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Despite weak business sentiment, the Australian stock market recently hit an all time high, though it has pulled back this week.
According to the NAB Business Survey, business confidence ended 2019 on a very weak note. Not only did the number of pessimistic businesses outnumber optimistic businesses, it was the weakest result in over six years. Sentiment improved slightly at the beginning of 2020, but the bushfires and COVID-19 have made conditions very tough for some businesses.
Your outlook, however, may depend very much on what sector you are in. Overall, difficult operating conditions have translated to increased insolvencies. Insolvencies rose 4.6% in the 2018-19 financial year, following a two-year period of declines. In addition, insolvencies in the first half of 2019-20 are 5.2% higher than the same period a year earlier.
The construction sector was responsible for nearly half of the increase in insolvencies, with residential construction demand down, and with a red hot contractor market in the infrastructure space also creating operating difficulties. Interestingly, the number of insolvencies in the accommodation and food services sector have risen strongly in 2018-19, but the retail sector had fewer insolvencies compared to the year earlier. These statistics don’t include the large number of store closures across the retail environment as big retailers try to reduce their store footprint in the face of tough operating conditions.
Figure 1 Insolvencies - 2005-06 to 2019-20 (First Half)
Despite the increase in number of companies under pressure, Australian profits have performed relatively well. Gross operating profits increased 10.2% in 2018-19, led by a strong performance in the mining sector. Profits in the financial sector declined sharply, in part due to the fallout from the banking Royal Commission. The reporting season indicates that company performance is mixed heading into 2020. According to Deloitte’s MarketEdge analysis, two-thirds of companies reported an increase in revenue but less than half experienced an increase in profits.
The overall performance of companies has been mediocre relative to the advances in the stock market. The ASX 200 climbed 18.4% over the year to December 2019, its best year in a decade, before moving to record highs in early 2020.
The price-to-earning ratio is another key metric to watch, often used to assess whether a stock is expensive or cheap. This ratio had gone up by 15% in the year to November 2019, hitting a median of 18.2, suggesting that the ASX has surged ahead of the general performance of the economy. To put this simply, the median ratio of 18.2 implies that investors would have to hold on to their shares for 18 years to recoup the price in annual earnings, assuming earnings remain unchanged.
The bullish sentiment and strong returns on the ASX we observed in 2019 and into 2020 are likely to have been fuelled by the low interest rates and bond yields. Investors have headed into the equities market in a desperate search for a decent rate of return, given the return to holding bonds is so low. No surprise then that the sharemarket is now showing the same fragility as business confidence.
David is a macro economist with extensive experience in applied economic and quantitative analysis of the Australian economy, along with considerable experience in labor market analysis. David is a regular commentator on macroeconomic trends, and prepares a weekly economic briefing newsletter.
Emily is an Associate Director within Deloitte Access Economics' macroeconomic team in Sydney. She has experience delivering economic analysis and commentary to a range of clients across the public and private sectors.
Jasmine has extensive experience as a macroeconomist. She has extensive experience in macroeconomic analysis and forecasting, econometric modelling and scenarios design/modelling. She is responsible for the Deloitte Horizon macroeconomic scenario model. Prior to joining Deloitte Access Economics, Jasmine has worked as a macroeconomist across the private and public sectors in Australia and Singapore.