Productivity not population key to Aussie living standards | Macrobusiness

From Leith van Onselen at Macrobusiness:

Former ALP minister Craig Emerson has penned an article in The AFR calling on the Morrison Government to tackle Australia’s declining productivity growth, which is central to boosting the nation’s living standards:

“Productivity growth has contributed 95 per cent of the improvement in Australians’ material living standards since 1901”.
“From the turn of the century, Australia’s productivity performance began to slide and the longer it has gone on the worse it has gotten”.
“Over the period from 2015 until the COVID-19 pandemic struck, actual productivity growth was worse than the low-productivity scenario included in the 2015 intergenerational report”.
“In the decade since 2010 – even excluding last year – Australia recorded its slowest growth in GDP per capita of any decade in at least 60 years”.
“Without a comprehensive economic reform program, Australia will inevitably have weak growth in living standards during the remainder of the 2020s and into the 2030s”.

Craig Emerson’s assessment is broadly correct, as evidenced by the stagnant real per capita GDP, wage and income growth experienced over the past decade (even before the coronavirus pandemic).

Sadly, however, the Morrison Government with the help of the Australian Treasury seems hell bent on leveraging the other ‘P’ – population growth – to mask over Australia’s poor productivity performance and to keep headline GDP growing, even if it means per capita GDP, income growth and living standards deteriorate.

Rather than using the coronavirus pandemic as an opportunity to reset the Australian economy to focus on quality over quantity, the Morrison Government is intent on repeating the policy mistakes of the past by returning to the lazy dumb growth policy of hyper immigration.

Rebooting mass immigration will inevitably contribute to Australia’s poor productivity growth by:

  • Crush-loading cities, increasing congestion costs and rising infrastructure costs;
  • Encouraging growth in low productivity people-servicing industries and debt creation, rather than higher productivity tradables; and
  • Discouraging companies from innovating and adopting labour saving technologies.

It’s time to put the Australian Treasury’s Three-Ps framework to rest once and for all, along with the snake oil solution of mass immigration.

Policy makers must instead focus first and foremost on boosting productivity, followed by lifting labour force participation. These are the two Ps that actually matter for living standards.

We agree with the concern over poor productivity growth, but focusing on labor force participation is putting the cart before the horse. The key cause of low productivity growth is declining business investment.

Business Investment

Without business investment, new job creation and wages growth will remain low. The way out of this trap is to prime the pump. Boost consumption through infrastructure programs — investment in productive infrastructure that will boost GDP growth (to repay the debt). Boost business investment through strong consumption, a lower Australian Dollar and tax incentives (like accelerated write-off) for new investment.

The lower exchange rate is important to rectify a serious case of Dutch disease1 from the resources industry. There are only three ways to achieve this:

  1. Increase imports, which would be self-defeating, destroying jobs;
  2. Reduce exports; or
  3. Export capital, of which Australia has little.

China is doing its best to help us with the second option, by restricting imports of a wide variety of Australian resources, but that has so far achieved little. David Llewellyn-Smith came up with an interesting alternative:

If we accept that the CCP is the latest manifestation of the historical tendency to give rise to political evils intent on dominating the lives of freedom-loving humanity, then why don’t we cut the flow of iron ore right now…….

The results would be instant. The Chinese economy would be structurally shocked to its knees. 30% of its GDP is real estate-related. 60% of the iron ore that drives it is sourced in Australia. Roughly speaking that is 18% of Chinese GDP that would virtually collapse overnight. Vast tracts of industry would fall silent. An instant debt crisis would sweep the Chinese financial system as its bizarre daisy chain of corruption froze. Local governments likewise. Unemployment would skyrocket.

…..What we can say with confidence is that it would pre-occupy the CCP for many years and hobble it permanently. Its plans for regional domination would be set back decades if not be entirely over.

The problem is how to convince the old boys around the boardroom table at BHP that this would be in their interest as well as in the country’s interest.

Notes

  1. Dutch disease is a term coined by The Economist to describe the impact on the Netherlands’ economy of a resources boom from discovery of large natural gas fields in 1959. The soaring exchange rate, from LNG exports, caused a sharp contraction in the manufacturing sector which struggled to compete, in export markets and against imports in the domestic market, at the higher exchange rate.

ASX: Financials suffer, A-REITs advance on lower rates

The ASX 200 advance is tentative, with a short doji candle signaling hesitancy, and we expect retracement to test support at 7000.  The Trend Index trough above zero indicates longer-term buying pressure. Respect of support is likely and would signal a fresh advance.

ASX 200

Financial Markets

Bond ETFs broke through resistance, signaling falling long-term interest rates.

Australian Bond ETFs

A-REITs advanced on the prospect of lower long-term interest rates.

ASX 200 Property

Bank net interest margins, however, are squeezed when interest rates fall.

Bank Net Interest Margins

ASX 200 Financials retreated to test support at 6500. The trend is unaffected and Trend Index troughs above zero indicate long-term buying pressure.

ASX 200 Financials

Mining

Mining continues to benefit from the infrastructure boom, with iron ore respecting support at $200/ton1. Troughs above zero, flag buying pressure, and respect of support both signal another advance.

Iron Ore

The ASX 300 Metals & Mining index is again testing resistance at 6000. Breakout would signal another advance, with a target of 65002.

ASX 300 Metals & Mining

Health Care & Technology

Health Care respected its new support level and is advancing strongly. Expect resistance between 45000 and 46000.

ASX 200 Health Care

Information Technology recovered above former resistance at 2000, warning of a bear trap. Expect resistance at 2250; breakout would signal a new advance.

ASX 200 Information Technology
Gold

The All Ordinaries Gold Index (XGD) is testing resistance at 7500. Breakout would signal a fresh advance, with a target of 9000.

All Ordinaries Gold Index

The Gold price is retracing to test the new support level at A$2400 per ounce. Respect of support is likely and breakout above A$2500 would be a strong bull signal for Aussie gold miners.

Gold in AUD

Conclusion

We expect A-REITs and Bond ETFs to advance on the back of lower long-term interest rates.

Financials are expected to undergo a correction as interest margins are squeezed.

Metals & Mining are in a strong up-trend because of record iron ore prices.

Health Care is recovering well and expected to test resistance.

Technology had a strong week but the outlook is still uncertain.

We expect the ASX 200 to retrace to test support at 7000 as its largest sector (Financials) undergoes a correction.

Notes

  1. Tons are metric tons unless otherwise stated.
  2. Target for Metals & Mining is calculated as support at 5000 extended above resistance at 5750.

Memorial Day | Gettysburg Address

Abraham Lincoln

Four score and seven years ago our fathers brought forth upon this continent, a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.

Now we are engaged in a great civil war, testing whether that nation, or any nation so conceived and so dedicated, can long endure. We are met on a great battle-field of that war. We have come to dedicate a portion of that field, as a final resting place for those who here gave their lives that that nation might live. It is altogether fitting and proper that we should do this.
But, in a larger sense, we can not dedicate — we can not consecrate — we can not hallow — this ground. The brave men, living and dead, who struggled here, have consecrated it, far above our poor power to add or detract. The world will little note, nor long remember what we say here, but it can never forget what they did here. It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us — that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion — that we here highly resolve that these dead shall not have died in vain — that this nation, under God, shall have a new birth of freedom — and that government of the people, by the people, for the people, shall not perish from the earth.

~ Abraham Lincoln: Gettysburg Address, November 19, 1863

Gold breaks $1850 per ounce

10-Year Treasury yields remain soft despite the recent CPI spike. The Fed is weighting purchases more to the long end of the yield curve. Breakout above 1.75% (green line) would signal a fresh advance.

10-Year Treasury Yield

10-Year TIPS yield sits at -0.78%, unaffected by the $369bn in overnight Fed reverse repurchase agreements which remove liquidity but mainly affect short-term interest rates.

10-Year TIPS Yield & Fed RRP

Gold broke through resistance at $1850/ounce. A rising Trend Index indicates medium-term buying pressure. Long tails on the last three daily candles indicate retracement to test the new support level; respect signals a test of $1950/ounce.

Spot Gold

Silver is testing resistance at $28/ounce. Rising Trend Index indicates medium-term buying pressure. Breakout above $28 is likely and would offer a target of $30/ounce in the short/medium-term.

Spot Silver

The Dollar index is testing primary support between 89 and 90. Rising Trend Index (below zero) suggests another test of the descending trendline. Respect is likely and breach of primary support would offer a medium/long-term target of 851.
Dollar Index

From Luke Gromen at FFTT:

When you are an externally-financed twin deficit nation with insufficient external funding (as Druckenmiller pointed out), there are three potential release valves:

  1. Higher unemployment.
  2. Higher interest rates.
  3. Lower currency (inflation.)

With US debt/GDP at 130%, Options #1 and #2 aren’t an option……

Conclusion

We expect long-term Treasury yields to remain low while inflation rises, causing the US Dollar to sink and Gold and Silver to advance.

Our long-term target for Gold of $3,000 per troy ounce2.

Notes

  1. Dollar Index (DXY) target of 85 is calculated as the peak of 93 extended below support at 89.
  2. Gold LT target calculation: base price of $1840/ounce + [TIPS yield of -0.87% – (nominal Treasury yield of 1.64% – real inflation rate of 5.30%)] * $400/ounce = $2956/ounce

ASX Technology stocks fall

The ASX 200 continues to test its February 2020 high at 7200. Narrow consolidation below resistance is a bullish sign but we need to keep a weather eye on the US and China.

ASX 200

Financial Markets

Bond ETFs, in a sideways consolidation, indicate that long-term interest rates are holding steady. Inflation remains muted and the RBA is following through on their stated intention to suppress long-term yields.

Australian Bond ETFs

A-REITs are testing resistance at 1500. Reversal below 1340 is unlikely but would warn of a double-top reversal.

ASX 200 REITs

Financials are testing resistance at 6500. A rising 13-week Trend Index — with troughs above zero — flags buying pressure, suggesting that a breakout is likely.

ASX 200 Financials

Health Care, Discretionary & Technology

Health Care is testing resistance at 42500. The rising Trend Index is bullish but failure to cross above zero would confirm long-term selling pressure. Breach of 40000 would complete a bull-trap (a bear signal for investors) and warn of another test of primary support at 37500.

ASX 200 Health Care

Technology broke support at 1900 to signal a primary down-trend, imitating the pattern in US markets. Breach offers a medium-term target of 14001.

ASX 200 IT

Consumer Discretionary is testing its rising trendline. We expect a test of support at 2900 as the impact of government stimulus fades.

ASX 200 Discretionary

Mining

Iron ore retreated slightly, to $210/metric ton. Chinese steel mills are stockpiling — due to rising tensions with Australia and anticipated production curbs in China (to reduce pollution levels). The boom is only expected to last as long as stockpiling continues. Then prices are likely to fall steeply as mills run down stockpiles. Reversal below support at $175-$180 would warn of a sharp decline.

Iron Ore

The ASX 300 Metals & Mining found resistance at 6000. A tall shadow on this week’s candle warns of short-term selling pressure. Another test of support at 5000 is likely.

ASX 300 Metals & Mining

The All Ordinaries Gold Index (XGD) continues to test its new support level at 7000. Follow-through below recent lows would warn of another test of 6000, while recovery above 7300 would signal a fresh advance. Breakout above the long-term descending trendline would strengthen the bull signal. Gold bullishness is fueled by rising inflation fears.

All Ordinaries Gold Index

The Gold price, in Australian Dollars, is testing its descending trendline and resistance at 2400. Breakout above the two would deliver a strong bull signal.

Gold in AUD

Conclusion

Technology stocks have commenced a primary down-trend. Metals & Mining look highly-priced and susceptible to a sharp reversal. They have looked that way for months but sooner or later we are bound to see a rapid re-pricing.

Steady long-term interest rates and a buoyant housing market are lifting REITs and Financials respectively. Health Care and Consumer Discretionary look hesitant, while Gold stocks are making a tentative rally.

Notes

  1. Target for XIJ is its 2400 peak extended below 1900.

Beware of the GDP “spike”

Hours worked jumped to a massive 13.5% (YoY) spike in April and GDP is expected to follow.

Real GDP & Hours Worked

Jim Stock’s Weekly Economic Index predicts a similar 12.2% (YoY) spike in Q2 GDP.

Weekly Economic Index

Apologies for being the bearer of bad news but that spike is entirely due to base effects: the year-on-year change is measured from the pandemic low of April 2020.

In real terms, hours worked are still 3.8% below their Feb 2020 level and GDP for Q2 2021 is expected to come in at close to the peak in Q4 of 2019.

Real GDP & Hours Worked

Labor market turmoil

Pundits are wringing their hands about the poor jobs report, with +266K of new jobs in April compared to 1M estimated. Non-farm jobs recovered to 144.3 million in April, compared to 152.5m in Feb 2020, a shortfall of 5.4%.

Non-farm Payroll

Hours worked has done slightly better, at 5.05 billion in April, compared to 5.25bn in Feb 2020, a shortfall of 3.8%.

Real GDP and Hours Worked

The rate of increase (in hours worked) slowed significantly from March 2021, but that is to be expected. It will be difficult to match the recovery rates achieved at the re-opening and we suspect that the +1m new jobs estimate for April was over-optimistic.

Increase in Hours Worked

Manufacturing

Manufacturing jobs are not fully recovered either, at 12.3m in April, a 4.0% shortfall from the 12.8m in Feb 2020. But manufacturing production in March 2021 (104.3) was only 1.7% below its Feb 2020 reading and is expected to close the gap even further in April. A sign that productivity is improving.

Manufacturing Jobs & Industrial Production

Average hourly wage rates continue to grow between 2.5% and 3.5% (YoY). A sign that employers are able to fill job openings.

Manufacturing Hourly Wage Rates

Job Openings

Outside of manufacturing, job openings are growing. A sign that wage rates are likely to follow.

Job Openings

We suspect that job openings are concentrated in low paid jobs where the pandemic and higher unemployment benefits are likely to have the most impact on participation rates.

Low Participation

Low Participation

Unemployment Benefits

Bond Market

After momentary panic, the bond market seems to have decided that the weak jobs report is a non-event and unlikely to reduce inflation or require increased Fed intervention. The 10-year Treasury yield dropped to 1.525% in the morning but recovered to 1.572% by the close.

10-Year Treasury Yields

Conclusion

The labor participation rate has been declining for 20 years and the COVID-19 pandemic may have accelerated the decline. Participation rates may never fully recover to pre-pandemic levels.

Declining Labor Participation

But as long as the difference is made up by rising productivity (output/jobs), boosted by increased automation, then the economy is expected to make a full recovery.

Manufacturing Production/Jobs

Higher unemployment benefits and a lower participation rate are likely to drive up wages for unskilled jobs, while de-coupling from China and on-shoring of critical supply chains is expected to lead to skills shortages, driving up wages for higher-paid employees. The Fed will be reluctant to increase interest rates to cool the economic recovery, allowing inflation to rise.

When the (inflation) train starts to roll, it is difficult to stop. Sharp pressure on the (interest rate) brake is then required, but would cause havoc in bond and equity markets.

Gold and Copper: Towards a new measuring stick

Our old measuring stick, the Dollar, is broken and no longer fit-for-purpose. The Fed and other major central banks have consistently eroded the value of their national currencies through quantitative easing; expanding their balance sheets by 580% — from $5T to $29T — over the past 14 years, as the chart from Ed Yardeni below shows.

Total Assets of Major Central Banks

Currency debasement is easily hidden from view by simultaneous policies across central banks, affecting all major currencies.

Gold as a benchmark

Attempts to use Gold as an independent benchmark are frequently interfered with by government attempts to suppress the Gold price, dating back to the London Gold Pool of the early 1960s. Alan Greenspan even went so far as to base Fed monetary policy on Gold, not so much to suppress the Gold price but as an early warning of inflation (measured inflation figures are lagged and therefore useless in setting proactive monetary policy). The result was similar, however, suppressing fluctuations in the Gold price.

A new benchmark

Earlier than Greenspan, Paul Volcker had used a benchmark based on a whole basket of commodities to measure inflation.

Our goal is derive a similar but simpler benchmark that can be applied to measure performance across a wide range of asset classes.

Copper and other industrial metals, on their own, are not a viable alternative because demand tends to fluctuate with the global economic cycle.

Gold and Silver also tend to fluctuate but their cyclical fluctuations, especially Gold, tend to run counter to industrial metals. Demand for Gold is driven by safe haven demand which tends to be highest when the global economy contracts.

We therefore selected Gold and Copper as the two components of our benchmark because their fluctuations tend to offset each other, providing a smoother and more reliable measure. A mix of 5 troy ounces of Gold and 1 metric ton of Copper provides a fairly even long-term balance between the two components as illustrated by the chart below. The middle line is our new benchmark.

5 Troy Ounces of Gold & 1 Metric Ton of Copper

Copper (red) leads in times of inflation, when industrial demand is expanding rapidly, while Gold (yellow) leads in times of deflation, when the global economy contracts.

First, let’s address the weaknesses. China’s entry to the World Trade Organization (WTO) in the early 2000s, a once-in-a-century event, caused a surge in the price of both Copper and Gold. The change drove up commodity prices but drove down prices of finished goods; so we are undecided whether this is truly inflationary.

The sharp fall in 2008, however, is accurately depicted as a massive deflationary shock, caused by private debt deleveraging during the global financial crisis (GFC). Central banks then intervened with balance sheet expansion (QE). Accompanied by fiscal stimulus, QE caused a huge inflationary spike lasting from 2009 to 2011.

5 Troy Ounces of Gold & 1 Metric Ton of Copper

Fed expansion paused in 2011-2012 and was followed by a sharp contraction by the European Central Bank (ECB), causing deflation, as the breakdown from Ed Yardeni below shows. The ECB then reversed course — following Mario Draghi’s now famous “whatever it takes” — and, accompanied by the Bank of Japan (BOJ), engaged in another rapid expansion.

Total Assets of Major Central Banks

The Fed attempted to unwind their balance sheet in 2018-19, causing a brief deflationary episode before all hell broke loose in September 2019 with the repo crisis. Fed balance sheet expansion in late 2019 was, however, dwarfed by the expansion across all major central banks during the pandemic. Fed QE caused a sharp spike in the M2 money supply as well as in our Gold-Copper index (GCI), warning of strong inflation.

GCI & M2 Money Stock

Market Values using our GCI benchmark

While not as high as some valuation measures (PE or Market Cap/GDP), plotting the Wilshire 5000 Total Market Index against the GCI shows stocks trading at levels only exceeded during the 1999-2000 Dotcom bubble.

Wilshire 5000 Total Market Index/GCI

The Case-Shiller Index plotted against GCI shows home prices are relatively low in real terms, most of the froth being created by a shrinking Dollar.

Case Shiller US National House Price Index/GCI

But if you think housing is cheap — after the China-shock — look what happened to wages.

Average Hourly Manufacturing Earnings/GCI

Precious Metals

Plotting Gold against the GCI might seem counter-intuitive but it highlights, quite effectively, periods when Gold is highly-priced relative to its historic norm. The yellow metal retreated to within its normal trading range in March 2021.

Gold/GCI

The plot against GCI offers far less distortion than the Gold-Oil ratio below.

Gold/Brent Crude

We only have 4 years of data for Silver (on FRED). Plotting against GCI warns that silver is highly-priced at present but we will need to source more data before drawing any conclusions.

Silver/GCI

Conclusion

Stock prices are high and overdue for a major correction but this is only likely to occur when: (a) government stimulus slows; and/or (b) the Fed tapers its Treasury purchases, allowing long-term Treasury yields to rise. Market indications — and dissenting voices (Robert Kaplan) at the Fed — suggest that the taper could occur sooner than Jay Powell would have us believe.

The Gold-Copper index (GCI) warns of strong inflation ahead, which should be good for both commodities and precious metals. But bad for stocks and bonds.

Netflix heralds end of COVID boom for tech stocks

A sharp fall in new Netflix subscribers may signal the end of the boom for many tech companies that enjoyed stellar gains since the start of the pandemic. Economies are starting to re-open as vaccination levels rise, warning of tepid growth ahead for companies that thrived during the COVID-19 lockdown.

Zoe Samios at The Age writes:

In the first three months of 2020, Netflix acquired 15.77 million paid subscribers, sending its already elevated shares into the stratosphere. In the corresponding period this year, Netflix added just 3.98 million subscribers, its results on Wednesday morning (AEST) showed.

Netflix (NFLX) momentum has slowed since July last year. Breach of support at 500 would warn of a correction, while breach of support at 460 would signal a primary down-trend.

Netflix (NFLX)

The big five technology stocks all enjoyed a huge surge, up to September 2 last year, gaining between 28% (GOOGL) and 91% (AMZN) since early January. Since then, only Alphabet (GOOGL) and Microsoft (MSFT) have recorded further gains.

AAPL,AMZN,GOOGL,FB,MSFT

The broad S&P 500 index has gained 16.5% since September 2, 2020.

Conclusion

Growth in large technology stocks is slowing as the economy re-opens.

This time is different

The chart below compares the Wilshire 5000 broad market index (light blue) to the money supply (MZM or “at call” money). The previous two recessions show a surge in the money supply (green circles) as the Fed injects liquidity into financial markets to forestall a deflationary spiral. In both cases, stocks took more than two years to react, with the low-point reached 8 quarters after the Fed started to inject liquidity in Q1 2001 and 9 quarters after liquidity injections commenced in Q3 of 2007.

MZM Money Supply and Wilshire 5000

It took almost 13 years for the index to make a new high after its Q1 2001 Dotcom peak and 5.5 years after its Q3 2007 peak (values are plotted relative to GDP).

The recovery in 2020 was quite different. The index formed a low two quarters after the Fed started to inject liquidity and had recovered to a new high in the next quarter.

While the recovery from the Dotcom crash took an unusually long time — because of the extreme valuations — we can still conclude that the latest recovery was exceptional. Record government stimulus caused a surge in disposable incomes, rather than the fall seen in previous recessions.

Disposable Personal Income

The surge in disposable income combined with a sharp fall in consumption caused a massive spike in personal saving, much of which flowed into the stock market.

Personal Saving

Huge inflows caused a surge in stock prices, which in turn led to similar exuberance to the Dotcom bubble of 1999-2000.

“This is the only time in my 88 years when I saw technology stocks go to 100 times earnings; or, when there were no earnings, 20 times sales. It was insane, and I took advantage of the temporary insanity.” ~ Sir John Templeton, in 2001.

Conclusion

While the government attempt to prevent a fall in personal disposable income during the pandemic is laudable, their overreaction caused a massive spike in personal saving — spreading the contagion to the stock market. Stocks are now trading at precarious levels relative to earnings, with no easy way for authorities to engineer a soft landing.

We are not sure how long the Fed can prop up the stock market but are certain that it will end badly for investors who ignore the risks.

Notes

Sir John Templeton (1912-2008) was an American-born contrarian and value investor, banker, fund manager, and philanthropist. He founded the Templeton Growth Fund in 1954, which averaged more than 15% p.a. over 38 years. In 1999, Money magazine rated him as “arguably the best stock picker of the century.”