Profit margin squeeze

They might be expanding at a slower rate but they're still expanding.

The Australian Industry Group's (AiG) performance of manufacturing and services indices both slowed in September from August but remained above the 50 expansion/contraction line.

The manufacturing PMI fell to 54.2 in September from 59.8 in the previous month, indicating continued expansion - the 12th straight month and the longest run of above 50 readings since 2007.

According to AiG: "The Australian PMI is currently leading the ABS manufacturing output data by about three months. The latest ABS estimate of manufacturing output volumes growth of 1.8% quarter on quarter in the June quarter of 2017, the strongest quarter of growth since June 2011. The latest results from the Australian PMI indicate another quarter of growth in ABS output volumes is likely in September 2017, but probably at a slower pace than in June."

The performance of services index (PSI) declined to 52.1 in September from 53 in August. Though this is the lowest reading since May this year, it also marks the seventh consecutive month of expansion in the services sector. AiG explains that: "Respondents to the Australian PSI in the business-oriented sub-sectors noted positive demand coming from the construction and mining sectors, predominantly in the eastern states. Respondents in retail and hospitality are reporting reduced spending by consumers due to a mix of increased household electricity costs, flat income growth, and relatively poor consumer confidence."

Yes, Virginia, we're back to the problem that is Australian consumers. Apart from record high household debt to disposable income ratio, AiG points out "household electricity costs, flat income growth, and relatively poor consumer confidence."

The details of both surveys suggest this will be the state of play in the near term. Although still expanding, the September reading showed the employment sub-indices weakened for both the PMI (down four points to 52.4 in September) and the PSI (down 1.1 points to 51.4).

This could worsen should the profit margin squeeze in manufacturing and services persist.

This is underscored by the diverging trend in input prices and selling prices in the manufacturing sector. Input prices increased by 2.9 points to 65.9 in September while selling prices dropped by 4.4 points to 49.3 (contracting) over the same period.

While input prices for the services sector slowed by 2.5 points, at 56.8 in September, costs are still expanding but just as in manufacturing, selling prices are in retreat - down 0.1 points to 47.4 last month.

The point is that this risk becoming a vicious cycle whereby weak consumer spending prevents Australian businesses from lifting selling prices, eroding their profit margins which, in turn, would prompt firms to cut back on other costs - particularly, employment and wage increases - to maintain profitability. This would circle back into softer household spending.

These, among others, help explain the Australian equity market's flat performance this year to date - the All Ordinaries index is up a full 0.01% - and the RBA's reluctance to move.

Read more: Australian PMIAll OrdinariesAustralian Industry GroupAustralian PSI
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