Why Falling Business Investment Points to a Recession

Stock investment analysis

Business investment in Australia is falling — again. It’s a timely reminder that, no matter how bad things look, they could get much worse.

Of course, it’s not surprising that businesses are cutting back on spending. The resource sector remains hamstrung by declining revenues. Miners aren’t investing, which means Australia isn’t investing. If that sounds too simplistic, it’s because it is. As the mining sector goes, so too does the Aussie economy.

And yet, there are still some that believe non-mining sectors will come to our rescue. They argue that services could spend enough to lift the entire economy out of trouble.

Nothing could be further from the truth. How bad is investment tanking?

ABS figures show capital expenditures (capex) fell 4% during the June quarter. That’s far worse than the 2.5% drop many economists penned. Worse still, capex is down by 10.5% this time last year. Falling anything is bad. But declining capex figures are particularly worrying. Why?

Business investments are closely related to GDP growth. Any downturn in investments signals poor business conditions. If businesses aren’t spending, then the economy struggles to grow.

All of which makes next week’s second quarter GDP figures particularly concerning. With business investment down, second quarter GDP growth could fall.

As expected, the mining sector drove the bulk of the contraction. Manufacturing expenditure didn’t help matters either. It fell by 3.4%, the seventh consecutive month of decline. But it still pales in comparison to the mining sector, which fell by 11.3%.

It’d be handy if we could place all the blame on mining. But there’s a more worrying trend lurking beneath the surface. The non-mining sector continues to underperform.

JP Morgan economist Stephen Walters says non-mining investments are the issue in falling capex. Here’s what he had to say on the matter:

Unfortunately I remember the last recession back in the early 1990s. [These] numbers are worse than that. So there’s really something pretty fundamental going on here. The mining side of it is not a big surprise. Once you get to the highest level of mining investment we’ve ever seen, you’re going to have a big fall, so let’s put that aside.

            ‘The real worry is what’s going on in the rest of the capital spending spree’.

Business investment is the weakest since 1992. I don’t need to remind you that 1992 was the year of Australia’s last recession.

UBS, an investment bank, is equally downbeat on non-mining spending. It notes that weaker capex suggests the Aussie economy actually contracted in the June quarter.

All doom and gloom aside, it’s bodes poorly for the economy. Avoiding a recession in 2015 is by no means a guarantee. If anything, the odds are stacking in favour of one.

Non-mining sector lifts investment, but not by enough

It seems harsh to blame non-mining sectors on falling investments. After all, the service sector was up 4.4% for the quarter.

But Mr Walters is right to point the finger at non-mining sectors. Why? Well, businesses aren’t investing despite improving fundamentals for non-mining sectors.

If the economy is to wean itself off mining in the future, it requires growth from elsewhere.

But non-mining growth isn’t anywhere near enough to offset the downturn in resources. Which begs the question: where will growth come from? The answer is unclear. But we do know that non-mining sectors could do more. Even though it’s hiring at the fastest rate in four years, it’s still holding back on spending.

Unfortunately, the future doesn’t look any better.

The outlook for investments over the next year is sobering, at best. Business spending won’t bounce back during the 2015–16 financial year. Industry estimates suggest this will amount to $104 billion in spending cut backs.

So much for the non-mining sector steering the economy out of trouble.

Government tax break working…or it is?

The Abbot government tried to lift non-mining spending in its May budget. You might remember, the government offered businesses a generous tax break. Firms can now write off taxes on purchases of up to $20,000.

No doubt, this tax break played some part in lifting non-mining capex. But the extent of this is unclear. We’ve seen that hiring is up, but little in the way of other investments.

Yet maybe we shouldn’t be surprised by any of this. The non-mining sector simply can’t spend fast enough. At least not to the extent that could offset falls in mining expenditures.

In saying that, the second quarter figures improved on the first quarter in one respect. The speed of declining investments slowed from the first quarter. That’s positive because the first quarter was notably bad. Private sector investments fell at their quickest rate since 2011.

However this is only a small consolation. And it’s nowhere near as promising as Treasurer Joe Hockey makes it out to be. He believes this trend bodes well for the future. It’s hard to share Hockey’s optimism though. That’s because mining investments will only worsen as the rest of 2015 unfolds.

We know this because several coal and iron projects are nearing completion. Beyond that, there’s nothing on the horizon suggesting a lift in mining investments.

But it might be worse than that.

Westpac believes that service sector investments will decline too. If both the mining and service sector spending dips, we’re in a lot of trouble. There’s a likelihood we’ll see two quarters of negative GDP growth this year. Or, as you might know it better — a recession.

GDP growth to fall in the second quarter

Next week is an important one for the Aussie economy.

We’ll find out whether GDP figures matched growth in the first quarter. Westpac predicts the GDP numbers will come up short.

First quarter GDP data showed the economy grew at 2.3% in the year to March. Westpac believes falling investments could shave 0.1% off that figure. That’d put growth at 2.2% in the year to June.

However you look at it, Australia is set for a challenging second half to 2015. As Stephen Walters says, investments haven’t been this bad since 1992. With no improvement in investments forthcoming, what does it tell us about the future?

You put two and two together, and falling investments point to an imminent recession.

None of this is news to The Daily Reckoning’s Greg Canavan. As one of Australia’s leading investment analysts, Greg’s warned for months that we’re sleepwalking into a recession.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why economic growth is going to fall sharply over the next four months.

Falling mining revenues, and higher trade deficits, are already taking their toll on the economy. Government revenues are down, household debt is up, and business spending is falling too. It’s a grim outlook, and one which could shake the economy to its core.

But there are actions you can take right now to lessen the blows of the recession.

Download your free copy today to learn how to protect your wealth from the fallout of the crash. To find out how to download his free report right now, click here.

Mat Spasic,

Contributor, The Daily Reckoning


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