Australia | Oct 09 2009
By Andrew Nelson
The global economy is slowly entering a phase of renewed expansion in Q3, with the US and Europe gingerly shifting from contraction to growth, while major emerging markets are consolidating on their previously commenced expansions. Yet as we move into the US Q3 earnings season, there is an increasing amount of pressure on company results to justify the current rally in investment markets.
While not negative, economists from Westpac are less than optimistic about what we’re likely to see in terms of US economic performance. More specifically, the team is doubtful about the sustainability of economic growth going into 2010, noting that the deep balance sheet stresses that were inflicted over the last year are a long way yet from being fixed.
While the current month started out well, with the bulk of leading indicators continuing to paint a pretty picture of a second half bounce in economic growth, a weaker than expected durable goods report and a much weaker than expected non-farm payrolls update in the US raised some real questions about the sustainability of the recovery.
The team at Westpac remains fairly comfortable with the view that the US economy will continue to grow though the second half this year and into the first quarter of 2010, but the economists also think the prospects for the rest of next year are far from certain. With household balance sheets still under considerable pressure, it’s tough to see exactly where growth will come from once the current boost from inventory adjustment has run its course, they say.
It’s the slowdown in the inventory cycle that remains one of the bank’s biggest concerns as regards the US recovery. The team believes there is a significant chance that in early 2010, companies will become more convinced that the current economic momentum is real, rather than just stimulus related. This would lead to a continuation in the rebuilding of inventories on the expectation of improving sales prospects. But Westpac thinks that “this may be tantamount to jumping onto a burning bridge”.
The economists reason that if demand remains anywhere near as stagnant as it is now, which the balance sheet situation supports as being a very real possibility, companies will be forced to enter into a second de-stocking phase. This would mean companies would have to shelve current workforce and investment expansion plans that are currently in the works and crucial to a sustained recovery.
Access to credit, particularly for small business, also poses a significant problem for the prospects of a sustained recovery, says the team. The economists point out the most recent National Federation of Independent Business survey indicates that credit conditions are tougher now than what they were in 1990. So while Federal Reserve surveys indicate the pace of standard credit tightening has eased, Westpac believes the overall standards are still being tightened in an absolute sense.
In the 1990s, the net balance had to move to easier credit conditions before small business reported a net improvement in the availability of credit. However, this time around, the team doesn’t see growth in non-bank lending as being able to offset currently tight bank lending standards.
Tight credit conditions is also one factor that has the bank doubting the sustainability of the current, if minor, recovery we are seeing in housing prices as well. While the team admits that a recovery of sorts is under way in housing, it is dubious that lending will continue to support it. Even if banks do become increasingly willing to lend, the weakened state of household balance sheets makes it doubtful there will be sufficient appetite for expanding mortgage debt.
This view, says Westpac, is supported by the observation that household perceptions of their own finances remain about the worst they have been since the University of Michigan consumer sentiment survey started in the 1970s. So despite the significant increase in housing affordability, the team just can’t see how a full blown housing recovery can actually be happening.
With around 4m houses still for sale versus a long-term norm of around 2.5m, plus the disappearance of recent government action taken to slow the pace of foreclosures and boost first home buyer demand, the team sees a clear risk of a further correction in house prices and activity in 2010. This would, of course, place the household balance sheet measures under even more pressure.
All of this means that unlike previous cycles, this time around employment will have to play a major leading role given its obvious influence on household incomes and consumption. Up to now, government largesse has been offsetting the income loss from rising unemployment. But as this money dries up, as it is already doing, more pressure will be heaped on labour generated income growth, which means households will have to reduce already diminished savings even further to maintain consumption in early 2010.
The larger than expected fall in September non-farm payrolls started the alarm bells ringing, but more worrying, says Westpac, is the 0.5% month on month decline in total hours worked. This means that even those that are working will be making less, meaning a reduction in labour income. So with US household working furiously to de-lever, consumption will be constrained as households try to claw back some of their savings.
With the US being above and beyond all a consumer driven economy, until the average American is happy with the household balance sheet, a real and sustainable recovery must remain in doubt.
