In recent times there has been much discussion as to whether Australia is about to enter a recession. While we do not believe we will enter a recession, we do expect the discussion to continue over the next twelve to 18 months. In this note we outline the areas of the economy that will slow growth, the areas that will take their place and what it means for investment. In particular, we note that the negative sentiment has kept share prices subdued and that lower prices means solid returns going ahead.
What we will be hearing on the nightly news
We expect the media will continue to focus on the negatives in the Australian economy. There will be talk of a collapse in capital spending, a downturn in exports to China, a collapse of residential property prices, and with them, a sharp fall in consumer confidence and residential property construction activity.
Some of this may come to pass – but it doesn’t add up to a recession.
Capital expenditure has been down sharply and will continue to fall in coming years as the construction phase of the mining boom comes to an end. It’s not good for growth – but that is likely to slow growth rather than send the economy into reverse. Expect to hear alarming media reports each time new data is released over the next year. Ignore it! The downturn is widely expected and will not, of itself, based on current forecasts, be sufficient to drag the country into recession.
The slowdown in China is also real. The impact on our economy to date has been felt in the prices our exporters receive for iron ore and coal. However, the amount of these commodities shipped has been holding up – and, for the purposes of deciding if we have a recession, that’s what will matter. Nonetheless, this is an area we will need to watch carefully.
Finally, the boom in residential property prices does appear to be coming to an end. Unlike many commentators, we do not expect residential property prices to collapse, but we do expect very little capital growth for many years after the increases we have seen in recent times.
The boom in residential construction will also end; but not yet. The number of units being built each year has doubled since 2012 and that’s not sustainable. However, most of the building activity that has started will be completed. A fall off in activity is likely next year or the year after.
The good news parts of the economy
Don’t expect to hear too much about these.
The big falls in the Australian dollar have provided a much needed boost to tourism and education. We are now far more cost competitive than we were just a few years ago when the Australian dollar was 50% higher than today’s value.
We have also seen a big lift in consumer and business confidence since the ascension of Malcolm Turnbull to Prime Minister. Like him or hate him, Turnbull has, in the short term at least, provided a much needed boost to confidence. Now he has to deliver. One area where we expect to see a big lift is in infrastructure spending which, up until now, has been something of a no-go area with both sides of politics rigidly pursuing a budget surplus. While we acknowledge that the budget must be brought back into balance at some point, the time to do this is not when the economy is weak – as it is right now. Our expectations are that increased infrastructure spending will come in time to offset the expected downturn in residential property investment.
All things considered, we expect economic growth to be slow but a recession avoided.
The Tipping Points – markets at fair value or cheap
Recession fears have kept a lid on share prices – particularly in Australia. In turn this means that they remain cheap and our forecast returns remain high, particularly when compared to the alternative: term deposits.
Our Tipping Point chart summarises the longer term prospects for the major markets. Markets that are classified as cheap are forecast to produce returns that beat term deposits (TDs) by 5% p.a. or more, those at fair value are forecast to give returns between 2.5% and 5% p.a. better than TDs, whereas fully valued assets are forecast to beat TDs by less than 2.5% p.a., and overpriced assets are forecast to produce returns below those generated by TDs.
The rest of the world
The biggest talking point amongst investors worldwide will be the imminent increase in US interest rates. Some respected commentators make solid arguments this will make share prices fall. Equally well respected commentators make good arguments that prices will rise as a result of US rates increasing. From our perspective, we cannot see that an increase in interest rates from 0%pa to 0.25%pa in anyway makes us want to reduce our investment in equities which should produce long term returns of 8 to 11%pa.
In Europe and Japan central banks will keep interest rates at 0% – or less. Five years ago, who would have thought it impossible that interest rates could be negative, and yet, that is exactly what we find in Europe. You have to pay the government and the banks to take your money! As crazy as this seems, it is nonetheless the situation in much of Europe, and it is clearly positive for equities. Negative returns are not too hard to beat.
What does all this mean for investment?
- A recession in Australia is unlikely but economic growth will continue to be slow in the short term.
- Our interest rates are unlikely to rise significantly for at least two years.
- The Australian sharemarket is unlikely to boom, but should nonetheless churn out solid returns – well in excess of those from cash and TDs
- International sharemarkets should also produce respectable returns
- Residential property is unlikely to continue the strong run it has enjoyed in recent years.
- Now is a good time to be fully invested; keep cash and fixed interest holdings to a minimum
by Tim Farrelly, Principal – Farrelly’s Investment Strategy (reproduced with permission)
Disclaimer: This article is not legal advice and should not be relied on as such. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every care has been taken in the preparation of this information, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Australian Unity Personal Financial Services Ltd is a registered tax (financial) adviser. Any views expressed are those of the author and do not represent the views of Australian Unity Personal Financial Services Ltd. If you intend to rely on any tax advice in this document you should seek advice from a tax professional. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL & Australian Credit Licence No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in December 2015. © Copyright 2015