Australia outlook 2019
Martin Currie Australia Chief Investment Officer Reece Birtles and Portfolio Manager Will Baylis discuss what investors can expect for Australian companies and the equity market.
29 January 2019
What has changed your outlook for 2019?
The key issue we see going forward for markets everywhere is the sustainability of world profit growth.
A year ago, global growth had been accelerating but had probably peaked in December 2017, while the US remained really strong. During 2018, the PMI numbers around the world weakened. The US has continued to show remarkable growth, and while this remains strong, the country is nearing full employment with limited spare capacity and is seeing a lessening effect from the fiscal stimulus.
The Fed rate hikes had a massive impact on world markets during the year. Does the Fed keep tightening above neutral, and actually endanger growth? It's a key debate as to whether the Fed a risk manager or is it really just worried about that inflation mandate. The rhetoric of recent times looks as though the Fed is going to back off a bit earlier than it may have. But if the inflation numbers keep on rising and the economy holds together it'll be hard for the Fed not to raise.
What's on your radar for 2019?
Global profit growth has slowed from ~15% to ~7%1. With PMI numbers around the world weakening, there are question marks about whether globally we are in a profit recession, or whether it's just a slow-down.
If the inflation numbers keep on rising and the economy holds together it'll be hard for the Fed not to raise.
Despite this, the Australian economy is in a relatively good position. It is at an earlier stage of its economic cycle than the US, both in terms of the Philips curve (the relationship between the unemployment rate and inflation) and size of government stimulus, and thus we see the Australian equity market with more room for improved earnings-per-share (EPS) growth. The US has already seen significant fiscal stimulatory activity, but Australia is just now starting to move into its stimulus cycle (via personal income tax cuts). We believe this will be positive for consumption, and particularly the cyclical sector of the market.
Australia’s economic growth also benefits from the growing population, and strong employment growth and wages growth. We expect to see signs of this emerging this year in the form of higher household incomes and a bigger capex spend by companies. We also see that the lower Australia dollar, relative to the US dollar, as beneficial and stimulatory for Australia, particularly the tourism sector and exporters.
What are the risks in 2019?
In Australia specifically, the most significant tail risks for 2019 are high household debt, restrictive household lending from cautious banks, driven by APRA and the Royal Commission, and whether that creates a contagion and house prices start to move into a more downward spiral.
Australia's trade surplus and fiscal surplus position is going to be strong for the next government, and positive for the economy.
Our base case is that less than 15% house price falls would be quite manageable, especially given things like Australia's population growth, where there is plenty of demand for new housing, given the population growth. If it goes beyond that level there's bigger and bigger risks in terms of spending patterns on households, confidence, whether that causes people to delay further purchase decisions.
Politics also presents a risk from populist interventionist moves in Australia, but also an opportunity for greater confidence and wage growth. We believe it’s likely that the government will bring tax cuts forward – no matter which party is in power after the next federal election, which must be held by May this year. We also see a greater spend on infrastructure to support the growing population, which will also be stimulatory. Australia's trade surplus and fiscal surplus position is going to be strong for the next government, and positive for the economy.
Local growth risks, however, are heightened by the US-China trade tensions, leading to slowing China growth. Tightening US & emerging market monetary conditions, and divergent growth and central bank policies globally may also impact Australia.
Current economic growth data remains far more bullish than global financial market indicators suggest, such as the US 2-year/10-year spread alluding to a rising risk of US recession. The US Federal Reserve is likely to continue raising rates in 2019, to a point where its monetary policy is no longer stimulative, but risks of over or undershoot are higher than usual.
What's the market missing?
Household consumption makes up over 60% of Australian GDP2, so consumer confidence is critical to the economy. However, we think this area is being underestimated by many investors, who are too focused on recent falls in Australian house prices. In fact, we don’t see this drop as being as big a risk as others do. Because of the employment and wages growth starting to come through, consumer confidence is actually holding up.
A lot of market participants have also been too focused on the saving rate in Australia, but we see that the savings rate is very backward looking and focuses too much on historical income growth. In fact, we have found that the ‘wealth effect’ from higher house prices was not evident in the early stages of this cycle and thus not a risk to consumption. People didn’t spend more when house prices went up, so it’s unlikely they will spend less when they fall.
With stronger wages and employment growth, a growing household income will reduce stress on the consumer. Add to that the strong fiscal position of the government, we should see tax cuts or rebates that will help household income more. To us, this points to a supportive position for the consumer in Australia.
We should see tax cuts or rebates that will help household income more.
In the current environment, we believe investors should avoid paying too much for growth/quality style stocks that have outperformed and appear overvalued on our metrics. The cheap stocks in the market are a lot cheaper than they were 12 months ago, and the spread of how much cheaper our portfolio is relative to the market is at very high levels compared to what we've seen in the past. Similarly, the forward income yields of our income portfolio are very attractive compared to the market.
The opportunity set for quality stocks with attractive valuations and growing earnings is better than ever. We currently see opportunities in sectors that are leveraged to the consumer, such as consumer staples, strongly positioned consumer discretionary and energy stocks, which now have attractive valuations.
1 Source: Martin Currie Australia, Factset; as of 31 December 2018. Based on MSCI World EPS growth for the next 12 Months.
2 Source: World Bank national accounts data, and OECD National Accounts data files (CC BY-4.0).
The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds.