (1982) and 25 (1990).

However in the descent to those low points we only saw one fall (September 1974) in the entire history of the series which was steeper than in December 2008.

The story on the Expected Composite was even more disturbing. The level of the Expected Composite Index fell by 17.4 points to 33.8. The previous sharpest quarterly fall was 10.3 points in 1974 to a low of 33.4. Low points in the Expected Composite in the two most recent recessions were 26.2 (1982) and 31.8 (1991). The chilling signal there is that expectations are already pointing to the low point of expectations in the two latest recessions.

The story on the labour market is no more encouraging. The Westpac Labour demand Indicator fell by 10 points from –6 to –16. That fall is comparable with the largest falls in the 1990/91 recession, but not as sharp as that in 1982.

Certainly the low points in the two recessions were much lower than the current reading. Through 1982 the Index fell by 53 points to –45 and through 1989 H2 and 1991 it fell 47 points to –37. It is not surprising that the level of the Employment Index is well above those recessionary levels given that the unemployment rate is still only 4.4 per cent but the speed of deterioration in the December quarter is very disturbing.

The other labour market indicator in the survey is "whether it had become harder to find labour”. The index fell from 14 to –20 in December. That compares with low points in recession times of –61 (1982) and –60 (1990). On each occasion the Index fell sharply through the year preceding the low point, 69 points in 1982; and 55 points in 1991. However, the largest single quarterly drop since 1980 was 25 points in September 1982 – in the December 2008 the index fell by 34 points!

As demonstrated, the Composite index has provided reliable lead indicators for both domestic demand and business investment. The Labour Market Composite has also been a useful lead indicator (6 month lead) for employment growth so this chilling collapse in the indexes must be taken very seriously.

Part of the clue to this extraordinary collapse in the indices lies with the unprecedented financial market conditions in Australia. These conditions, while much less threatening than that in other developed economies have undoubtedly tightened. We can see that in the question in the survey of whether finance has become harder to get. The Index registered an increase in whether "finance is harder to get" from 28 to 40. That index rose to its highest level since the 1974 recession. Comparable peak levels in the 1982 recession were "only" 30 (1982) and 1990 (19).

The Westpac ACCI Survey is signalling very strongly that business conditions are deteriorating rapidly. Whether Australia experiences a much sharper downturn than our current forecast of an anaemic 1.6 per cent growth in 2009 will be determined by the interaction of aggressive policy stimulus (of which there is plenty more to come) and the negative effects of contracting wealth; falling confidence and tightening credit conditions.

We think the resolution will centre around the business sector and its reaction to these countervailing forces. The Westpac ACCI Survey is not encouraging in that regard.

Bill Evans, Managing Director Economics & Research

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