Australian Strategy Insight

Transcription

1 21 March 218 INTERNAL ONLY CHIEF INVESTMENT OFFICER Malcolm Wood mwood@baillieuholst.com.au Australian Strategy Insight INVESTMENT STRATEGY US starting to outstrip Australia Over the past 25 years, Australian real GDP growth has outpaced its advanced economy peers 85% of the time, including the US and Eurozone 73% and 85% of the time respectively. This impressive record is now under threat. Australia s productivity performance has significantly deteriorated. Australian consumers face headwinds from flat real wages, a rising debt burden, high energy prices and a depleted savings buffer. Housing is beginning to soften from extreme levels, and while business sentiment is more constructive, it is unlikely to drive the economy. By contrast, US productivity growth is now above Australia, even before the impact of major tax reform. The US consumer is benefitting from rising real wages, a record strong balance sheet and a major tax cut. A significant housing shortage should lift housing activity. Business sentiment is near 3-year highs, and businesses are receiving major tax cuts and investment incentives. Such divergences are rare. In the past Australia s business cycle generally moved with the US (Figure 1). In recent years, however, this has not been the case, and now the balance is moving against Australia. This outlook supports our themes of overweight international equities, overweight Australian global leaders and underweight challenged domestic sectors. FIG.1: After long underperformance, the US is just beginning to outstrip Australia 8.% 6.% AUS vs US Real GDP Growth 4.% 2.% 2.% AUS Real GDP YoY% US Real GDP YoY% 4.% Mar 8 Mar 85 Mar 9 Mar 95 Mar Mar 5 Mar 1 Mar 15 Baillieu Holst Ltd ABN Please read the disclaimer at the end of this report. Page 1

2 US starting to outstrip Australia Over the past two weeks, GDP reports for the US, Eurozone and Australia have revealed economies growing neck-and-neck, with US and Eurozone growth of 2.5% YoY and 2.7% YoY respectively edging Australia s 2.4% YoY. But looks can be deceptive. Looking forward, US and Eurozone growth seems highly likely to outstrip Australia, reflective of major US fiscal stimulus, superior consumer, business and housing fundamentals and fewer critical imbalances. This outlook reinforces three of our key themes: overweight international equities, overweight Australian global leaders and underweight challenged domestic sectors. Australia s deteriorating productivity performance Australia s GDP growth is increasingly being driven by population growth. Population growth is a key source of demand: population is up 1.6% YoY, meaning that in 4Q17 per capita real GDP rose just.8% YoY. This is a persistent trend since the GFC (Figure 2). On the supplyside, reported employment growth of 3.3% YoY (far above GDP growth) means productivity growth over 217 was negative 1.% YoY. Poor productivity growth is not new in fact, over the past four years it has now averaged just.5% pa (Figure 3). This is particularly disappointing as during this period Australia has dramatically expanded its iron ore and LNG exports capital-intensive projects with very little on-going labour input. Low productivity growth has very significant implications, inhibiting real wages growth, which has fallen to about zero in real terms. In our view, Australia s low productivity growth has deep-seated causes: the country s major reform era occurred in the 198s into the early-2s. The resultant gains have been exhausted, and the appetite for on-going reform has waned. Some recent reforms, such as energy policy, have impeded productivity growth. With the resources boom now largely exhausted, business investment has fallen back from a peak of 18.8% of GDP to a relatively low 13.4% share. The current infrastructure boom should lift productivity, but this may be blunted by congestion costs associated with highly concentrated population growth in Melbourne and Sydney. Increasing years of education should also lift labour productivity, but this is a long-term positive, and Australia appears to be slipping in international rankings. Whilst US productivity performance has also underwhelmed in this cycle, growing at an average 1.1% rate, it is now above Australia. Looking ahead, tax reform may encourage improved capital allocation and increased investment, lifting productivity growth. FIG.2: Australia s GDP growth increasingly driven by population growth FIG.3: Australia s productivity performance has deteriorated 6.% AUS Real GDP vs Population Growth 6.% AUS GDP & Productivity Growth 5.% 5.% 4.% 4.% 3.% 3.% 2.% 2.% 1.% AUS Real GDP YoY% 1.% AUS Population Growth YoY% 2.% Mar 9 Mar 95 Mar Mar 5 Mar 1 Mar 15 1.% AUS Real GDP YoY% AUS Trend Producticvity 4 Year Avg 1.% AUS Productivity YoY% 2.% Mar 96 Mar 1 Mar 6 Mar 11 Mar 16 Baillieu Holst Ltd ABN Please read the disclaimer at the end of this report. Page 2

3 Consumer fundamentals strongly favour the US US ex-auto retail sales are up 4.9% YoY, far outstripping Australia at 2.5% YoY. US retail sales are being supported by strong consumer fundamentals. Employment is rising at a robust 1.5% YoY rate, which has driven the unemployment rate to a 17-year low 4.1%. Aggregate hours are rising even faster than employment, up 2.% YoY. On our outlook, the unemployment rate should fall to a new 5-year low in 218. Wages are growing 2.7% YoY, or about 1.2% in real terms. But consistent with the tightening labour market, signs of rising wages pressures are building, which should lift wages growth at a moderate pace. With the strong US stockmarket and recovering home prices, household wealth has risen to a record 679% of disposable income. Given our positive outlook for both the US equity market and home prices, this ratio should continue to rise. The household debt ratio is at a moderate 14% of disposable income, and the debt burden a near-record low 1.3%. With the vast majority of household debt in fixed rate mortgages, and thus protected against rising rates, higher US interest rates should only have a very gradual impact on debt burdens. On top of this the Trump US$1.5 trillion tax cut will deliver individual tax cuts of US$189 billion in its first full year, equivalent to about 1.1% of personal income. Not surprisingly, these strong fundamentals are reflected in consumer confidence being at multi-decade highs, driving strong consumer spending (Figure 4). In our view, real consumption growth above 3% YoY seems highly likely. FIG.4: US Consumer Confidence at 18-year highs, reflected in strong Retail Sales FIG.5: Australian Retail Sales a sluggish 2.5% YoY US Consumer Confidence vs Spending 1 8.% 1 9.% 8.% AUS Retail Sales & Consumer Confidence % 7.% US Conf Bd Confidence (Left) US Retail Control Sales 3M YoY% (Right) Jan 93 Jan 97 Jan 1 Jan 5 Jan 9 Jan 13 Jan 17 4.% 2.% 2.% 4.% 6.% 6.% 5.% 4.% 3.% 2.% AUS Retail Sales 3M YoY% (Left) 1.% AUS Consumer Sentiment (Right) Jan 92 Jan 96 Jan Jan 4 Jan 8 Jan 12 Jan In Australia reported employment is up an unbelievable 3.3% YoY. While aggregate hours are a less explosive 2.6% YoY higher, it still points to negative productivity growth. The unemployment rate at 5.5% remains well above pre-gfc lows which, when combined with high levels of underemployment, is restraining wages growth. The combination of poor productivity growth and unemployment translates to near-record low 2.1% YoY wages growth, about flat in real terms. The household balance sheet appears strong, with the wealth-to-income ratio above the US at 752%. But this largely reflects over-inflated home prices, with housing wealth about three times that of the US. The household debt ratio is at 2%, about twice US levels. The interest burden is at 8.8%, slightly above average despite record low interest rates. When debt repayments are added on, we estimate the debt burden is approaching 17% of disposable income. With a shift away from interest-only loans, this burden will probably rise about.3% pa. Looking ahead, the Turnbull government has hinted at possible personal income tax cuts. In all likelihood, these will be modest, and only reverse some of the tax take from bracket creep (by contrast, the US indexes its tax brackets to inflation, avoiding bracket creep). Baillieu Holst Ltd ABN Please read the disclaimer at the end of this report. Page 3

4 The savings rate has fallen to ~2.7%, well down on the ~1% levels seen post-gfc. Such a modest buffer has only been seen in the debt-driven boom pre-gfc. A key driver of the savings rate is the wealth effect. With home prices flat-to-slightly lower since mid-17, and challenged by over-supply, record high valuations, record leverage and high investor speculation, we expect this effect to push the savings rate higher over In our view, the combination of flat real wages, rising debt burdens and a rising savings rate points to on-going sluggish retail sales growth (Figure 5). We also expect a material slowdown in Australian consumer spending to about 2% in real terms, or possibly lower. Business fundamentals also favouring the US Business fundamentals in the US are very strong, with business surveys such as ISM s at unusually high levels (Figure 6). Corporate profits are at record levels, with S&P 5 earnings in 217 up ~13% YoY and an even stronger 16% YoY in 4Q17. On top of this, the Trump tax cut delivers a major profit kicker to US companies. We estimate this will directly lift profits by 8-1%, while stronger US growth should lift profits by another 4-8%. Whilst some of this upside has been factored into S&P 5 earnings estimates, which are up 18% YoY, we see further tax-related upside to estimates. An important feature of the tax reform is the immediate expensing of business investment for the next five years, which should also stimulate business investment. In Australia, the NAB business survey is at strong levels. Conditions are very robust, but confidence is at moderately above average levels (Figure 7). Corporate profits, as measured by ASX 2 companies, however, are still below pre-gfc and peak commodity price levels. Australia seems unlikely to see business tax reform. The modest 5ppt reduction in the company tax rate over 1 years, as proposed by the Turnbull government, has been blocked in the Senate, and would be most unlikely to proceed under an ALP government. FIG.6: The US ISM indices are at the 2 nd highest levels in 3 years, driving strong earnings growth FIG.7: AUS Business Sentiment is modestly above average, consistent with modest earnings growth 3 US S&P5 EPS vs ISM Mfg & S's 2. 2 AUS Business Sentiment vs Earnings Jan 9 Jan 93 Jan 96 Jan 99 Jan 2 Jan 5 Jan 8 Jan 11 Jan 14 Jan 17 US S&P5 fwd EPS YoY% (Left) US ISM Mfg & S's Comp. z score (Right) NAB Business Confidence (Left) 2 AUS 12MF EPS (Right) 15 Mar 97 Mar Mar 3 Mar 6 Mar 9 Mar 12 Mar 15 Mar 18 Baillieu Holst Ltd ABN Please read the disclaimer at the end of this report. Page 4

5 Housing: A major divergence emerging US housing, almost a decade after the GFC, is still in an early-recovery phase. US housing starts continue a moderate recovery, but remain at about 17% below average levels. The persistent low build is also creating a housing shortage, with the inventory of homes for sale around record lows (Figure 8). The combination of the home shortage, solid income growth and still low mortgage rates is driving strong home prices, up about 6% pa. By contrast, Australian dwelling approvals have been at record levels for five years (Figure 9). The home price boom has depressed affordability. Together with the tightening of lending standards by APRA, home prices have been flat-to-slightly lower since mid-17. We see further downside as the result of the combination of oversupply, extreme leverage, overvaluation and near record levels of speculation. FIG.8: US Housing indicators point to a growing shortage FIG.9: Australian Housing is confronting unprecedented supply US Housing Indicators US Housing Starts (''s, Left) 5 US Homes For Sales (Mths, Right) Jan 8 Jan 84 Jan 88 Jan 92 Jan 96 Jan Jan 4 Jan 8 Jan 12 Jan AUS Housing Supply indicators 7 Starts (Left) Completions (Left) 6 Approvals (Left) Under Construction (Right) Q Q Q Q2 2 Q2 24 Q2 28 Q2 212 Q Investment implications We see three significant investment implications from this analysis: i) Overweight International Equities: international equities offer exposure to higher earnings growth. Strong US earnings growth should be partly offset by higher Fed rates and a modest de-rating of the market as bond yields rise. Outside the US, growth should also be strong, but central banks are well behind the Fed in raising rates and valuations are much cheaper. Altogether, we are positive on international equities with a tilt toward ex-us markets. Exposure to this theme can be created through a mix of ETFs, LICs and managed funds ii) Overweight Australian Global Leaders: Australian multinationals with exposure to higher international growth should grow earnings faster than their domestic peers. Global leaders we like include global funds managers Macquarie Group (MQG) and Janus Henderson (JHG), increasingly global property developer Lend Lease (LLC), global healthcare plays Resmed (RMD) and Sonic Healthcare (SHL), leading logistics company Brambles (BXB), packaging leader Amcor (AMC) and US housing play James Hardie (JHX). iii) Underweight challenged domestic sectors: a muddle-through Australian economy will constrain the growth of domestic-focused sectors. Rising competition will also be a headwind. We are underweight Banks, Retail, A-REITs, Telecoms and Utilities. Baillieu Holst Ltd ABN Please read the disclaimer at the end of this report. Page 5

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