The case for diversity – Australian equity investing in the current market
The Reserve Bank of Australia (RBA) recently cut the target cash rate to an all-time low of 1.75 per cent, placing the Australian economy in a unique situation. Underlying economic data is puzzling policymakers – on the concerning side we saw our first quarter of deflation in seven years, resulting in a weak yearly CPI gain. Wage growth also remains stagnant, printing at the lowest level since the current statistical methodology was first utilised in 1998. On the other side of the ledger, recent economic growth figures (released on 1 June) were robust and surprised the market on the upside, driven by the falling Australian dollar and the commodity price upswing increasing our export volumes.
Isn’t this growth a positive thing?
While the headline growth figures do seem positive, other economic metrics provide a less than rosy picture of the economy. This is led by the worrying trend of a fall in real net national disposable income – a gauge the Australian Bureau of Statistics (ABS) introduced as “a broader measure of the change in national economic well-being”. The ABS data tells us that this real income level per capita has been falling since March 2012, including a 1.3 per cent fall over the last year1, making the average Australian worse off.
Translating into underlying business earnings, we observe that Australian companies have continued to experience relatively soft trading conditions, driven by this and other areas of weakness in the domestic economy. While analysts initially predicted relatively resilient earnings for this financial year, prevailing economic conditions have led to earnings being downgraded to the lowest levels seen since the 2011 financial year, and gross company operating profits have fallen sharply.
Conditions in the wider economy and stagnant business earnings are worrying for investors in the domestic market, but this has not been reflected in the sharemarket to date as the RBA rate cut has acted as a support for local asset prices. The confusion lies in the rate cut indicating to the market that the RBA believes economic conditions are not robust and business conditions will continue to be strained – yet more investors have become ‘risk on,’ leading to nine-month sharemarket highs as investors chase returns in the compressed yield environment and drive valuations higher.
Asset price inflation in this environment is not sustainable for long-term returns
Investors should consider reviewing their allocation to Australian shares in light of the headwinds our economy continues to face. While holding excess cash can be hard to bear in this low yield environment, capital preservation should always be at the forefront of investors’ minds. Reviewing overweight allocations to Australian shares and ensuring a well-diversified portfolio is maintained is key to protecting capital on a short, medium and long term basis.
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.