The media and economists have started to describe the Australian economy as having entered an income recession. The fact is that Australia has been stuck in a nominal recession for three years now. During that time, nominal GDP (which in effect is the sum of real GDP, domestic inflation and the terms of trade) has grown at a paltry annualised rate of 2.6%. This represents a weaker outcome over a three year period than even the balance sheet recession of the early 1990s (see chart).
Economists might wish to argue about the benefits of focusing on real GDP, particularly across periods characterised by different rates of inflation. But low inflation in Australia has persisted for over two decades now, and nominal GDP represents a better gauge for household and business sentiment. After all, employees earn nominal wages and businesses do not generate inflation adjusted cash flows. Given that portfolio managers continue to project company cash flows in nominal terms, it remains puzzling that economists remain fixated on real GDP.
Australia's nominal recession is more than just of passing academic interest, because low growth in nominal GDP has underpinned persistently subdued revenue conditions. Since mid-2011, analysts have downgraded their revenue forecasts for the ASX200, which remains 15% below the pre-GFC peak (see chart).
Given that top-line growth has been so weak, it is little surprise that companies continue to trim costs aggressively, defer capex, undertake restructuring and are becoming more focussed (thanks to the de-merger wave) in order to boost profitability and cater to investors' insatiable appetite for income. Consequently, the Australian economy has undergone a productivity renaissance over the past three years. Despite the slowdown in productivity growth in the September quarter, it has grown at an annualised rate of over 3% since March 2011, growth not seen since the golden period of the late 1990s and early 2000s (see chart).
The flipside from the widespread corporate restructuring and greater corporate focus is that labour market conditions continue to deteriorate. Aggregate hours worked has now been stagnant for over three years, which is a dismal outcome considering that Australia's population growth has boomed over this time (see chart).
Glenn Stevens, the RBA Governor, has drawn the line in the sand and made it clear that he doesn't see that monetary policy has a role to play in reviving the corporate sector's animal spirits. The RBA clearly has little influence over the steep decline in commodity prices and the terms of trade. But at a time when the economy is suffering from a shortfall in aggregate demand, the RBA's timid approach to monetary policy continues to consign Australia to a nominal recession.
Stock picking necessary to add alpha in domestic cyclicals while investors will continue to reward sustainable dividends
Against this backdrop, domestically exposed cyclical sectors - particularly discretionary retail, consumer services and media - will continue to be beset by revenue headwinds. Investors would be wise to cherry pick those companies in these sectors that would benefit from industry consolidation or those that have low operational leverage (ie. the ability to lift efficiency without undermining their sustainable sources of competitive advantage). As long as the nominal recession persists, investors will continue to reward companies that have the ability to become more focused, shed underperforming assets and sustainably lift payout ratios. Despite commodity price headwinds, the big miners are becoming increasingly well placed to return capital to shareholders.