|Summary: Australia’s unemployment has risen, and many are already sounding the economic alarm bells. Yet, the rate is still well down on where it has been, and with the labour market being a lagging economic indicator, the impact of a modest lift in unemployment is actually a net positive for equities.|
|Key take-out: Wages growth is the lowest it’s been for at least 16 years, and with labour costs a huge proportion of any company’s costs, lower growth supports the earnings environment. The firms up the view that earnings growth will remain robust through 2014 and 2015.|
|Key beneficiaries: General investors. Category: Economy.|
Rising unemployment is shaping up as one of the biggest obstacles to Australia’s economic prosperity – some claim – and it is frequently cited as a key reason why investors can’t expect ongoing earnings outperformance.
Even company managers often cite a rising unemployment rate as either a reason for their company’s underperformance, or a factor in their ongoing caution. The Reject Shop is a shining example, but so too is Toll and may others. More broadly, it is also offered as a reason to be bearish about property, our banks and the Australian economy. It’s big, and a critical point of concern.
But just how bad is the story really?
Well, that all depends on where you want to look from. Relative to February 2008, it’s bad. The unemployment rate has spiked 50% since – from a low of 3.98% – to 6% now.
But think of the economic circumstances that saw unemployment hit 3.98%. We had booms everywhere – credit, housing (here and abroad). The global economy itself was booming and we had the mining boom . Households were on a consumption binge and had tax cuts nearly every year. An unemployment rate of 4% can and could have only ever been regarded as an outlier.
Looked at over a longer time frame, Australia’s current unemployment rate stacks up well. Certainly the average unemployment rate since 1978 is much higher at 7%, and that average actually becomes 8% if you exclude the one-off boom years. Indeed, prior to that period, a 6% unemployment rate was a well-established and much welcomed trough (see chart 1 above). Participation was a lot lower then as well, I might add – 62% or there about (currently over 64%) – and for interest, a similar participation rate now would yield an unemployment rate of just 4% or so.
The fact that there has been no mass job shedding in Australia also argues against the more dire scenarios being painted. This is a very important point. A sustained lift in the unemployment rate can really only occur if jobs are being shed. We’re not seeing that now and, in fact, we didn’t see it after the GFC. Instead, from the years 2009 to June 2012, 575,000 jobs were created – about 190,000 per year. Why would we go from a situation where 190,000 jobs were being created every year – all the way up to 2012 – to the situation we have now where in 2013, no jobs were created? If we can create 190,000 jobs per year when interest rates were much higher, and the exchange rate well above parity – why can’t we do that now with the lowest cash rate on record and an exchange rate some 17% lower? To think that we can’t defies logic and any reasonable or sensible economic analysis.
So then why is the unemployment rate rising, and will it go much higher?
Some of the rise is structural, in that a 4% unemployment rate and the associated jobs growth reflected boom-time activity. We don’t have that now; it wasn’t normal. Moreover, a number of industries have had to adapt to changes in technology. It’s natural then to expect the unemployment rate to be higher.
Overlaying that is the fact that Australia has a leadership crisis. It permeates through politics, business and our key policy institutions. This results in bad decisions being made – and one such decision was the adoption of an exchange rate target. This has been an unmitigated disaster. How so? Because, if you recall in 2011 when the Reserve Bank began to cut rates to lower the dollar, there was actually no tier 1 economic data that justified or suggested the economy needed rate cuts. The unemployment rate was very low at 5%, consumer spending was at a trend pace, and the domestic economy more broadly was growing well above. Growth was broad-based and confidence was high!
Confidence, spending and growth was subsequently decimated only as the RBA slashed rates to lower the Aussie dollar – you can see it very clearly in the data and I don’t doubt that this is the right view. Not that it was rate cuts per se that did the damage, but rather the rhetoric that was associated with it – the prospect of a Euro zone implosion, a US double dip, the end of the mining boom – anything the RBA could use. This rhetoric altered, falsely, business and consumer expectations, and it is expectations that ultimately matter. Even the US Federal Reserve is often more concerned about expectations for a variable, like inflation, than the actual result at any given point in time. There is a reason for that – expectations change behaviour. This is a well-accepted economic principle. So, in this context, the fear trickled down to the rest of the economy. It exacerbated the uncertainty already in place due to the minority government.
With that in mind, recent rhetoric from the RBA suggests the Australian dollar target is no longer as prominent as it once was, and rates look set to remain on hold for some time. A more stable and consistent policy environment will do much to lift confidence – it is working already, which is why confidence indicators have started to lift and spending is on the up. Confidence will build (is building) and so I think jobs creation will come back soon, just like it did in 2009. Indeed, the experience of 2009 would caution against too much pessimism. Economists at the major financial institutions said then the unemployment rate would rise well into 7% territory – some suggested it could get to 10%. As it was, it didn’t even break 6% and it promptly fell back down to 5% over the year – where it stayed for two years! But only once confidence came back to the country.
A bit of slack in the labour market is actually beneficial for equities – to a point.
Noting that a spontaneous increase in unemployment has never caused a downturn – the labour market is always a lagging, not a leading indicator – the impact of a modest lift in unemployment is actually a net positive for equities.
Why? As we found out this week, wages growth is the lowest it’s been for at least 16 years and unit labour costs more broadly are negative. What that suggests is that the costs of labour are actually declining – relatively – to profit growth and, of course, broader inflation. Labour costs are a huge proportion of any company’s costs and this obviously supports the earnings environment. It firms up my view that earnings growth will remain robust through 2014 and 2015.
But surely a rising unemployment rate and modest wages growth will lead to a slowdown in spending – which, in turn, will hit corporate earnings and lower economic growth?
Its sounds logical, and it does happen – but not in each and every case. Much of it has to do with timing. Think of it this way.
- Wages turned down only in 2013, helping to buttress earnings growth. With no structural impediments to growth now, as confidence lifts and spending rises, firms will be better placed to meeting rising wage demands over the next few years.
- In the interim, households will be able to weather the moderation in wages growth, given past robust rates of wage growth, high savings and a still very low unemployment rate.
- Jobs growth is more important to overall household earnings and economic growth than wage growth anyway and low wages will actually encourage firms to hire more quickly when the rebound comes. This will do more to lift spending and overall economic growth than an additional 1% lift in wage growth.
Don’t forget also, that the current lift in the unemployment rate is a little misleading. It hides very low unemployment rates for the key earning and spending demographics – 25-64 year-olds. The unemployment rate here is about 4% for most of them – refer to chart 3.
So for me, I don’t see this lift in the unemployment rate in anyway being a malign influence for stocks or corporate earnings more generally.
It’s not the threat to the economy or earnings that many claim. There are also very clear implications of this for property and bank earnings as well.
* This article is part of the 'It's Time' series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.