When the 2023-24 financial year begins in some six weeks, many investors will face an environment in the non-mining sector that they have never seen before.
Already the largest part of the market, banking, has signalled a trading environment that is different from anything we have seen in recent years. Some analysts are speculating on dividend reductions, perhaps matched by capital returns.
But in many ways, the tough trading conditions for banks are a surface manifestation of the turmoil taking place in the consumer community, which was revealed this week in a remarkable study conducted on the aggregated de-identified Commonwealth Bank customer base by the CBA itself and the Quantium analytical group.
Retailers that do not understand and adapt to the messages that will be coming from their customers will trade very badly.
But first the banks. During the recent housing boom, banks went on a low interest rate lending spree anchored by fixed priced home building contracts.
Those contracts contributed to the destruction of large parts of the home building industry, which was an essential part of the banks’ lending supply chain and had generated large bank profits over many years.
In any industry where there is a boom driven by bad practices, there is often a period of much tougher trading. The banks are a good illustration of a phenomenon.
In the initial stages of the higher interest rate regime introduced by the Reserve Bank to combat inflation, including spectacular construction inflation, the banks quickly increased their mortgage lending rates but did not match those increases with higher interest rates on deposits. Margins and profits rose.
But then the ACCC decided to investigate the banks deposit practices; the cost of money overseas rose sharply, and a number of banks such as Macquarie began offering much better interest rates for depositors.
Suddenly the restricted deposit rate dam wall was broken, and banks are now offering much higher deposits. Accordingly, bank margins are declining at a time when house loan volumes are falling, and overall costs are rising.
At least for the start of the 2023-24 financial year, bank profits will be under pressure, especially as new home buyers that actually have the money are petrified to sign contracts with a builder because they worry, the builder will go broke.
Fortunately, Australian banks are well capitalised and although many mortgage customers will struggle to make payments the value of the dwelling asset behind the loans has held up or increased so actual bad debts are unlikely to skyrocket.
Business loans, particularly to the construction sector, may be a different story.
And so, in the coming months, banks will look at their capital position in the light of their loan assets and decide whether to make capital returns.
The CBA-Quantium survey of CBA customers shows a landscape where families in their early 30s are being ravaged by the higher interest rates, and those in their mid-20s are not that much better off.
It slowly improves as people get older and on average are not as exposed to mortgage stress. But the survey has surprises because it shows that people that face a big fall in their discretionary spending power (outside the essential payments liked mortgages/rent, petrol etc) is to cut back on household goods and apparel.
Historically in such situations the big discretionary spending cutbacks are on cafes and takeaway food. This time around, while those markets have been impacted, after adjusting for inflation, they have held their ground. As the mortgage squeeze tightens in coming months, it is likely that a downturn will follow previous patterns and discretionary food expenditure will be slashed.
The big winner is travel, which is rising strongly. Some of that extra travel is coming from people who are under mortgage stress looking for experiences rather than physical goods, but a huge chunk is coming from the older age groups who have affluence and had cut back on their travel during Covid-19 years.
Those selling appliances, furniture and building products are therefore copping it both from mortgage stress people and those with affluence spending money on travel.
It will require great skills to market to the customer areas where there is still spending. Media outlets that have older, affluent audiences are enjoying heavy advertising, particularly from travel groups.
Bunnings will be under pressure, which is trying to draw people into their stores with pet products, realising that during Covid-19 years there was a big rise in pet ownership. This is an illustration of the techniques retailers will need to develop.
There seems to be a similar trend in the US and this week profits of Home Depot, a US retailer that taps similar customers to Bunnings, fell below expectations which impacted Wall Street.
The 2023 budget followed the CBA estimates of a sharp downturn in the next six months. The budget spending will help those in the lower income areas, but the stress of people in their late 20s and early 30s will continue, so this will to be the area where the downturn will be concentrated.
But there are still many retailers that believe their skills will overcome that downward thrust.
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