Crikey

Economists and analysts at Bank of America/Merrill Lynch have warned that Australians have become too complacent about “potential poor economic conditions”.

The warnings have come in the past two days of client notes, with economists warning yesterday of the impact of the sizeable downturn in demand for our strongly performing export sector in the months ahead.

“We don’t want to overstate the case for Australian economic weakness for the remainder of this year but we do think that there is complacency about what lies ahead,” ML economists wrote.

And this morning, broking analysts warned, in a sweeping downgrade to the outlooks for some of our major retailing names, that “households and businesses are expected to find it tougher in the months ahead with both profits and wages hurt by the income effect of a delayed drop in commodity prices and investment”.

The warning comes as the Organisation for Economic Co-Operation and Development has released figures showing the worst-ever performance by the group’s 30 countries as a whole (plus the six major non economic members such as China and Brazil).

Based on preliminary estimates, the 30 OECD and the six other economies saw growth contract by 2.1% in the March quarter, the biggest ever fall recorded by the OECD, following the 2.0% contraction in the December quarter.

Our first quarter growth figures are out next week and estimates put our contraction around 0.3% to 0.5%. That would make it the first recession since 1991, but even so, many analysts point out that compared with our trading partners, its outperformance.

This view has been supported by solid retail sales figures, building approvals and housing finance numbers for February and March, while the jobs situation refuses to worsen like it has in the US, UK and Europe. In fact since Lehman Brothers collapsed last September, Australia has seen 177,000 jobs lost, while 62,000 have been created. That’s a far more buoyant labour market than in our trading partners.

Hence this feeling of complacency that Merrill Lynch has warned about yesterday and today.

The economics team said yesterday:

Data over the next fortnight should show that, during the just completed half year of global economic “heart attack”, Australia’s GDP contracted only very modestly despite a 6 to 7% annualized drop in trading partner activity.

It is hard to believe that Australia won’t now under-perform other economies in the next phase, especially since Australia’s National Accounts have benefited from a very large positive net export contribution, at odds with the global implosion of trade, suggesting lags are at play. Moreover, a leading indicator comparison suggests Australia is vulnerable to “catch-up” deterioration.

We don’t want to overstate the case for Australian economic weakness for the remainder of this year but we do think that there is complacency about what lies ahead.

Looking at two leading retailers, David Jones and the still rapidly growing JB Hi-Fi, ML said this morning:

We believe they have a very tough 12 months to get through with economic conditions in Australia likely to deteriorate. We believe that there is too much complacency toward potential poor economic conditions in Australia — highlighted by the recent out performance of the discretionary stocks in the last few months.

Households and businesses are expected to find it tougher in the months ahead with both profits and wages hurt by the income effect of a delayed drop in commodity prices and investment. This was seen in Canada, Norway and New Zealand, where the income effect of falling commodity export prices through the economy was initially underestimated by the respective central banks.

ML Economics has also noted leading economic indicators have been just as weak for Australia as they have for the top 36 countries (OECD30 plus the six major non member economies), with indicators worse than in the 1990s.

We have downgraded our recommendations for the discretionary retailers. We have now moved to an Underperform (from Neutral) for both David Jones and JB Hi Fi and have maintained our Underperform recommendations on Billabong, Wesfarmers and Pacific Brands. Although FY09 for the retailers could surprise on the upside, we believe FY10 will be a year of heavy disappointment, as economic conditions in Australia are likely to be at their worst.

Like our Australian Economist, we believe that there is a high level of complacency broadly in Australia toward the economic conditions that potentially lay ahead. Australia has been insulated or shielded from probably the worst global financial crisis in 75 years through extremely aggressive central actions directed solely toward the consumer … which look unsustainable and extremely costly to future consumers.

The retailers are benefiting enormously at present, and FY09 earnings are likely to be strong. However, the concern is what will happen when the stimulus packages run off and retailers have to cycle current conditions at a time when unemployment is expected to rise significantly. We expect 1HCY2010 to be a very difficult time for discretionary retailers in Australia…and based on the experiences of the retailers in the US … the impact to earnings from a downturn could be very severe.

Billabong’s most recent downgrade in earnings (its fourth in the past six months) should be seen as a wake-up call for others in the discretionary space given its magnitude and speed of deterioration … particularly when the slowdown starts hitting Australia.

Overnight there were reports from Canada (mentioned above as being a possible model for Australia) where the Government is now belatedly waking up to the slumping economy. Canada’s position has been worsened by the Eastern half’s (and most populous part) exposure to the US economy, especially the imploding car industry and Chrysler and General Motors in particular.

Bloomberg reported Canada’s Finance Minister Jim Flaherty as saying the federal deficit will be “substantially” greater and the economy will shrink more than he forecast in January. He forecast growth would contract by 0.8% in the Federal budget on January 27.

Now the Bank of Canada has estimated growth will shrink by 3% this year after a fall of 3.4% in the last quarter of 2008. With the Bank of Canada cutting interest rates to 0.25%, it is effectively hostage to the contracting US economy and the car industry.

The central bank reckons first quarter growth could fall at an annual 7.3% when the final figures are released shortly.

Merrill Lynch reckons that fate could be ahead of Australia as export prices and volumes for coal and iron ore contract sharply. Offsetting that is that much of contraction in export income will be felt offshore through the foreign owners of our resources (such as Xstrata, Anglo American, UK and other shareholders in BHP Billiton and in Rio Tinto).

That could prove a crucial difference, and the absence of a heavy preponderance on exports of manufactured goods of all types, especially cars and computer equipment which have been devastated by the slump in demand and global trade since late 2008.