Reality checks defy relief rally

As we said earlier this week, the ongoing sharp contraction in both the real economy and corporate earnings leaves little margin for error at current above average valuations, which are based on what are likely overstated earnings estimates. We are only in the early innings of earnings season in the US, but so far analyst estimates have proven already to be too optimistic. Uncertainty remains high and there is a wider than usual range of outcomes, this poor visibility is not accounted for in the consensus outlook. Many companies have withdrawn guidance and the effective information vacuum has encouraged the relief rally. As the weeks roll on and visibility improves, this will become more difficult. As we move into the next phase of this crisis and COVID-19 case counts are put aside in favour of the true impact the resilience of the recent bounce back is about to be tested, regardless of the unbounded stimulus/Fed bailouts. The realities unfolding across developed world labour markets, extended lockdowns and the process of “opening up” being just that, a process leaves the risk of disappointment at current levels very high even if containment progress continues.

In Australia, the focus today was on the March jobs report. Headline unemployment came in at 5.2%, versus 5.4% expected and 5,900 jobs were added surprising to the upside of the 30,000 decline expected. Despite the beat on the headline read, underemployment and underutilisation picked up in March indicating that labour market slack was on the rise prior to the worst of the COVID-19 hit.

However, before reading too much into this data we have to remember that the survey was performed in the first half of March before the heightened measures to control the spread of COVID-19 were implemented so incorporates little of the true impact. We know that the near total shutdown in economic activity has been sharp, and the labour market deterioration will have been equally sudden so the true state of the labour market has been vastly understated by the data released by the ABS today.

In addition, as we highlighted earlier this week the JobKeeper subsidy and a potentially lower participation rate will mask the true dislocations in the labour market and keep the headline unemployment rate lower than would have otherwise been. The real gauge of the dislocations will be most evident in the hours worked and underutilisation data.

Aside from consumer confidence, key for Australia will be the dislocations in the labour market. Not least because consumption accounts for almost 2/3rds of economic growth but also a key area of vulnerability is the excessive levels of household debt across Australia. Household debt to income ratios across the nation are well above OECD averages, at approximately 2x household income. This debt is serviceable whilst unemployment is low. However, as Australia’s unprecedented streak of economic growth fizzles out, a rise in unemployment or even underemployment will be just one catalyst for reversing the nascent recovery in the housing market. Having the potential to set in motion a more drawn out lag on economic activity and consumption. Both via forced or voluntary deleveraging and a negative wealth effect as house prices decline.