Global investors have been fretting about the impact of a possible US Federal Reserve tapering. But a new report from PIMCO warns that Australian investors should be factoring in the fallout from another form of tapering: the tapering of mining investment in Australia.
Full In Focus feature, Taper time for mining sector, available here.
In a report, Taper Time – Mining, That Is, PIMCO’s Adam Bowe and Robert Mead say that a fall in mining investment is already hitting the Australian economy, and the Reserve Bank of Australia (RBA) will be forced to keep official rates low, and potentially even cut them further in the next 12 months, in a bid to boost investment growth outside the mining sector.
The outlook for rates has major implications for advisers and their clients. It suggests that cash and term deposit yields will remain low and even keep falling over the next year.
Many clients are also worried about capital losses on bond portfolios as a result of rising interest rates. But the mining tapering and its effect on rates means that bond prices could actually rise in 2014 as the market realises that rates won’t be hiked.
GOOD, BAD, UGLY
In their report, Bowe and Mead say there are three growth options, which they’ve dubbed the good, the bad and the ugly.
Under the “good” growth option, non-mining companies renew business investment, and there is a smooth handover from the mining sector. But Bowe and Mead note this hasn’t happened yet: real growth in non- mining business investment has contracted in the year to June 2013. What’s more, with dividend payout ratios increasing in the past 12 to 18 months, firms seem to prefer paying earnings back to owners rather than reinvesting in their own businesses.
The “bad” growth outcome would see demand continue to slow as the global mining sector tapers, and no new sectors step forward to drive future growth. Bowe and Mead say the first half of 2013 fell into this category, and the RBA responded by cutting the cash rate by 0.50 percentage points.
The worst outcome is the “ugly” growth scenario. That’s where a sector, such as household consumption, is boosted by low rates. It might create a short-term boost to the economy, but the increased leverage on household balance sheets from already elevated levels would create longer-term risks to the outlook.
WIND-DOWN
Saul Eslake, chief economist at the Bank of America- Merrill Lynch, says there is some evidence that the wind-down of the investment phase has been worse and quicker in Western Australia than had been expected: the trend unemployment rate is up 1 per cent since June last year, labour force participation rates have dropped, and retail sales growth has slowed from nearly 10 per cent in 2012 to just 1.4 per cent in the year to August. In Queensland, the LNG investment boom is still going strong, Eslake says, but coal investment is winding down.
Heuristic Investment Systems’ Damien Hennessy, a consultant investment strategist to van Eyk, says
that mining will continue to detract from growth over the next couple of years, but he believes that a surge in exports on the back of a doubling of production capacity over the past decade will provide a “bit of an offset” to falling mining investment.
But while export volumes rise, prices are likely to soften. “I suspect [commodity] prices will continue to fall a bit as China growth slows in a structural sense over the next few years”, Hennessy says.
