After the most dramatic weekend on financial markets since the onset of the GFC, it’s time for smart entrepreneurs to sit down, breathe deeply and take stock of this chaotic situation.
While the downgrade of US debt by Standard & Poor’s has sent shockwaves through global financial markets, exactly how the ripple effects of that event will touch Australian SMEs is a little harder to read.
With this in mind, we’ve developed a special SmartCompany Q&A to examine what happened, why it happens and what it all means.
Last week everyone was talking about raising interest rates. This week everyone is talking about global recession. What the hell happened on the weekend?
What happened can actually be explained fairly simply: financial markets finally woke up to the fact that the global economic recovery is patchy at best and anaemic at worst.
While entrepreneurs in Australia and abroad have been dealing with the difficulties of slow growth for the last two years, financial markets – particularly in the US have been travelling reasonably well.
While the US economy is frankly stuffed, corporate profits have actually been pretty strong because companies have slashed costs (that is, they cut jobs) and rebuilt sales. Relatively strong profits have helped support share prices in the US and allowed investors to think the recovery was under way.
But the events of the last few weeks have shown investors around the world that the recovery wasn’t really happening. The political crisis over the US debt ceiling was one problem, but GDP figures released as the politicians squabbled were just as alarming – the US economy grew at just 1.3% in the second quarter after growing at just 0.4% in the first quarter. The latest unemployment figures (released last Friday) also showed the jobless rate is still above 9%. And the plain fact is that the jobless cannot spend.
So Wall Street has been tanking for the best part of two weeks. On Thursday night the US market dropped 4% and on Friday the Australian market dropped by the same amount.
So we’re following the Yanks down the gurgler?
Certainly global markets are extremely sensitive to what happens on Wall Street. But global markets aren’t just blindly following the US – there are plenty of other problems outside of the US to contend with.
In Europe, the seemingly never-ending debt crisis drags on, with Spain and Italy last week joining Greece, Portugal and Ireland on the bailout-or-bankruptcy list.
In China, questions remain about how strong the economy really is – and whether the 9-10% growth of recent years can really continue.
And in Australia, we’re dealing with the fallout of all of these issues and more. While our sovereign debt levels are low and our exports are booming thanks to the resources industry, poor consumer and business confidence and the impact of the high Australian dollar have many suggesting that certain sectors – retail and building are two obvious ones – are in recession.
Explain this significance of the downgrading the US debt. Is that an indication that the US economy is in recession?
Not really. The S&P downgrade was really a reaction to the political impasse we saw around the US debt ceiling last week. Put simply, S&P believe that this showed that the US will be unable to take steps to reduce its massive debt burden in the long-term. The ratings agency said it was “pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilises the Government’s debt dynamics any time soon. “
So it’s something very specific to the US?
That’s right. However, it’s yet another symbol of how stuffed the economy is over there and it’s this psychological affect that is most worrying.
Which suggests further falls are likely on sharemarkets this week.
Volatility is a certainty and falls are highly likely. The S&P downgrade was released after the US market closed on Friday, so American investors haven’t had a chance to react to the news yet.
Australian shares fell about 2% on opening this morning. Not a disaster, but it does mean shares are now at fresh two-year lows.
Okay, so financial markets are under pressure. But does it necessarily follow that we’ll see a recession?
No. In fact, a recession looks extremely, extremely, extremely unlikely in Australia. It’s worth noting that while the RBA cut its growth forecast for calendar 2011 from 4.25% to 3.25% on Friday, the Bank also raised its forecast for the 2011/12 financial year by 0.25% to 4.5% per cent.
If we achieve that, we will be humming along over the next 12 months, although a lot of that will be driven by the mining sector.
Could the US end up in recession?
It’s possible, but as this stage it looks unlikely. Growth will be very slow for much longer than expected, but an actual recession is not the certainty that some commentary would suggest.
Okay, I’m feeling a little better about the recession thing. But what should I be watching out for in Australia?
A crisis of confidence. The problem with sharemarket drops like we’re seeing is that it makes people anxious about their finances – even if they haven’t actually crystallised any losses yet. And when people feel poor, they tend to hoard cash.
It will be a few weeks before we have official measures of business and consumer confidence, but expect both to take a big hit from this latest crisis.
Consumer confidence plunged by 8.3% in July to levels not seen since the GFC, so we should expect to see households retreat even further into their shells in the next few weeks as they suddenly find themselves feeling poorer.
Business confidence took a hit in January due to the floods and has really remained stuck ever since. The resilience of those in the B2B sector are likely be tested again in the coming months.
So the great spending strike could run a bit longer.
Unfortunately, that looks very likely.
And when will the strike end?
That’s the $64 trillion question. Retailers will be praying we can get a period of stability in the lead-up to Christmas, but it is going to take a fair bit of time to repair the confidence of consumers. I would say spending will be subdued until at least the end of this year.
Surely interest rate rises are completely off the agenda now?
Certainly for the next few months. In fact, bond markets are pricing in a good chance of a rate cut before the end of the year.
That would be brilliant for confidence, wouldn’t it?
It certainly would be a real boost for the retail and property sectors.
I’m sensing a “but”…
Um, yes. The “but” is that the RBA is still expecting very strong growth in the 2011-12 financial year. If they are right then inflationary pressures may start building again next year and a rate rise may be back on the cards.
Fair enough, but rates rises are unlikely this year which is good. What indicators should we be watching in the next month or so?
Business and consumer confidence is important, retail sales are important to watch and unemployment is also something to monitor. And anything the RBA says is also good to watch.
After that, it’s your sectoral stuff. Housing starts, vehicle sales, job ads – whatever tells the story of your sector.
What else can entrepreneurs do?
I think it’s crucial to get good market intelligence so you can adjust your business as required. Call suppliers, investors, mentors, advisers (such as your accountant) and get their impressions of the market.
What about customers?
Yes, this is the time to get very close to them. While you don’t want to do anything that puts your business in any danger – like suddenly extending your payment terms or working for nothing – it is important to be flexible enough to react to any changes in customer behaviour.
What else should I concentrate on?
Cashflow is likely to become even tighter in the coming months as consumers and businesses hold onto their cash for as long as possible. Entrepreneurs need to be particularly vigilant about late payers – offer discounts for early payments if necessary and jump on overdue debts immediately. The phone is your friend in this situation.
Right, I’m going to check our debtors right now. It’s going to be a rough couple of weeks, isn’t it?
It is, but the key is not to panic. Rushed decisions based on poor information are particularly dangerous at these times. Stay close to your suppliers, investors and customers and keep you competitive advantage at the forefront of everything you do.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
