The productivity pickle. A weird bonds reversal. This week and next.


John Addis

Low productivity creates a dividends pickle

Believe it or not, that smartphone in your pocket has more computing power than all of NASA circa 1969. Okay, so it won’t get you to the moon but it can get you a pizza, or anything else. The silicon revolution that spawned the internet has created global companies and upended centuries-old industries. It’s the kind of creative destruction Schumpeter would appreciate, making us (labour, that is) more productive and the companies in which we invest more profitable.

Except that there’s no evidence of that actually happening, at least not since the 1990s. Earlier this month the US announced that non-farm productivity fell for the third consecutive quarter, the longest period of decline since 1979. It’s strange, don’t you think? Here we are in the midst of a transformative era of Uber, AirBnB, gene splicing and coffee cups that give you a kiss* – and the country that’s leading the way is experiencing falling productivity.

Theories abound as to why; from lazy workers and poor data to income inequality and under-investment (a story I will one day get to). Facebook investor Peter Thiel is so concerned he’s lovingly published a beautiful online lament (one must be careful about what one says about dear Peter), titled ‘What happened to the Future?’ It claims the rate of technological innovation is actually slowing, which is why we got Twitter’s 140 characters instead of flying cars.

The truth is more banal; no one really knows why productivity growth has been in long-term decline.

The Treasury chart shows Australia’s performance is better than most, although that’s not saying much. It’s been decades since Western countries experienced the rates enjoyed in the 1950s and ’60s. We might be transitioning away from the mining boom with some success, via an investment-led property boom, but slow productivity growth is a global problem.

This issue looms large over negative interest rates, currency wars and sovereign debt; all of which would be less of an issue if productivity growth were stronger. Rising productivity drives increases in household income, which boosts economic growth and corporate profits. In the long run we can’t expect dividends to increase without it. And yet dividends have been increasing faster than corporate profit growth.

Higher dividend payout ratios mean lower levels of reinvestment but that’s what investors demand, sacrificing higher future income in favour of cash right now. And companies have all the excuses they need to comply. Hurdle rates are ridiculously high compared with interest rates and they, like their customers, are worried about the future. Why not spend earnings on mergers, acquisitions, share buybacks and dividends? So, enjoy the sounds of those fat cheques hitting the doormat over the next few months, they may not be quite as high in years to come.

Reading between the lines, Commonwealth Bank chief executive Ian Narev might hold a similar view. At the bank’s recent results presentation he said that “dividends are not annuities”, a bland statement of fact but a rebuke of sorts to dividend-chasing investors. Our banking analyst, Jon Mills, meanwhile, believes the big banks “are going to find it tough to raise earnings and dividends over the next few years”.

It’s a common view among brokers and fund managers and has been for quite a while. Increased capital requirements and regulatory costs, potentially higher provisioning and slower credit growth could be a drag on the sector’s earnings. Last week, corporate trailing indicator Moody’s joined the slumber party, putting the sector on a negative credit outlook – not an actual downgrade but the threat of one.

Bank shareholders shouldn’t be too concerned. InvestSMART’s research director James Carlisle, who excitedly told me yesterday the banks are within spitting distance of joining the Buy list, certainly isn’t. If investors are reaching for yield, they’re not leaning the banks way.

Perhaps a change is afoot. Wealth manager IOOF Holdings and conglomerate Wesfarmers, both of which in the past have registered extremely high dividend payout ratios, recently announced dividend cuts. Neither were punished for it, which is as it should be. Dividends should reflect the state of a company’s finances and the opportunities it has to reinvest capital. When boards get hung up on maintaining dividends bad decisions can be made on both those fronts.

Kudos, too, to BHP Billiton, where management rather than mine-quality is the problem. It has committed to pay out at least 50 per cent of underlying earnings as dividends. With one hand tied behind its back the company’s capacity to make more overpriced acquisitions is therefore halved. Sometimes, a company unable to reinvest too much capital is a good thing.

There’s another lesson here, too, one that might be echoed in the banking sector should a credit downgrade actually occur. Deputy research director Gaurav Sodhi, in his review of BHP, put it thus: “It’s not good enough to wait for improvements in business conditions before buying shares. Uncertainty and pessimism are what create opportunity and expectations will always lead reality.” Investors aiming to outperform the market must lead, and we can’t do so from the back.

Another factor evident this reporting season is the effect bond yields are having on growth. Low bond rates have caused a weird reversal, one where bonds are purchased for capital growth and shares for income. Highly-leveraged, tick-tock infrastructure stocks like Transurban and Sydney Airport, plus just about every Australian Real Estate Investment Trust (AREIT) you can think of, have enjoyed huge share price increases as a result. We’re currently at the point where high yield usually implies higher share price risk.

Now it’s the turn of growth to get a little love. Earnings growth expectations were low this reporting season and any company that managed to beat them, even by a bit, has benefited. ASX and Trade Me – the latter still on our Buy list and the former only recently removed from it (disclosure: I’m a shareholder) – are good examples. Whether this is the return of common sense or an early preview of another episode of crazy we’ll just have to wait and see.

All of these examples, though, point to the incredible influence the bond market is having on share prices. Bond yields that are either negative or in low single digits are the widespread numerical expression of Larry Summers’ belief in secular stagflation. In non-economists speak, that means structurally lower global growth, accompanied by lower-for-longer rates as a consequence. So common is this thesis it’s hard to find anyone of note that contradicts it. Right now “lower for longer” seems the epitome of a cheery consensus, which is perhaps the best reason to worry about it.

Time to kiss the coffee cup for good luck perhaps?

*Korean designer Jang Woo-Seok’s ‘Human Face Coffee lids’:

Click here to read this week’s Eureka Weekly Review PDF.


Readings & Viewings

For retirees struggling with low interest rates, this article finds that low yields cause more problems than they solve.

But do low bond yields really matter? According to US economist Gary Shilling, they don’t and the bond rally is alive and well.

Deutsche Bank has been wrapped up in many a bank scandal over time but the latest exposé is one of the biggest. A long but fascinating read from the New Yorker.

InvestSmart’s own Andrew Legget on why a good brand is a great thing for a company to have but a competitive advantage it is not.

Here’s an interesting paper from the US Fed on 'Gauging the Ability of the FOMC to Respond to Future Recessions'.

Now, it seems Chinese companies wanting buy foreign assets are not only facing regulatory hurdles in Australia. A $285m bid this week by Beijing Xinwei Technology Group to buy Israel’s Spacecom is one of many deals there awaiting government approval.

The ever readable Tyler Cowan brings start-up thinking to the nation state. Singapore, Israel, the UAE and Taiwan managed it. So who’s next?  

Onto a 3-minute New Zealand documentary on Mr Sunshine, a former millionaire and self-described a-hole who now shines shoes, and is all the happier for it.

The lack of productivity growth is a big problem (see above). In the US it peaked between the 1940s and 70s but has fallen since. This New York Review of Books piece explains why.

Ever wondered what it might be like to be a lighthouse keeper. Wonder no more. Peter Hill’s diary captures the sense of it without actually having to do it. Wonderful.

Conservative strategist Matt Mackowiak explains “blowhard outsider” Donald Trump’s rise - going back to the birther allegations - via a tweet storm.

The taxi world is in for more shake-ups, and Singapore is leading the way with the first self-driving taxis hitting the streets.

Lastly, here’s one that’s a mix of modern finance and early aviation disasters. Think of the Hindenburg, and you’re on the right track. So it’s back to the drawing board for the world’s biggest “flying bum”, originally developed by the US military for $100 million and later sold for just $300,000.

Last Week

Shane Oliver, AMP Capital

Investment markets and key developments over the past week

– Shares were mixed over the last week with Eurozone shares up slightly, Australian shares little changed but US, Japanese and Chinese shares down. Nervousness ahead of Fed Chair Janet Yellen’s address to the Fed’s symposium in Jackson Hole along with downwards pressure on defensive shares weighed on the US share market and concerns about regulatory controls of interbank lending and property weighed on the Chinese share market. In a broader sense some sort of consolidation/correction seemed likely after the strong gains in share markets seen over the last six months. Meanwhile commodity prices were a bit softer, bond yields were generally flat to down slightly and the Australian dollar was little changed.

– The next few months will see a bit of a renewed ramp up in political risk in Europe with the main events being the Italian Senate referendum and Austrian presidential election re-run in October both of which have the potential to see a return to worries about a break-up of the Eurozone (which I continue to think ultimately won’t happen). But in the week ahead the focus will be on Spain. In an effort to break a political deadlock Spanish PM Rajoy has called a confidence vote to be held Tuesday or Wednesday, with a potential follow up on Friday, to help resolve the political impasse Spain has been in since the December election. While the June election saw his centre right People's Party attract more support (and the far left Eurosceptic Podemos attract less) and he has the support of the Citizen’s party, he still lacks an outright Parliamentary majority. The vote will put more pressure on the centre left Socialist party to at least abstain or risk having another election later this year. Our base case is that a minority centre right Government will ultimately be formed, but there is still some risk around that and some way to go before it is confirmed.

– Ukraine tensions on the rise. After falling out of the headlines following a peace deal, the Ukrainian conflict may be hotting up again with increasing violence in the Donbass region of eastern Ukraine and tensions around Crimea. A further escalation could threaten the peace deal and potentially cause nervousness in investment markets. However, while this may occur we doubt it will become a major problem for the same reasons we couldn't see it escalating two years ago – the US regards Ukraine as part of Russia's "sphere of influence" and Europe has little interest in getting directly involved. And of course both the US and Europe are a bit distracted at present anyway (which may partly explain what Putin is up to). In any case the lifting of sanctions on Russia next year is starting to look less likely.

– 2015-16 was a bad year for listed company profit growth in Australia, but the worst may be behind us. As is often the case with profit reporting season, the quality of results deteriorates towards the end and we have seen that over the last week. With nearly 95 per cent of results having been released the past week has seen the total number of companies exceeding expectations fall back to 41 per cent, which is below the norm of around 45 per cent. The key themes have been pretty much as expected: with a horrible year for resources stocks (with a 48 per cent profit plunge) but improving conditions ahead on the back of improving commodity prices, cost controls and supply side discipline; constrained revenue growth for industrials; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends with 86 per cent of companies raising or maintaining their dividends.

– While overall Australian listed company profits have fallen by around 8.5 per cent in 2015-16 thanks largely to the resources slump, it is notable that 62 per cent of companies have actually seen their profits rise on a year ago and the median company has seen profit growth of around 4 per cent. 54 per cent have seen their share price outperform the market the day results were released which adds to the view that results haven’t been worse than expected. Overall profits are on track to return to growth in 2016-17 as the slump in resources profits reverses and non-resource stocks see growth. 2016-17 earnings growth is expected to be around 8 per cent, with mining companies now seeing the fastest rate of upgrades.


Source: AMP Capital

Source: AMP Capital

Major global economic events and implications

– US data was a bit mixed. Manufacturing and services conditions PMIs fell slightly in August but against this durable goods orders including for capital spending were stronger than expected in July. Existing home sales fell in July but this followed several months of gains and new home sales surged higher pointing to a sharp rise in housing starts and permits and home prices continue to rise moderately. Meanwhile unemployment claims remain very low.

– Eurozone business conditions PMIs continue to point to resilience with the composite PMI for August rising slightly to a solid 53.3, a level which is consistent with ongoing moderate growth.

– The Japanese manufacturing conditions PMI improved slightly in August but remains weak at 49.6 indicating continued weak growth in Japan. Meanwhile the CPI remained in deflation at -0.4 per cent year on year and core inflation slipped back further to just 0.3 per centyoy. The benefits from Abenomics – at least in terms of breaking the deflation mentality in Japan – look to be fading. Ultimately I think the BoJ and the Japanese Government will jump in with more aggressive policies – but that may still be a way off.

– China's MNI business sentiment indicator for August fell, but retains most of the gains it has seen since its low earlier this year. Meanwhile, after the rebound in property prices seen over the last year it’s no surprise to see Shanghai looking at ways to cool it down again and People’s Bank of China moves to tighten up rules around interbank lending arrangements also caused some consternation in the last week.

Australian economic events and implications

– Australian construction activity fell more than expected in the June quarter, led as usual by another sharp slump in mining related engineering activity which offset gains in residential and non-residential building activity. With this pointing to another weak quarter for business investment and trade unlikely to contribute much to growth after the March quarter surge, June quarter GDP growth could fall back to around 0.3 per cent quarter on quarter after the 1.1 per centqoq surge in the March quarter. That said, it will still be up 3.1 per cent year on year. Perhaps more significantly, the volume of engineering construction has now fallen back to near its long term trend indicating that the wind down in the mining investment boom is almost complete and that it will be less of a drag on growth next year. Meanwhile, skilled vacancies slowed again in July consistent with a further slowing in jobs growth after the surge of the last year but the ANZ-Roy Morgan weekly consumer confidence index has hit a three year high which may be good news for consumer spending.

Source: ABS, AMP Capital

Shane Oliver is head of investment strategy and chief economist, AMP Capital.

Next Week

Craig James, CommSec

Spring has sprung

–  Every change in seasons is ushered in with a barrage of economic data. So with the profit reporting season coming to an end, now it is time for the economic data reporting season. Business investment and retail spending are the highlights in Australia in the coming week.

– The week kicks off on Tuesday with the volatile Building Approvals indicator from the Australian Bureau of Statistics (ABS). The data represents the collated information of approvals by local councils to build new homes and commercial buildings.

–  Also on Tuesday ANZ and Roy Morgan issue the usual weekly consumer confidence survey. Confidence levels are at three-year highs.

–  On Wednesday, the Reserve Bank releases data on private sector credit – or loans outstanding. And at the same time the Housing Industry Association issues estimates of new home sales.

– Private sector credit surprisingly slowed to just 0.2 per cent growth in June, with both business and personal lending going backwards. Still, the data covered the election campaign period, and other indicators also have pointed to a slowdown of the economy over that time.

– New home sales soared by 8.2 per cent in July after falling by a similar magnitude over the previous two months. It now appears clear that new construction has peaked, although activity could end up running across the top of the mountain for a few months before easing.

–  On Thursday the Home Value Index for August is released by CoreLogic and RP Data. Based on figures released to date, Australian home prices may have lifted 0.5 per cent in the month, led by Sydney (up 1.1 per cent) and Melbourne (up 0.9 per cent) while other capital city home prices have flattened.

–  It clearly is a big day on Thursday. Not only is the closely-watched home price data released, data on business investment, retail trade and the Performance of Manufacturing gauge are also on the agenda.

– Retail spending softened over June and July as consumers sought to tread cautiously over the election period. Spending may have risen 0.3 per cent. And business investment was also likely affected by the election campaign as well as the UK vote on European Union membership. Private capital expenditure may have fallen by 5 per cent in the June quarter.

– The Performance of Manufacturing index may confirm that the sector is recording its strongest expansion in a decade.

US jobs data focuses minds

–  The key economic data release on international markets in the coming week is the US non-farm payrolls or jobs data to be issued on Friday. Key purchasing manager surveys in the US and China are also in the spotlight.

–  In the US, the week kicks off on Monday with the release of data on personal income and spending. Incomes may have lifted 0.4 per cent in July with spending up 0.3 per cent. But the Federal Reserve’s preferred inflation measure (the core personal consumption deflator) will also be in focus. Annual price growth stands at just 1.6 per cent.

– On Tuesday, the CaseShiller home price series is released, with a measure of consumer confidence and the usual weekly estimates of chain store sales. Home prices are up 5.2 per cent over the year but may lift further on indications that the new home market is tightening.

–  On Wednesday the ADP national employment report covering private sector jobs is scheduled. The report is the forerunner to Friday’s jobs report and analysts are tipping a 165,000 lift in jobs.

– On the same day the influential Chicago purchasing managers index is released together with the weekly data on home loans.

–  On Thursday, the surveys of purchasing managers come into focus. The surveys are released across the globe with much interest in results for China and the US. In China the manufacturing purchasing manager’s index stands at 49.9 with services at 53.9. The US manufacturing sector appears in better shape, currently standing at 52.6. Any reading above 50 indicates expansion of activity.

–   And on Friday the US non-farm payrolls data is issued. It is clear that the job market is in good shape with jobs up 255,000 in July and the jobless rate at 4.9 per cent. Economists are tipping more job creation of 164,000 in August. Stronger-than-expected job gains together with higher wages would lift speculation about a December rate hike.

–  Also on Friday in the US, international trade data is released with factory orders.

Sharemarket, interest rates, currencies and commodities

–  The MidCap50 share index has continue to scale new highs and is up 18 per cent in 2016. eLeading the way are the three heavyweights in the sector: Aristocrat Leisure, up 55 per cent, Fortescue, up 169 per cent, and Cochlear, up 48 per cent since the start of the year.

Craig James is chief economist, CommSec.

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