The world’s best economy, with the world’s best banks, run by the world’s best treasurer, just posted a world-beating economic growth rate of 1 per cent for the three months to September. The Australian economy is, apparently, on fire, growing at an annual rate of nearly 5 per cent over the past six months.
This raises a few questions. Why has the RBA slashed rates by 50 basis points in the past two months? And why does the stock market continue to languish, seemingly unimpressed with the economy’s growth?
Well, the RBA sees a slowdown ahead and is getting on the front foot. It’s nearly a first for them. And while we can’t bring ourselves to praise a central bank, it’s certainly good to see they have taken their eyes away from the rear-view mirror for a change.
They also realise the banks will use their privileged oligopoly position to pass on only a small amount of the interest rate cut, so these days it will take two cuts to do the work of one.
The banks really are a class act, aren’t they? A few weeks out from Christmas, they have the opportunity to pass on the cut and gain in goodwill what they would lose via a shrinking net interest margin.
But who needs to think about goodwill when you get your own way by threats and bullying anyway? Never has a business group taken so much from society and given so little in return. Shame on them.
As for the stock market, here’s a theory for you. A great deal of Australia’s economic growth has come from huge investment in resource projects to satisfy the demand from China. WA’s economic growth rate for the September quarter was 8.4 per cent, the fastest state growth ever recorded. In contrast, NSW managed just 0.5.
Chatting across the desk about it this morning down in sunny St Kilda, Dan Denning pointed out the growth rate in WA resembled that of China. Coincidence?
We think not. Here’s the deal. GDP growth rates don’t really care for profitability. But the stock market does. The market recognises the resource-led investment boom is a product of China’s credit boom. It’s looking a few years ahead and discounting the effect greater capacity will have on prices and profitability.
In other words, all those billions of dollars of investment won’t generate the returns they are expected to. If the companies and investors are lucky, the returns will just be above the cost of capital. But if things go the way of most credit-bubble-bust aftermaths, returns will be below the cost of capital, leading to writedowns…and slower future economic growth.
for The Daily Reckoning Australia