Market Update

In this update we examine the market during the quarter and the first part of the year, why the Australian economy has avoided a recession in the past and key areas of support for the Australian economy.

First Quarter

The September quarter has seen markets finish up slightly. A period of consolidation is hardly surprising given the Australian market is up 23.07% since 1st January 2019. The combination of declining interest rates, policy continuity post the federal election, and reasonable company earnings for our core stocks have underpinned share prices.

The Reserve Bank of Australia again cut the cash rate to a record low of 0.75% in October. As we have written previously the key reason the RBA is cutting interest rates is to stimulate the economy, create more jobs, and increase inflation. The central bank believes the unemployment rate needs to be below 4.5% to push inflation from the current rate of 1.3% up into its 2 to 3% target range. Typically, lower unemployment contributes to higher inflation. The RBA previously thought that an unemployment rate of about 5% (currently 5.3%) was low enough for inflation to reach its target.

The RBA is expected to cut interest rates again between now and February. Our base case for a number of years is that we are in a period of structurally lower interest rates, in part due to ageing populations and technology innovation.

Why has the Australian economy avoided a recession over the past 28 years?

Australian economic growth has slowed to the weakest since the GFC. June quarter GDP growth was just 0.5% and annual growth has fallen to 1.4%.

The absence of an Australian recession – whether defined by two quarterly GDP contractions in a row or negative annual growth – for 28 years is instructive. Many forecast recessions at the time of the 1997-98 Asian crisis, 2000-2002 tech wreck, the GFC and from around 2012 as the mining investment boom ended. But it didn’t happen. Key reasons why:

• Economic reforms made the economy more flexible;
• The floating of the $A has seen it fall whenever there is a major economic problem providing a shock absorber;
•  Strong growth in China that helped through the GFC;
•  Strong population growth; and
•  Counter cyclical economic policy – like stimulus payments and monetary easing;

Key areas of support for the Australian Economy

Sources of support for the economy which should mean that an official recession is unlikely:

• Tax cuts should provide some growth boost – while July retail sales were disappointing, the experience from the GFC stimulus payments is that the tax cuts will provide some lift to growth in the months ahead and various retailers have expressed optimism about this recently.
• The threat of crashing property prices looks to be receding – while it’s so far been on low volumes, buyer interest has returned to the Sydney and Melbourne markets and we never saw the much-feared surge in non-performing loans or forced selling. This has helped remove the threat of a debilitating negative wealth effect on consumer spending.
• Infrastructure spending is booming – recent state budgets saw the projected peak in infrastructure spending pushed out yet another year to 2020. And its likely states will seek to take even greater advantage of ultra-low long-term borrowing costs to further push out the peak in infrastructure spending.
• The low $A is helping to support the economy – the $A is down 39% from its 2011 high and this provides a boost to Australian businesses that compete internationally by making them more competitive.
• The business investment outlook is slowly improving – the big drag on growth as mining investment fell back to more normal levels as a share of GDP is over and mining investment plans are rising. This is driving some pick-up in the outlook for overall business investment.
• There is scope for extra fiscal stimulus – the Federal budget is back in surplus and while we have had a long run of deficits our public finances are in good shape compared to the US, Europe and Japan. As a result, there is scope to provide more fiscal stimulus.
• Population growth remains strong – Australia’s population growth at around 1.6% pa remains strong. Solid population growth also has significant benefits in terms of supporting demand growth, preventing lingering oversupply and keeping the economy dynamic.

Investment Strategy

Historically periods of low inflation, low interest rates and low unemployment have been very positive for shares. Our preferred exposures include healthcare, infrastructure, technology, overseas earners, and resources.
Please do not hesitate to contact us if you have any queries, or if you would like to discuss your portfolio.

Best regards,

Paul Israel
Investment Manager