In a world where Japan and the UK are now in recession and China and Europe’s economies slowing; what is the prognosis for Australia and the rest of the world?
For a while now, the anecdotal evidence indicated the Australian economy was trending towards a slowdown, whether from talking to retailers or from conversations with consumers about the cost of living. However, the critical economic measures were not reflecting it. Now that is starting to change. Unemployment rising is the canary in the recessionary coal mine. As the economy slows, businesses are forced to lay off workers. That further reduces the amount of money consumers have to spend in the economy. This creates a downward spiral of slowing business conditions and job losses that ultimately lead to a recession.
Outside of the USA and a handful of emerging markets, there are few regions that display robust economic growth. Part of the reason for the continued strength of the USA share market and economy more broadly is their position as the focal point of the global economy becomes magnified as geopolitical tensions rise around the world. Emerging markets such as Chile, Mexico and Vietnam are doing well as the beneficiaries of the US reshoring their supply chains away from their reliance on China.
China’s systemic issues are a problem, from their over supplied property market through to their over reliance on building and infrastructure to stimulate growth. Overlay the slow but steady shift away from China being the worlds supplier and they are severely restricted in their ability to stimulate their economy. This does not bode well for many economies, especially Australia because of our reliance on the mining industry and China being our key export partner.
In Australia, a recession was always on the cards when you get such a fast rise in interest rates. Interest rates are starting to bite. Its taking a long time but all the signs are there from rising mortgage stress to falling retail sales. However, until there is a greater slowdown in the jobs market it’s a guessing game for central banks as to when to stop hiking rates, let alone drop rates.
We now have unemployment creeping up from 3.5% in June 2023 to 4.1% now. This is data I have been watching most closely as an indicator that Australia is starting to head to recession. A sustained China slowdown, impacting the mining industry here would compound this issue and accelerate the timeline.
Central banks manage interest rates in a comparable way to driving a car. Unfortunately, it’s much more like hitting the accelerator and jamming on the brake rather than moving smoothly through the gears which is how it would work in a perfect world.
The problem then is that there is a lag effect. Once you have that material move in the unemployment rate the wheels of economic decline have already been set in motion. So, in the months that follow, as the RBA works out its next move, it is more likely than not that unemployment keeps rising from here. Until it gets to a level where it is very clear that interest rates do need to be cut. At that point however, real damage will have been done to the economy and it will continue to flow through for some time even as rates are being cut.
What this means from an investment portfolio perspective is that I am very cautious. We are underweight growth assets such as international and domestic equities. We still have exposure to many of the big tech companies across the world that I believe should form the core of your investment portfolio for the next decade. But we don’t hold the level that they represent in the S&P500 index.
We have a strong preference for solid and almost boring businesses that are more likely continue to deliver reliable profits in tough times. Additionally, we are overweight cash and income assets such as bonds and high-quality corporate debt.
We have positioned our portfolios for recession as a realistic risk we want to mitigate against. If it doesn’t happen that’s great for Australia and our portfolio’s will do just fine collecting dividends and interest and adding some growth along the way. However, I’d certainly prefer to err on the side of caution in this environment and continue to protect against the downside risk of a recession.
General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.