Expect a two-speed in Australia next year. No, it won’t be mining vs other industry sectors; it will be strong investment returns vs a weakening broader economy, says Instreet Investment MD George Lucas.
In the past few years, a new word has entered the Australian lexicon – a two-speed economy. It refers, of course, to a booming mining industry, and those two states where it is largely centred, Queensland and Western Australia, and the rest of the economy that has been lagging, notably services, construction and retail.
Well, mining has lost its lustre somewhat in recent months in the wake of a slowing China. But we expect that Australia will still experience a two-speed economy in 2013, albeit in a different form. Let me explain.
The Global Financial Crisis (GFC), which will 'enjoy' its fifth anniversary in September 2013, has perceptibly changed people’s investment outlook in many ways; but two factors, to my mind, are most significant.
First, people are debt averse; the latest figures show households are saving 10 cents in every dollar of net disposable income, which includes credit card debt being slashed and home mortgages being paid off, helped along by falling interest rates.
It’s not just households that are being more frugal; companies, too, are focussing on having strong balance sheets as evidenced by the slow credit growth of the banks. And now governments have joined the party; deficit has become a dirty word as both state and federal governments strive to deliver surpluses.
It seems everyone is saving.
Second, investors are far more focussed on capital preservation than the rate of return an investment can earn. As evidence of this they are still attracted to bank term deposits that come with government guarantees compared with higher yielding, blue chip stocks that have the added attraction of franking credits. It is the complete turnaround from before the GFC when investors were liberally employing gearing to chase higher returns.
So, in a nutshell, investors are deleveraging and an investment’s security is of paramount importance. So what does this mean for the broader economy?
With credit being tightly held, it will mean slower growth across the economy as companies, at both ends of town, and households, continue to put spending plans on hold. In this environment, expect unemployment to rise. More people in the dole queue, will, in turn, induce the Reserve Bank to keep interest rates lower for longer, especially if rising unemployment goes hand in glove with construction activity remaining weak and subdued retail numbers over the Christmas-New Year period.
This is the first part of my two-speed economy thesis; a slowing Australian economy. Not dipping into recession, mind you, but sluggish.
For investors, though, it could easily be a different story. The stronger equity markets of recent months is beginning to tempt some back into the market, a move that will be encouraged if China exhibits political stability and moderate increasing growth (about 7.5%) post the leadership change, and the Obama administration negotiates a deal with Congress to avoid the 'fiscal cliff' at the end of 2012.
Remember, too, a stronger dollar has meant that Australian wages have been able to grow around 4% a year while inflation has remained lower than wage growth. It means Australians are getting richer; it’s just that they are just saving the cash, not spending it. However, we expect, the equity yields on offer will eventually bring them back to the market, which we have begun to see and I expect this to continue next year. Especially as interest rates remain low or continue to fall.
We often forget that the materials and banking and finance sectors of the Australian share market make up 65% of its market capitalisation. The latter sector historically tends to pay high dividends, and I would expect this to continue even with slowing GDP growth because they will continue to pay dividends even if profits are not growing. Material stocks will be driven by the China story and the recent numbers indicate growth picking up in China that may switch investor sentiment towards this sector.
That’s equities. Falling interest rates will be positive for bonds (government and corporate) and the property market; notice the number of companies that have been issuing hybrid securities in the past six months. There are also signs that retail property market has stabilised and may be beginning to rise, a trend that can only gather momentum if the Reserve Bank decides, to cut rates again.
For many investors, it seems counter initiative that the markets could be buoyant yet the broader economy is stagnant. Yet it isn’t that surprising; historically rising markets (especially equity markets) have foreshadowed economic growth. It is reverse of what we have experienced over the past few years when the Australian economy was the envy of the world while our stock market consistently underperformed. So if I am right, 2014 could see the Australian economy rebound strongly. Let’s hope so.