REPEAT Rudi’s View: Weak Labour Market Data, A New Trend?

This story features SEEK LIMITED, and other companies. For more info SHARE ANALYSIS: SEK

(This story was originally written and published on Wednesday, 29th June 2011. It has bee re-published to make it available to non-paying members at FNArena and to readers elsewhere).

By Rudi Filapek-Vandyck, Editor FNArena

Australia's "miracle economy" has shed some of its strength this year and unfortunately it was not all due to weather related events, or even the earthquake in Japan, or the growth deceleration in the US, China and elsewhere. Domestically, the environment for most sectors has remained tough and this has had a direct impact on the labour market where recent data have surprised to the downside.

No surprise thus, share prices for labour market related services providers including Seek ((SEK)), Talent2 ((TWO)) and Chandler Macleod ((CMG)) have lost quite a bit of value since April-May this year. This has already prompted a response from analysts at BA-Merrill Lynch that Seek shares are now too cheaply priced. A substantial part of this assessment is based upon an anticipation that Australia's labour market will continue to grow tighter and tighter in the 18 months ahead. According to Bloomberg, which collects economic data such as these, market consensus is now projecting an unemployment rate in Australia of 4.5% by year-end next year compared with 4.9% today.

Hence why most stockbrokers rate the above mentioned companies as Buy (or an equivalent).

But what if the labour market is not as strong as it appears in statistics? What if the outlook is more subdued than market consensus is suggesting? It wouldn't be the first time that what appears to be a no-brainer, widely carried market consensus assumption turns out to be too rosy and ripe for downward revisions further down the track. Think RBA rate hikes (forecasts are all moving into Q4 if not 2012) or oil prices (no more talk of US$130-plus price projections, at least not for this year), not to mention all those predictions the ASX200 would at least rally to 5400 this year.

Last week I mentioned a survey by economists at UBS into the underlying labour market dynamics in Australia. This week UBS published part two out of three and it makes for fascinating reading. Fascinating because the economists have dared to challenge what has been general assumption thus far; that the unemployment rate can only move closer towards 4% from here. Fascinating because the economists have done some serious homework and the data to prove it. This is not just about expressing a view and then keeping the fingers crossed it will hopefully prove correct.

Conclusion number one (which I mentioned last week) is that Australia's labour productivity is amongst the worst in the world and contrary to what sometimes is being suggested, this is not only because mega-investments by the mining and energy sectors require money and work upfront, with real productivity gains to follow later. UBS data suggest most Australian companies outside mining and energy are too heavily loaded when it comes to labour. This fits in with the general expectation last year the domestic economy would perform better in 2011 and, apparently, companies in retail, transport, construction and other sectors had been hiring in anticipation of.

Alas, it turns out this view was too optimistic and what we have seen in past months is some companies actually starting to shed some staff. UBS analysis suggests this is why labour market data have been rather soft recently. Note the mining industry only represents 3% of the labour force in Australia. Add the sectors that had been weak, but are recovering including the public sector, finance & insurance, arts & recreation and accommodation plus "eating out" and UBS estimates some 20% of the labour market is currently exhibiting strength.

No wonder recent data have been soft.

States UBS, if it wasn't for a fall in the overall participation rate, Australia's unemployment rate would not print 4.9%, but 5.25% instead. This suggests the labour market in Australia is not as strong as official statistics indicate (a fact underpinned by softer indicators elsewhere). This might well translate into more soft data as the year progresses. We might even see economists having to adjust their projections to less positive scenarios.

UBS economists suggest the official unemployment rate could well print 5% by year-end, indicating a complete stand-still compared with late last year. Note this is not the in-house view. UBS "officially", just like all the rest, projects a gradual further tightening of the unemployment rate to 4.3% by year-end 2012, 4.7% by December this year.

If the analysis turns out to be correct, ramifications are much wider than simply for labour market statistics and services providers. Two conclusions drawn in the analysis make this instantly clear:

– too much labour weighs on company's abilities to improve margins and thus profits
– too much labour tends to translate into a slower pace of growth for the economy overall

All of the above can potentially impact on interest rates as tightness in labour and upward pressures on wages remain key focal points at the Reserve Bank.

Here's what has happened, in UBS's words: "Over the 6 months to November the annualised pace of jobs reached a peak of 4.2% (after 6 months of consistent near 40k per month gains). At this time (Q410), GDP growth was running around 2¾%, suggesting a pretty poor productivity outcome. By May this year – 6 months further on – jobs growth has slowed to a 2.3% y/y pace, reflecting only 5k per month job gains, and an annualised pace of growth closer to zero."

Jobs growth is now on par with GDP growth in Australia, implying zero productivity. On UBS's analysis, no less than 13 sectors in Australia, out of a total of 19, appear to have progressed into negative productivity. 15 out of 19 are underperforming against their long term trend.

At the very least, this suggests Australian companies have over-hired in anticipation of better times ahead and thus even if economic growh picks up over the year ahead, as is widely expected, this will not translate into a parallel growth recovery for the jobs market.

More reason to assume the RBA won't be in a hurry anytime soon to hike interest rates further (they shouldn't).

More reason also to be a little more cautious than what analysts at BA-ML suggest. Share prices of Seek, Talent2 and Chandler Macleod may well represent better value today than they did earlier in the year, it is also likely that forecasts need to be cut and price targets adjusted.

Having said so, the current discounts seem excessive with Seek, which is a high-multiple stock, today trading 25% below consensus target and Talent2 no less than 30% below target. If, however, UBS's assessments about weak labour market data in the months ahead proves accurate, shareholders might have to be patient to see these valuation gaps closing.

Also: don't automatically believe what statistics tell you. In the end, statistics are just what they are; statistics.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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