Rodney’s Ravings: Why the recession will be much worse for some firms than others

Guest post by Rodney Dickens

New Zealand is officially in recession, with economic activity having fallen 0.8% over the last two quarters.

In my assessment, the recession is likely to linger for a few quarters, given that still to come is a major fall in residential building activity, something which plays a pivotal role in economic cycles.

Apart from the Covid recession in 2020, when national production, or GDP, fell 11% in just two quarters, past strong recessions (those of 2008/09 and the early 90s) have seen it take several quarters for GDP to drop slightly less than 3%.

Put another way, during a normal solid recession, the likes of which is needed to fix a sizeable inflation problem, roughly 97% of what was being produced before the recession is still being produced at the end of it.

But for some firms, namely goods manufacturers and suppliers of raw materials, the negative impact of a recession is magnified

And that's as a result of destocking in the supply chain - by which I mean that not only do they face lower end-user demand (reflected in the 2.3% drop in retail spending we’ve seen over the last two quarters), but are also impacted by retailers, distributers and wholesalers reducing stock levels as well.

Most at risk are industries where stock levels are highest, and those where end-user demand falls most during recessions, like residential building, non-residential building, and spending on plant, machinery, and equipment highest. Demand for lumber is also one of the better examples of the double whammy of a big fall in end-user demand and de-stocking – written about in this article.

Let's take the impact on residential building, for example…

Generally, economic activity falls no more than 3% during a “normal” recession, retail sales volumes can fall more (retail spending dropped 9% during the GFC) – but consents for new dwellings typically fall up to 30%, or more.

This is shown in the chart below, which tracks the annual % change in the three-month average number of consents for new dwellings (orange line), and the results of an ANZ survey of residential builders which points to more near-term downside for consents (dark grey line).

Nationally, significant destocking takes place during recessions

For example, during the GFC, Statistics NZ estimates that the value of national inventories fell by $2.4 billion (calculated based on 2009/10 prices). This occurred over five quarters and equalled a 5% reduction in quarterly GDP from the pre-fall level.

That fall was also greater than the $1.1b fall in consumer spending, and the $1b fall in residential building activity – calculated using the same pricing.

"Just-in-time” inventory management has not alleviated what has been a significant factor in economic cycles: destocking in response to falling end-user demand, and restocking in times of economic recovery.

Just as I expect the recession to linger for a few more quarters, the period of destocking is likely to continue for another 2-3 quarters, adding to the recession and especially the pain experienced by numerous manufacturers and suppliers of raw materials.

This is subject to quarterly GDP being volatile, while one-off factors could mean falls are not recorded in each of the next few quarters.

The worse things get, however, the greater the case should become for a market-led fall in interest rates – and when the recovery starts, restocking will provide an extra boost for many of the manufacturers and suppliers that are suffering most right now.

By Rodney Dickens, Managing Director, Strategic Risk Analysis Ltd www.sra.co.nz.

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