Summary: While policy makers fret about Australia’s declining terms of trade, another more significant development is taking place: consumer confidence is on the rise. The latest data show the household savings rate is falling, even with policy makers and their rhetoric instilling fear in the market. Consumers are finally responding to the ultra-low lending rate environment and, though it appears gradual, there is a long way to run yet.
Key take-out: The impending rise in consumer spending will positively impact numerous sectors in the Australian equities market, including the retailers, the banks, consumer staples and various industrial companies.
Key beneficiaries: General investors. Category: Economics and Investment Strategy
While the nation’s policy makers obsess about the decline in the terms of trade, a much more significant development may be underway. Specifically, it looks like consumers are becoming less risk averse.
To see why this is so important, note that consumer spending accounts for about 60% of the economy. Then spare a thought for how reliant our equity market is on consumer spending – either directly or indirectly.
Consumer spending clearly affects financials, which is already 40% of the S&P/ASX200 index, especially our banks. Then there’s more obvious impact to consumer staples (think Woollies, etc.) and consumer discretionary (including retailing, publishing and casinos). It drives our industrials, such as Brambles, the airlines, Sydney Airport and Transurban. Everything relies on the consumer at the end of the day (over 90% of the market) and it’s a very significant event – if risk appetite is lifting.
So is it? Well, yes. Chart 1 below shows one measure of risk appetite, the household savings rate and it shows it on a downtrend. I don’t want to overplay it, as savings are still very high relative to history. Yet the ratio has fallen about 3 percentage points from the peak in 2012 – which is an extra $40 billion or so being spent on the economy.
Chart 1: Household savings falling?
The key question is whether this fall is sustainable – and up front I think the on balance answer is yes. I say on balance because there are risks, of course, and I think policy-error is the single greatest risk.
Regular readers will already be aware that I think it has been policy makers and their rhetoric (in order to jawbone a weaker Australian dollar) that has been the key millstone around consumers’ necks. It has been confidence destroying. Noting that ‘known unknown’ and keeping it mind – as you read below, it will become clearer that the most likely outcome is for consumer risk appetite to increase further.
Ultra-low lending rates
There are few times in history where the disincentive to save has been so high. That consumers are still saving is a testament to how much fear is out there. Fortune has favoured the brave though.
I think it’s reasonable to assume that this low rates environment will be a part of the landscape for the foreseeable future. Interest rates aren’t even close to being restrictive and every major central bank has said that even when they do start hiking rates, it will be a slow, gradual process, that policy will remain accommodative over the long-term and that it is unlikely rates will rerun to previous peaks.
Read another way, this disincentive to save will be in place for a long time. Consumers may only be responding slowly, but they are responding and the process has a long way to run yet.
The wealth effect from property and equities
Since the GFC, house prices in our major capital cities have shot up about 45%. For investors, total returns are closer to 60% or 70%. Over the same period, stocks are 87% or so higher on an accumulation basis. They are about 22% higher since the beginning of 2013, although the All Ordinaries remains below record highs whereas other global benchmarks are breaking new ones.
Notwithstanding the comparative underperformance of our equity market, the total financial wealth of households has reached record levels at $3.8 trillion (according to the latest financial accounts). That compares to $1.8 trillion of debt, with the cash component of wealth at $822 billion.
At 21% of total financial assets, cash is elevated when compared to the boom years in 2006. But it is down fromm the peak (23%) – another sign that households are less risk averse. In the same vein, the still elevated levels of cash deposits and very high levels of wealth, adding further support to my view that risk aversion will continue to unwind.
A strong labour market
Defying expectations for mass jobs shedding as the mining boom came to an end, jobs have increased by 236,000 so far in the first eight months of the year.
Allowing for a correction from August’ good result, we’re on track for about 240,000 jobs to be created in 2014 as a whole – strong growth. The unemployment rate itself remains low at 6.1% and even lower still for those over 35 at around 3% to 4.5%.
As a result of all of the above factors, consumer confidence is on the rise - albeit slowly. Fair to say that there’s always something that seems to weigh on confidence though and in some respects it is remarkable, given the atrocious state of domestic policy and international affairs, that any of us have any confidence at all. But on the economic front things are looking much better than expected and consumers are responding to this better news flow. I suspect that has the economy continues to outperform, confidence will continue to grow.
The implications from the above are clear. Our market – and the economy more broadly – will receive ongoing support from the drop in risk aversion. Indeed, I believe it is a very grave error for policy makers and market analysts to put so much emphasis on the terms of trade and a modest slowing in China. The outlook for the consumer is far more important.