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In this update we review the first quarter of 2023 and examine essential drivers of long-term economic growth – innovation and population growth.
March Quarter
Stocks ended the quarter on a positive note, after a volatile three months in which markets whipsawed by strains in the banking system, as well as shifting outlooks for inflation and interest rates. The S&P/ASX 200 was up 1.98% for the quarter, while the US S&P 500 increased by 7%, its strongest start to a year since 2019. The increase in the US was mostly driven by large cap Tech stocks which returned 31% for the quarter.
Although the recent stress in the US banking sector raises the risk of recession, it accelerates disinflation. Historically, disinflation is positive for shares. Recent data showed the US Federal Reserve’s preferred measure of inflation slowed in February, lifting hopes the central bank is nearing the end of the rate rise cycle.
In Australia interest rate hikes are working in slowing spending with:
- CBA’s internal data on credit card spending is painting a picture of reducing consumer spending. This was supported by Retail sales in February which showed inflation-adjusted spending on goods falling on higher prices.
- Container port volumes down 19% in February. This was the fourth consecutive month of declines as the market prepare for softer demand ahead.
Despite slowing growth, the Australian economy is relatively strong compared to its peers. Analysis suggests that the key headwinds to growth from wealth and income shocks are currently peaking and should ease later in the year alongside falling inflation, a stabilization in house prices and interest rates.
Chart 1 – Australian GDP Growth has decelerated to a sub- trend pace but is relatively strong compared to developed market peers.
Source – Goldman Sachs
Population growth and innovation are fundamental long-term drivers of economic growth. For instance, 56% of Australia’s long term economic growth (+2.9%) has been driven by population growth.
Population Growth – Australia’s Immigration boom has recommenced.
Australia’s population grew by an all-time high 482,000 in 2022, driven by net overseas migration of nearly 400,000 (also a record). According to Macro business the early indications are that net overseas migration will surge even higher in 2023, on the back of unprecedented international student flows.
Australia, like most countries has seen a material jump in inflation. The tight labour market has been a contributor with our unemployment rate too low at 3.50%. The RBA estimates the natural rate of unemployment is around 4%. The immigration boom is likely to be disinflationary over the next few years as the large increase in labour supply will limit upward pressure on wages.
Chart 2 – Australian Population Change
Source – www.macrobusiness.com.au, Australian Bureau of Statistics
In the decade preceding the COVID shock, population growth in Australia averaged +1.5% p.a., which is double the rate of most other advanced economies. A fast-growing population means that the customer base which Australian companies are selling into is constantly expanding.
Importantly the seeds of a housing and building recovery are in place with booming migration, low rental vacancy, and limited dwellings. Australian capital-city dwelling prices rose +0.8% mom in March, the first monthly increase since the RBA started raising rates in April 2022.
The Potentially Large Effects of Artificial Intelligence on Economic Growth
The boost to global labour productivity could be economically significant, with Goldman Sachs estimating that AI could eventually increase annual global GDP by 7%. Although the impact of AI will ultimately depend on its capability and adoption timeline, this estimate highlights the enormous economic potential of generative AI.
Chart 3 – Previous Milestone Technologies (Electricity and Personal Computers) Led Labor Productivity Booms
Source – US Bureau of Lobor Statistics, Goldman Sachs Global Investment Research
It is estimated that two-thirds of jobs in the US and Europe are exposed to some amount of automation by AI, and that AI could substitute for around 25% of current work. The good news is that worker displacement from automation has historically been offset by creation of new jobs, and the emergence of new occupations.
Chart 4 – Historically Technological Innovation leads to the creation of new occupations that more than offset jobs lost.
Source – Goldman Sachs Global Investment Research
The combination of significant labor cost savings, new job creation, and higher productivity for non-displaced workers raises the possibility of a productivity boom that increases economic growth substantially. It is worth noting the timing of such a boom is hard to predict.
Investment Strategy – Stay Positive Longer Term Thematics
Maintaining a balanced portfolio structure, we think is appropriate for these times. We also note that share prices in some cases are 30% lower than 18 months ago, valuations have materially improved, especially in growth stocks. This does include many strong businesses with excellent track records. For longer term investors buying quality stocks during periods of uncertainty generally leads to excellent long-term returns.
Cost cutting is now gathering momentum across many sectors including technology, financial services and other service sectors as companies begin shedding labour. Return on capital remains historically high with companies generally in good shape.
From an investment perspective, we believe it prudent to have portfolios structured to withstand a slowdown or recession. In practice that means maintaining a balanced portfolio across Defensive (infrastructure, consumer staples, logistics, and healthcare), Growth (secular, predictable) & Cyclical (select commodities, building & banks).
If you need assistance or guidance managing your investment portfolio, contact CIB Private Wealth Director Paul Israel on 02 8274 5807.
