Pitfalls for businesses in ?accelerating? economy

March 23rd, 2007

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On Wednesday afternoon, we came across this article in the Sydney Morning Herald. Initially, the title of this article was ?Economy poised to accelerate this year: Westpac.? After we read the article, we were again flabbergasted at the mainstream media?s frequent bad habit of misinforming the public. Were they trying to convince their readers that Australia is going to make yet another miraculous economic growth? Did Westpac really say that the great party that we enjoyed for the past 16 years is going to get even better?

As we returned to that same article in the evening, its title was renamed to ?Economy to accelerate, maybe rates too: Westpac.? After re-reading it, we felt strange that we were not feeling as flabbergasted as before in the afternoon when we first read it. Were we overactive in the afternoon? But wait a minute! We realised, if memory serves us correctly, the content of the article was indeed different! Perhaps the chief editor saw what we saw in the afternoon and ordered a modification? We can only guess.

Anyway, the modified version of the article is what we should be focusing on for today?s musing. It should serve as a further warning to investors not to assume that the good times of record company profits are going to continue forever. As we said before in Another sign of the business cycle top:

If you expect the profit trend to continue and pay a premium price for stocks in anticipation for higher earnings next year, chances are, you will be disappointed. It is now time to hunker down in your bunker in preparation for the economic downdraft.

As we said before in Have we escaped from the dangers of inflation? and with the Westpac survey confirming our view, Australia is very much likely to be hit with more price inflation in the days to come. Thus, the implication is that there will be more interest rates rise to follow.

What is the implication for us as investors?

With the economy already near full productive capacity, any economic ?growth? will not result in any significant increase in production. As a result, such ?growth? will spill over to increase in prices (i.e. price inflation). Thus, Australian businesses in general will face the twin threats of rising input cost and higher interest rates. Businesses that have no market power will be unable to raise prices as their costs goes up. Those that are high in debt will find their interest payment expense rising as well.

If you want to remain invested in stocks, choose them wisely. Avoid companies that have no market power and/or are high in debt (e.g. Qantas if private equity gets its way).