Household Spending – Back To The Future

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By Greg Peel

Stock analysts have, since 2007, made a couple of glaringly incorrect assumptions, on a consensus basis.

When the Credit Crunch began in 2007 and started to morph into the GFC, analysts suggested buying Australian banks because “banks are defensive”. This call could not have been more wrong, and once this was realised the next assumption analysts quickly made was that levels of bank borrowing would bounce back quickly after the GFC. They haven't.

When the GFC hit, Australians suddenly went from being profligate spendthrifts gorging on credit to shell-shocked misers paying down debt and rushing into bank deposits. Stock analysts expected the retail sector to be hit in the short term, but they also expected a rapid rebound to pre-GFC spending levels. This call could not have been more wrong.

We could also throw in near consistent forecasts that Australian housing prices must just keep going up and up. They haven't.

In the bull market of 2004-07, Australians watched bank share prices soar, stretched household credit to levels which left their parents shaking their heads in disbelief, and bought houses for the sole purpose of selling them again for a profit. Or if not, filling them with every perceivable luxury and electronic good, on credit. Before this period, bank share prices did not “soar” because banks truly were defensive, based on steady, rather than exponential, household and business credit growth. Housing price rises were also steady, at levels more akin to simple population growth.

Today it feels like the Australian economy, outside of mining, is in a recession. Banks are facing minimal earnings growth on subdued credit demand, retailers are watching sales figures slide relentlessly, and new homeowners are watching their property values stagnate. However, if you were around in 1992, you'd say this is not a recession. Five percent unemployment is not a recession. Indeed, if we leave business out of it for a moment and concentrate on households, Australian consumer spending is not weak at all.

Commonwealth Bank researchers wish to explode a few myths.

The general perception has been that Australian consumer spending has been weak, driven in part by lacklustre retail outcomes. Yet in reality, suggests CBA, household spending has been growing strongly over the past two years.

Weak retail sales growth over past years is not just a function of consumers staying away in droves. The emergence of China, which has offered cheap labour for manufacturing, has driven down the cost of goods. This deflationary effect on prices has helped keep inflation at deceptively low levels, thus allowing for lower interest rates. Low goods prices act as an effective rise in real wages, CBA notes, while low borrowing costs have pushed up the demand for credit and thus in turn, asset prices. China's consumption of Australian raw material exports, which come back in the form of fridges etc, has helped push up the Aussie dollar. The stronger Aussie has allowed for more spending power both domestically and offshore.

China may have pushed down the global price of goods, but China has not impacted on the Australian services sector. In recent years household spending has been concentrated in services, where inflation has significantly outpaced the price of goods.

This all began from around the early noughties. However to appreciate just why Australia experienced such a debt and asset price (houses/stocks) bubble, one must go back further to a couple of significant structural changes, CBA points out.

Deregulation of the Australian banking sector in the 1980s provided for easier and cheap household access to credit. The commencement of central bank inflation targeting in the 1990s allowed households to sustain higher levels of debt. What we have, in reality, seen in Australia is not a credit bubble and bust and a subsequent asset price bubble and bust but a step-jump adjustment that has taken twenty years. Australia's household debt to income ratio peaked in 2006, prior to the GFC, and has been tracking sideways ever since, CBA notes. From 2007 household credit has been growing largely in line with disposable incomes, just as it did before the 1980s.

As this step-jump was slowly occurring, households left behind the concept of savings and instead accumulated wealth via credit-financed asset price appreciation. When the debt to income ratio peaked in 2006, the household savings rate began to rise again, and it has now reached around 10% of disposable income.

Where stock analysts and perhaps flummoxed retailers have had it wrong is in believing the GFC would represent merely a cyclical anomaly before a reinstatement of the roaring trend. What CBA is concluding is that household spending has returned to trending at historical levels, and that the structural influences of the last twenty years represent the (once in a lifetime?) anomaly.

How does this leave Australian retailers and retail investors?

It would be foolish to expect another spending frenzy anytime soon, there is little to suggest we may see a significant depreciation in the Australian dollar, and the online revolution is no passing fad. Chinese wages and costs will one day catch up to those of the developed world if the Japanese experience is anything to go by, but not for a long while yet.

In the nearer term scenario nevertheless, RBS Australia does not see yet another shocker of a reporting season approaching for listed retailers. If anything, retail stocks may outperform in the lead-up.

RBS has noted that the past six weeks have appeared to be more positive for discretionary retailers, however government hand-outs and cooler weather have been factors which are unlikely to be sustained. Yet the television category of electrical has shown some signs of deflation easing, the analysts note, and recent improvement may see the likes of JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)) meeting earnings expectations. Given this has become a rare occurrence, outperformance should follow.

RBS does believe, however, that FY13 consensus expectations for HVN are too high.

In the clothing sector, RBS cannot see much further downside for Billabong ((BBG)). Disclosures have left the market well informed, and asset write-downs have already been well flagged. RBS suspects new senior management and board appointments will also be announced, which one assumes cannot be a bad thing.

In the consumer staple sector, the tough sales environment (like-for-like basis) experienced in the second half of FY12 was expected given last year's inflation hurdle. The supermarkets have planned for this, and RBS expects both to speak of an improving inflation backdrop on the release of their results.

RBS expects Woolworths ((WOW)) to issue better FY13 growth guidance than FY12's 2-6%, and the market agrees with consensus currently at 9%. The market has Coles owner Wesfarmers' ((WES)) FY13 growth at 13% at present, which seems reasonable to RBS.

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