Business and Households Diverge on Economic Conditions

By Simson Sanaphay

It’s said that sentiment can be a fickle thing but as a rule of thumb, Australian household and business sentiment generally move in tandem.

That’s because consumers and industry both stand to benefit as the economy expands, bringing jobs, higher incomes and corporate earnings, it also means both stand to lose if the economy contracts.

It’s not surprising we’ve witnessed highly correlated swings in the monthly Westpac-Melbourne Institute survey of consumer sentiment and the monthly National Australia Bank survey of business confidence.

However, as the Australian economy continues its enviable track record of 25 years of economic growth there’s been a noticeable divergence in sentiment. What’s concerning is that Australian household sentiment is deteriorating, and is in stark contrast to improving business sentiment.

Driving this wedge between households and business is a secular change taking place in the proportion of income that’s being generated in the economy.

The observation is that household share of income in the overall economy is at the lowest point on record and equal to those during the GFC. This follows a sharp fall over the past year to 51.5% of total factor income (income from land, labour and capital), compared to the long-term average of 54.8%.

In contrast, the profit share of the economy accruing to private businesses has risen quickly to a three year high of 20.4% of total factor income, which is well above the long-term average of 17.9%. It’s no wonder that corporate heads are generally a more optimistic bunch.

Despite trend growth in the Australian economy that currently stands at 2.1% in 2017, households are just not as well off. It’s hard to imagine an improvement in sentiment unless real incomes rise and household financial conditions ease. In our view, weaker wealth growth from residential housing and increased debt burdens will remain significant headwinds.

The implications are two-fold, given only 31% of Australian adults hold shares in listed companies, households may consider broadening their participation to capture the shifts in factor income. Diversifying for income and growth by investing in the more optimistic Australian companies can be rewarding.

Despite the mixed results in the August corporate earnings season, a recent gauge continues to point towards earnings growth of 17.4% for 2017 and we think it’s credible to expect earnings upgrades, particularly from mining and industrials.

Finally, we think RBA policy rates are expected to remain lower for longer as “despondent” households still make an important contribution to the overall economy and stabilising household sentiment is fundamental to long-term balanced growth.

Simson Sanaphay, Citi's investment strategist for its Wealth Management business.