Trouble Brewing Down Under in One of World’s Few Growing Economies

by Jeff Reeves | August 29, 2012 7:00 am

Trouble Brewing Down Under in One of World’s Few Growing Economies

A few weeks ago, I offered up some Australian banks as top dividend investments[1]. Among them were Westpac Banking (NYSE:WBK[2]), Australia and New Zealand Banking Group (PINK:ANZBY[3]) and the Commonwealth Bank of Australia (PINK:CBAUY[4]).

But recent reading has made me a bit more concerned about the region. I still believe Australia bank stocks are some of the most secure financial investments in the world right now, but broader economic pressures on the Australian economy are pretty troublesome and worth calling out.

For starters, let’s begin with the good: Australia has had a better credit rating than much of Europe[5] since the debt crisis descended. Australia’s debt was upgraded by Fitch Ratings to the highest possible level — AAA — in 2011.

Australia also has the privilege of being the only developed economy that avoided recession since the 2008 crisis, never crossing the technical definition of a downturn that demands two consecutive quarters of GDP contraction. Its 0.4% growth at the beginning of 2009 was just enough to sidestep the label.

Recent growth has been brisk, too, with GDP surging about 4%[6] in the first quarter according to June reports.

So why the concern? There are three main reasons.

Mining Slowdown

For starters, the strength of Australia is also the reason it could be under pressure — namely, a heavy reliance on natural resources and the demand for those resources from Asian trade partners.

The Financial Times recently called attention to a commodity “supercycle”[7] that is weighing on the earnings reports of mining stocks. Falling prices and rising costs are the order of the day industry-wide, and that will result in smaller profits for these companies.

Since mining operations are a huge part of the Australian economy that is not a good thing. Some estimate that mining represents at least 10% of total Australian GDP thanks to giants like BHP Billiton (NYSE:BHP[8]).

Pricey Currency

Another problem is an overvalued currency. Australia’s strong economy and great debt rating has led to a huge influx of foreign capital. That’s what happens when you’re the envy of the world, right?

The downside, of course, is that dumping that much money into Australia has resulted in the specter of inflation and a run-up in the Australian dollar. As anyone who understands economics should know, a stronger currency makes exports cheaper for trade partners but less profitable for you.

And since Australia exports a lot of its resources to Asia and the west, a strong currency is a drag on the nation’s economy.

China Slowdown

I won’t belabor this too long, since I’m sure you’re familiar. China’s weak data in industrial output, retail sales and trade[9] are not encouraging. And even China’s manufacturing sector, long the poster child for growth, is seeing trouble[10].

Australia benefits from China big-time not just due to proximity, but also due to its natural resource focus. It provides the base metals and energy that China needs to build things. So as China builds less, they need less from Australia as a result. Simple math.

These are all big deals. There’s also fear of an Australian real estate bubble[11] if you want to throw more fuel on the fire.

So while I like Australian banks for their management and yield, it’s worth noting the region has troubles. If you’re looking to avoid a global downturn, Australia may not be the safest place to hide out anymore.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[12] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

Endnotes:
  1. Australian banks as top dividend investments: http://investorplace.com/2012/08/aussie-investments-that-offer-top-dividends/
  2. WBK: http://studio-5.financialcontent.com/investplace/quote?Symbol=WBK
  3. ANZBY: http://studio-5.financialcontent.com/investplace/quote?Symbol=ANZBY
  4. CBAUY: http://studio-5.financialcontent.com/investplace/quote?Symbol=CBAUY
  5. better credit rating than much of Europe: http://investorplace.com/2011/11/australia-credit-aaa-fitch-us-europe-bhp/
  6. GDP surging about 4%: http://www.ft.com/intl/cms/s/0/337d12a4-af88-11e1-a8a7-00144feabdc0.html#axzz23RG2cJIl
  7. commodity “supercycle”: http://www.ft.com/intl/cms/s/0/e20eb9f4-ef6a-11e1-9580-00144feabdc0.html#axzz24rBrkb1z
  8. BHP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BHP
  9. weak data in industrial output, retail sales and trade: http://investorplace.com/2012/08/chinas-weak-data-could-still-capture-gold/
  10. is seeing trouble: http://investorplace.com/2012/08/these-4-charts-show-the-ugly-state-of-global-manufacturing/
  11. Australian real estate bubble: http://finance.yahoo.com/news/analysis-australian-housing-bubble-never-200330411.html
  12. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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