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Wages data - a key to the future

Boom and bust. From “you beauty” to “we’ll all be rooned”. Australian traders tend to swing between these nodes. But what happens when the economy and the share market goes nowhere?

Clearly trending economies, and markets, are the easiest to trade. Booming markets means full investment and decisions that result in good or better outcomes. Falling markets see investors batten down the hatches to ride out the storm, selling out holdings or taking protection with derivatives, while traders take the reins. Modestly positive markets that trade broadly sideways and take regular plunges are much more challenging.

The data shows the Australian economy is generally in good shape. Growth is positive albeit low, as are inflation and interest rates. Household balance sheets are showing the benefits of savings rates that were elevated for many years. (The constant parading of a higher debt to household income ratio is a farrago for another time).  Concerns remain – patches of heat in housing, structural budget deficits, underemployment – but the overall picture is healthy.

The international outlook has improved markedly as well. Growth in China has stabilised at lower, more sustainable levels. The US economy is in upswing in anticipation of stimulus from a new government. Even European services and manufacturing gauges are showing consistent expansion.

More recently Australian business and consumer confidence have edged into positive territory. Yet the economy won’t kick over into a healthier higher growth phase. What’s holding Australia back?

Many analysts point to two missing ingredients in the Australian economic environment. The first is private, non-mining capital expenditure. As the commodity boom wound down mining companies slashed their capital spending. Spending in other sectors is required to replace this drag on the economy. Unfortunately at this stage the intentions among business leaders remain subdued.

The other factor is wages growth. The path to better economic times is a spiral higher. More confidence brings business investment for better times, in capital and in staff. This pushes wages higher, increasing consumer confidence and spending. Prices for goods and services rise, offering better profit margins. More sales and profit see businesses investing more and paying higher wages, increasing spending and prices, and so on.

This virtuous cycle is what supply-siders, central bankers and governments investing in infrastructure are all trying to spur. It’s interesting to note the estimates in the Federal Budget. Iron ore and coal forecasts significantly below current spot prices drew murmurs of approval. However estimates of capex growth accelerating from 1.5% to 4.5%, and wages growth lifting above 3%from current levels below 2% look much more aspirational.

This chart shows overall growth in the economy (GDP- green line), inflation (CPI- yellow line) and wage growth (ECI – white line). Both growth and prices appear to have turned. However for the virtuous cycle to begin and a significant expansion to occur wages must turn too.

This is not an academic exercise. The Australia 200 share market index has failed repeatedly at the 6,000 mark. To spur shares through this barrier requires an improvement in the broad economy.

On Wednesday this week the Q1 Wage Price Index is released. Expectations are muted, with consensus around an annual rate of increase around 1.9%, in line with the previous quarter. Any surprise at this release has very serious implications for the economy and the share market.

Current wages growth is at its lowest point this century. If the annualised rate of wages growth fell below 1.9% in the first quarter of 2017 it indicates an economy that is struggling. By implication it could also mean a correction in the share market, despite highly likely immediate calls on the RBA for further interest rate cuts.

Alternatively, an above forecast reading will indicate a turning point for wages and a significantly improved outlook. It would spark economists to revise expectations upward. In turn share valuations will also rise. In other words a Wage Cost Index reading at 2.0% or higher could act as a buy signal for investors.

Expectations of an economic recovery in 1-2 years arose in 2010. These expectations remain, despite being pushed out each year since then. Increasing wages is the missing ingredient. Readings on wages growth are therefore the most important number for traders and investors – at least this week.

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