A recent HSBC report looking at the state of the Aussie economy makes for interesting reading. The bank has cut its growth forecast for the second half of 2015 by 0.2%. Having initially penned growth at 2.6% this year, they’ve readjusted it down to a more modest 2.4%.
They cite two reasons for lowering their expectations. The first is that China’s slowing growth rate will continue to drag on Australia’s economy. The other concerns weaker business spending, with capital expenditures set to fall by $104 billion in 2015–2016.
According to HSBC, a lack of investment is just part and parcel of the modern world we live in. The ills affecting the Aussie economy are the same ones dragging on the rest of the world.
Growth prospects in the US remain weak. They, too, are suffering from investment stage fright like we are.
Since 2000, investment levels in both nations have plunged. Most worryingly, non-housing investments have been most affected. The problem is that both countries have had a disproportionate share of investments skew towards the property market. That’s partly to blame for worsening growth prospects in both respective nations.
So how do we address the issue of falling growth rates? The easy answer is to look to monetary policy to provide the solution. Unlike the US, Australia still has room to lower interest rates further to boost growth. But according to HSBC, that’s not going to happen. I’ll explain why.
Why we might be waiting on a rate cut that never comes
You wouldn’t be wrong in assuming that falling growth rates will result in further rate cuts. After all, that’s been the RBA’s modus operandi since mining revenues started to decline sharply in 2012. Already, we’ve had two rate cuts this year, shaving 0.50% off the cash rate.
But according to HSBC’s chief economist, Paul Bloxham, the RBA won’t consider cutting rates again anytime soon. He expects the current 2% cash rate to remain unchanged until 2017. Whether or not that proves to be the case is debatable.
Most economists fall into three camps today. There are those who think that a rate cut is imminent; those that believe a rate hike is coming; and those who agree rates will rise, but not for a while. HSBC fall into the latter category.
Admittedly, I’ve fallen into the first camp myself in the past. Yet their evidence to support the view that rates will remain on hold is persuasive.
The bank holds the view that the model of demand, when matched up against investment levels, doesn’t quite add up. By this, they point to company profits, which continue to remain relatively high.
Yet, taken in the context of low interest rates, investment levels have remained flat. In other words, the rate of investment doesn’t quite match up to profitability. They explain:
‘Instead of regarding low interest rates as a cause of stronger investment, it might make more sense to think of weak investment as a cause of lower interest rates’.
That makes sense, doesn’t it? Low interest rates don’t necessarily lead to increasing investments. Better to think of it the other way then, where falling investments cause rates to drop.
Why investment levels are dropping
A plausible answer to explain a decline in investments is that investor expectations are changing. By this I mean that shareholders are increasingly less likely to back expansionist strategies that rely on reinvesting profits.
As the world’s population ages, investors are increasingly becoming risk averse. This is reshaping how companies view long term investments on the whole.
Instead, savers are prizing a stable income stream over the potential returns of investments. As a result, companies are less willing to increase investment. Who could blame them?
Everyone, from investors to board rooms, is becoming more conservative. The effect of this is that lower investments are contributing to weaker economic growth.
This new outlook on investments is creating an investor mentality that prizes dividends payouts. More and more companies are benefiting by adopting a dividend-first policy. Naturally, that’s coming at the expense of companies who reinvest their profits.
The other factor not helping investments relates to hurdle rates. This simply refers to the rate of return businesses expect to make on future investments. For over 90% of companies in Australia, the rate of return remains above 10%. The problem is that many companies put off investments unless the hurdle rate exceeds the 10% threshold.
The low interest rate environment should have lowered the rate of returns that companies could realistically expect. But a paper released by the RBA shows that hasn’t happened. So it’s not difficult to see why investments are falling. Almost everything is conspiring against businesses that retain a progressive attitude towards investments.
All this explains why falling investments are taking a toll on global economies. The truth is that lowering rates just isn’t a viable way to boost economic growth anymore. The RBA have realised that trying to do so only pushes up asset prices without helping the economy grow.
What’s more, companies won’t care if rates go lower. That’s not going to convince them to increase their investment levels. Instead, they remain more concerned about hurdle rates, and satisfying an investor base that’s become more conservative.
None of which bodes well for the future prospects of the Australian economy.
Contributor, The Daily Reckoning
PS: The Daily Reckoning’s Greg Canavan has been warning for months that Australia is sleepwalking into a recession. One third of Australia is already in a recession. As one of Australia’s leading investment analysts, Greg says the rest of the economy isn’t far behind.
In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why a national recession is a near certainty. Falling mining revenues will continue to drag on government spending for years to come. As we’ve seen, the RBA won’t be able to keep the recession at bay by lowering rates.
But there is a silver lining for anyone who prepares for the worse. Greg wants to show you how to protect your wealth, and your family’s wellbeing, from the fallout of a recession. To find out how to download the report right now, click here.