What are the early warning signs a boom has turned to a bubble or the boom / bubble is about to burst. Case study: Australia.
In this episode you’ll learn:
- How Australian economic growth and debt levels compare to the U.S.
- How to use purchasing manager indices as an economic warning signal.
- What are terms of trade.
- What can the government or central banks to defuse bubbles.
- What can individuals do when they see signs that a boom is weakening.
- What are current valuations for the Australian stock market and outlook.
- How the economic rebalancing in China is influencing Australia.
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My son and I once took a nighttime walking tour in the Daintree Rainforest on the northeast coast of Australia.
Our guide had us hold our flashlights against our foreheads near eye-level as we walked. This allowed us to better see the light reflected off the eyes of the jungle creatures staring back at us.
I had hoped to see a cassowary, a shy flightless bird, but we mostly saw tree frogs and smaller birds.
The birds we came upon delicately rested on the ends of tender vines that were attached to tree branches.
In the darkness, they appeared to be sleeping in mid air. They slept in this manner for protection.
Dangers In The Jungle
If a green tree python or other tree snake approached, the vine would vibrate, alerting the bird well before the snake got too close.
Our guide also showed us how to identify dangerous plants and arachnids, like the gympie-gympie stinging tree with its heart shape leaves covered with glass-like silica hairs that inject a sting as painful as a wasps’.
He pointed out wolf spiders, whose bite is painful but not lethal, and we used that newfound knowledge to identify a wolf spider in our Daintree cabin after the hike.
The spider frightened my son so much that he convinced me to leave the Daintree early the next day and find more hospitable lodgings.
Knowing how to spot dangers and having early warning systems such as the vibrations used by resting birds on vines is crucial to surviving in the jungle.
Booms and Busts In Australia
I pondered that after reading a thoughtful email I received recently from an Australian gentleman.
He writes, “My country has had some good times lately. It’s enjoyed close to a quarter of a century of uninterrupted economic growth, due to reforms, deregulation, productivity increases and, of course, the mining boom – the latter largely driven by demand from China.”
“But as you have no doubt read and heard, the effects of the boom are fading fast.”
He goes on to point out evidence the boom is ending and how it impacts Australians and his investment portfolio.
He then asks, “How did it all come to this, and why didn’t we see it coming? And what can a country do – and me, but a humble investor caught in the middle of it – when the boom goes to bust, and the good times are over?”
A Slowdown, Not A Recession
First, it is important to recognize the Australian economy is by no means in a recession. Its last economic contraction was in 1990.
From 1996 to 2008, average annual real economic growth was 3.7%. Since 2008, it has averaged 2.5% growth per year.
For comparison, the U.S. economy grew at an average annual rate of 3% from 1996 to 2008 and has averaged 1.5% from 2009 through 2014.
Even during this period of slowing growth, the Australian economy is growing faster than most developed countries.
Australia’s unemployment rate has hovered between 5.8% and 6.2% over the past year. It was 5% in 2011 at the peak of the commodity boom so there has been an uptick in the unemployed.
Still, it is nowhere close to the 11% unemployment rate Australia experienced in 1990.
Consequently, I would not consider Australia’s current economic climate a bust. Just a period of slower growth.
Were there warning signs the Australian economy was slowing?
Yes. Like the vibrations of delicate vine can warn a sleeping bird of an approaching python, there were early indicators the Australian economy’s heady growth was ending.
Most countries conduct monthly surveys of their corporate entities regarding the business climate. These are called Purchasing Manager Indices or PMI.
A level below 50 for these surveys suggests an economy is slowing if not contracting. After rebounding above 50 in 2009, Australia’s PMI fell below 50 in 2010 and stayed there most of the time until late 2014.
Throughout this period, commodity prices were declining in response to less robust demand from China as it works to rebalance its economy from one primarily based on capital investment to one where households play a more significant role.
With commodities comprising over 50% of Australia’s exports, this shift was clearly having an impact on the Australian economy.
Yet, the average Australian was unaware the economic winds had changed.
Rising Debt Levels and Home Prices
Australian households continued to increase their debt burden, much of which was used to finance houses whose prices were skyrocketing.
Australian home prices increased by 10.5% for the year ending June 30, 2015 according to the Australian Bureau of Statistics. Home prices in Sydney are up by one-third since 2012. Australia has some of the most expensive housing prices in the world relative to income and rents.
Meanwhile household debt as a percent of disposable income rose to an all time high of 194% in June 2015. The comparable figure for the U.S. is 106% as household continue to deleverage. It reached a high of 132% of disposable income in 2007.
Good Times Eventually End
During a boom, it is easy to get caught up in speculative behavior believing the good times will continue even if there are signs it might not.
How else to explain the eighty-year supply of subdivision building lots approved in Teton Valley leading up to the Great Recession. Many of those subdivisions were approved after home and lot prices had peaked and were declining in other areas of the U.S.
Prudent investors don’t invest in a vacuum. They are mindful of economic trends, debt levels, asset class valuations (including for houses) and what others are doing.
They become more risk adverse when others become over zealous, borrow extensively and believe the goods time won’t end.