What happens the morning after the mining boom? For the real economy it will be like any hangover, characterised by a splitting headache, dulled taste buds and slow movement. Coming to grips with declining terms of trade (prices we receive for our exports compared with our imports) and slackening demand for capital and labour will be tremendously difficult for policy makers and companies. If we are not careful, the country could enter its first official recession in 20 years.
For stock market investors, though, the answers do not lie with the short term but in what the local economy looks like 12 months or even 18 months down the highway. There is no time to sit around popping Panadols while the world moves on. The sharemarket does not always predict accurately but it will always attempt to predict. One only has to see how investors scurried out of resources stocks from April 2011 onwards, not prepared to wait for the inevitable downturn that we are experiencing. How the market guesses right is always a mystery but it is a salient lesson that it pays to look forward and not behind.
So, what does the economy look like 18 months from now and where is the best place for shareholders to position themselves? In the short term, it could get quite nasty. Credit Suisse strategist Atul Lele says: "We could be on the brink of some of the toughest months we have faced for more than a decade. We are lucky to have a lot of policy ammunition that may offset some of this." He believes the prosperity of the last decade has been largely wasted and he finds it difficult to see what part of the economy is going to take the baton off the mining sector and lead the economy.
Lele's arguments are powerful, given Australia has depended heavily through its history on commodity prices and residential building to drive its wealth. The key for sharemarket investors, though, is Lele's comments about the ability of policy to ameliorate the situation. If we put aside international influences for the moment, the key to the post mining boom era will be the actions of the Reserve Bank governor, Glenn Stevens. Stevens has read the mining boom like a book. Despite a cacophony of calls to slash interest rates and boost domestic consumption, Stevens and the Reserve Bank board have been more circumspect. He was the first prominent figure to state the Australian terms of trade had peaked (early 2012) and he has been very clear that activity in the mining sector will hit a peak in late 2013 or early 2014. In the meantime, the economy has been running at about trend and there has been no need to provide further monetary policy stimulus. He has been much more disciplined that his northern hemisphere colleagues.
With commodity prices in free fall, Stevens will get a firmer grip on the future contribution to the overall economy from the mining boom. In other words, with mining slowing, the shackles will be off, allowing the RBA to loosen policy. Most economists believe the RBA will cut another 25 basis points sometime later this year, while others, such as Bill Evans at Westpac, are looking for a series of cuts. Stevens will remain cautious and he will not move with alacrity. Fortunately, with official interest rates at 3.75 per cent, the RBA has plenty of room to move. We could easily see 100 basis points of cuts between now and the end of 2013.
What are the consequences of lower official interest rates in 2013? The positive impacts of lower interest rates usually take somewhere between six months and 12 months to filter into the economy. However, over time, it should encourage people to stop putting their money into term deposits and start placing them in more productive assets. It may also entice individuals to start borrowing at a moderate but improved rate. Australians are doing a stellar job of getting their finances in order by saving approximately 10 per cent of their incomes. By late 2014 or early 2015, this savings level may start to dip. Lower rates should also encourage industrial companies based in Australia to once again start borrowing to expand their businesses.
Australian banks have also been in balance sheet repair mode in recent years, restricting credit in preparation for the introduction of Basel 3 in January 2013. This contraction of the banking balance sheet has been a major handbrake on the domestic economy. In recent times, though, there have been mutterings from banks to their corporate customers they would love to ratchet up their loan books. This is a good sign but will be gentle at first and accelerate in the years to come.
All this adds up to stockmarket investors trying to position themselves to take advantage of an economic upswing in 2014 and 2015. Traditionally this would be best served by wading into the finance, retail, housing and construction sectors. The stockmarket won't wait though. Investors will move early. Initially the fundamental numbers won't support a surge in these stock prices but by the time they do it may be too late. We have just seen this scenario play out in the mining sector.