Is the Australian economy on track for stronger growth?

It seems lately whenever we talk about the economy it’s largely doom and gloom. This week, however, the Governor of the Reserve Bank of Australia (RBA) Philip Lowe put a slightly more positive spin on it, saying the sentiment required to support domestic growth in coming years is now present.

As the RBA controls monetary policy, Mr Lowe has good access to information and his comments can be an indicator of how the RBA may act in the future. This more positive view may reduce the likelihood of further interest rate cuts. Pointing to inflation being back in the target range, how unemployment has reduced, along with positive global factors – such as improving manufacturing data, China’s fiscal stimulus boosting commodities prices and US business confidence surging after the election of Trump – this seems like good news.

But Mr Lowe also acknowledges that “we do, though, continue to face some headwinds”1 including the numerous data points telling us a different story, such as high household debt levels, inflated house prices, low wages growth and growing household expenditure driven by rising energy prices – all factors that are squeezing consumers.

Given consumers have a significant impact on economic growth, our Investment Committee’s view of overall caution on the Australian economy remains. Although these negatives are offset to an extent by Australian property owners feeling richer as a result of recent house price growth, the growth appears to be slowing, leaving the question – what is Australia’s key driver going forward?

Disruption continues to be a challenge for many companies – particularly in the retail sector

Across the different sectors, disruption continues to be a challenge for many companies, and the much anticipated arrival of Amazon in Australia is heating up the discussion of what the future of retail looks like. On a smaller scale, we’ve been seeing this in the fast food industry. The influx of scooter and bike couriers hitting the pavement for food delivery companies such as Foodora or Deliveroo, shows us this impact in a very visual way.

To keep pace with the rapidly changing market, KFC announced this week it will be trialling home delivery, with an aggressive rollout across stores if they see a viable business case. Adding a home delivery platform could help them penetrate inner-city areas, where drive-through stores are expensive and can be difficult to come by. It may be that KFC opens more inner city store fronts with little customer seating, big kitchens to produce large quantities of food and car park space mainly reserved for delivery drivers.

With premium restaurants also joining online food platforms, it’s likely we will see more pressure on all food outlets to keep costs low and evolve to stay competitive. As customers move away from brick and mortar restaurants and other forms of traditional retail-like department stores, the impact can be broad, and we’re already seeing commercial property managers re-thinking their long-term plans.

Overall, the sentiment from the RBA governor is positive if businesses believe it and begin spurring the economy along with investment

In the shorter term, the valuations of Australian equities are high and our Investment Committee believes they do not provide adequate likely returns to compensate for this perceived risk. It’s important to remember that Australian equities are highly weighted towards financials and the mining sector – which aren’t looking particularly rosy at the moment.

We’ve just seen the ASX fall 1.6 per cent in a day, wiping $27 billion off markets – the biggest single-day decline of 2017. It was a tough day – only one in 10 shares posted gains – and it’s likely most Australians’ investments or superannuation has been impacted. Oil has now entered bear territory, having lost 20 per cent since recent highs, with the drop impacting energy stocks, such as Woodside, Origin and Oil Search. The recent downgrade of the banks, saw the big four banks all post losses. With Australians so highly exposed to the residential property market, rating agencies are particularly cautious about the property on the banks’ books.

That’s not to say we aren’t seeing good profits from some companies, but profits are generally being used to pay dividends to keep shareholders happy, rather than investing in future growth opportunities.

Until companies are growing profits faster, the risk-return balance in the short term just isn’t there. But as stronger business confidence builds, we might start to see profits reinvested, spurring growth in our economy and potentially feeding into wage growth for consumers. While this isn’t our base case, it would certainly be a benefit for the share market.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
 

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