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When will the good times end?

October 11, 2018

Australia holds the record for the longest period of recession-free growth in the Organisation for Economic Co-operation and Development (OECD).

Since 1991, our economy has seen an average annual growth rate of 3.2 per cent, according to the Australian Trade and Investment Commission. This makes 27 years of positive economic growth, even during the Dot.Com bubble burst and the Global Financial Crisis. It’s clear we hold significant financial resilience as a nation, but will these good times last?

With the recent political unrest surrounding the leadership challenge at the end of August, the drought hampering Australian agriculture in Queensland and New South Wales and the property market seemingly slowing, does recession lie in wait?

It’s easy to tune out when people talk about the economy, as it can seem entirely abstract. If you can see where you are in the context of the economy, however, you can make personal decisions related to your investments, budgets, debts and business to protect yourself from losses and seize major opportunities.

Speak with an Invest Blue financial planner today about the resilience and flexibility of your financial plan.

Understanding the economic cycle

The business cycle, or economic cycle, is key to understanding fluctuations in gross domestic product (GDP), and what these mean for the wider economy.

Simply put, there are two key phases of the economy cycle.

Expansion

During the expansion period, GDP grows at an above average rate. This means the economy is growing larger – trade and employment are picking up and stock prices are increasing. These well-performing stocks encourage more people to enter the market, which is initially good, but leads to heightened inflation. Excessive inflation is marked by the growth of prices outpacing the growth of real value – or GDP growth surpassing the trend.

Over time, expansion reaches its natural peak and contraction begins. In some cases, reserve banks may need to step in to moderate economic growth and inflation.

Contraction

Following expansion, contraction marks a declining economy, wherein GDP achieves a negative growth. A shrinking economy typically results in higher unemployment and falling stock prices. During this time, traders are more likely to sell their shares, limiting their stock portfolios until the market turns around.

A trough occurs when GDP growth falls below the trend line and is marked by unemployment as jobs are lost as the economy contracts.

Australia’s economic cycle

These phases are cyclical, meaning a period of expansion is followed by contraction, which is then followed by expansion and so on. One cycle is defined as the time between two peaks and can vary significantly. Peaks and troughs can be shallow, representing a fairly stable economy, or deep and long. The longer it takes real GDP to return the trend line, the longer excessive inflation or unemployment persists. Expansion and contraction can occur organically as a result of behaviours in the economy, or due to fundamental factors such as interest rate fluctuations and policy changes.

A recession is defined as a period of contraction lasting longer than two quarters (six months). So, while Australia’s economy has experienced contraction much like any other, its avoidance of long periods means economic downturn has not been persistent and annualised growth remains positive.

Economic Cycle Connected Invest BlueAlthough it may not seem so, everything is connected in the economic cycle.

There are a number of elements that influence fluctuations in the economy. These can be broken down into fundamental factors and behavioural forces.

Unavoidable and sometimes sudden events can have ramifications for the economy.

Fundamental factors include things like policy changes and interest rates and are often controlled by governments or reserve banks to avoid deep recessions or excessive inflation. When an expansion period appears to be taking too long, the reserve bank may increase interest rates to discourage borrowing and spending, slowing the rise of prices. Conversely, to reverse contraction the reserve bank may lessen interest rates, encouraging people to put more money into the economy.

Meanwhile, behavioural forces are the peoples’ reactions to these fundamental factors. For example, with low interest rates, more people are willing to take out new loans. This money is then paid to businesses, increasing their profits and performance, which thereby drives stock prices upwards.

Everything is connected within the economic cycle – including seemingly external things. Outside of fundamental and behaviour forces, unavoidable and sometimes sudden events can have ramifications for the economy. Consider Hurricane Katrina, for example. This event had drastic effects on the United States, creating recession. More locally, the droughts along the east coast of Australia present threats to our economy. Dr Shane Oliver, Head of Investment Strategy and Economics, and Chief Economist at AMP Capital, claims that the effects of the drought on our agricultural industry could knock 0.50 per cent off our annual GDP growth – but an El Nino could result in far worse effects.

 

 

 

 

What’s next for Australia?

Australia has been relatively lucky for a long time now; market growth has been consistently strong and interest rates have been low. So when can we expect things to change? Should we be expecting tough times ahead?

AMPs Chief Economist Dr. Shane Oliver frequently shares his insights about the global and Australian economies; you can keep up to date on our Market Updates page. Recently he looked specifically at the Australian economy and the five things we should know:

  1. The economy grew solidly over the last year.
  2. Growth is likely to slow a bit from here,
  3. But it’s not going into recession.
  4. Spare capacity will remain for a while yet,
  5. Which means RBA rate hikes are a long way off.

You can read the full article here.

What does this all mean for me?

How would you feel if say, the markets dropped dramatically tomorrow? Or if the interest rates doubled (or possibly tripled) in the next six months? Would you feel confident that your financial security is protected?

Australia’s ongoing financial stability has meant that many of us have been able to get away with not considering what might happen next in the economy, but it’s harder to get back on your feet than it is to weather the storm. Building your financial literacy and knowing how cycles occur can help you gain some idea of what’s coming. But ensuring your personal financial plan is resilient and flexible, regardless of what the markets do is so important.

When was the last time you checked in on your investments? Download and complete your investment report card to get started.

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Working with a financial planner will help you gain confidence that your wealth is protected should the good times end. To speak with a financial planner, get in touch with Invest Blue today.

What you need to know

This information is provided by Invest Blue Pty Ltd (ABN 91 100 874 744). The information contained in this article is of general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regards to those matters and seek personal financial, tax and/or legal advice prior to acting on this information. Read our Financial Services Guide for information about our services, including the fees and other benefits that AMP companies and their representatives may receive in relations to products and services provided to you.