Greetings as we move into Spring and warmer weather
Domestic Interest Rates
Australian interest rate settings remain a matter of deep concern within the community asis reported daily in the mainstream media. The RBA last week, kept rates at 4.35% and indicated that they would review this later in the year, but at this stage would anticipate rates falling in February of next year and consensus is rates will fall to 2.95% by December 2025.
RBA Cash Rate(Source: Michael Read, AFR, RBA)
The backdrop to this has been substantial government spending at both a federal and state level without commensurate productivity improvements. The net effect of this is that for the last six quarters Australia has been in recession on a per capita basis. However, due to heavy net migration the absolute GDP numbers have stayed just above positive for calculation purposes. In essence, the Federal Government has its foot on the accelerator while the RBA has its foot on the brake leading to quite confusing seemingly uncoordinated policy.
I think it is important to acknowledge that much of the decision-making is made on historical data which is subject to amendment at a later stage. It is essential that policymakers understand the pulse of the community and not just look at retrospective data to make decision making.
Australian Net Migration over 20 years (Source: ABS, Migration, Treasury)
Australian Inflation
The monthly headline consumer price index had slowed down to 2.7% in annual terms, well within the 2 – 3% band that the RBA targets for long term economic stability. At issue is how much of this improved result is of a short-term nature impacted by federal government grants for electricity and wider changes to income tax policy for financial year 24/25.
Looking at the bond market there is 60% expectation of interest rates falling this calendar year reflecting in part the effect of what is happening with interest rate reductions in major comparable economies around the world. In summary interest rates will fall in Australia, it is just really a matter of time and at this stage markets are projecting four 25 BP drops over the next twelve months. Interest rates did not rise quite as high in Australia as in comparable countries so it is to be expected that we will be one of the last countries to reduce our rates.
Australia is, however, relatively unique in that most mortgages are now on variable rate and so interest rate policy quickly impacts on consumption leading to a reduction in savings. In aggregate, much of the nation’s savings from the COVID epidemic have now been used. To make up the additional interest payments required at the stage of the cycle.
A significant amount of the population who have high mortgages are really hurting now and this is also impacting on the rental market where landlords have passed on their additional mortgage payments to tenants in the form of higher rental fees. In essence lifting interest rates can be a self-fulfilling loop of ongoing inflation in the housing sector which ultimately can only really be broken in the longer term by having adequate supply of properties to provide choice in both the owner occupier and rental market.
Annual Inflation Monthly CPI (Source: Michael Read, AFR, ABS)
Overseas Experience
The US reduced their interest rates by 50 basis points last week and signaled that this would be the start of an easing process. This is currently projected to be as much as10 reductions over the next 18 months depending on market conditions. The US is by far the largest market in the world and including their exports account for around 70% of production. As such, any change in their interest rates materially impacts decision making and other jurisdictions. In the immediate the Australian dollar has gone up, which will act as a mechanism for reducing inflation in our domestic market.
At this stage it would appear that the US has avoided any major recessions, with our economy still remain in strong but clearly slowing down as reflected in their more recent jobs data. The swift uptake of AI and improved efficiency in general in operating systems has led to an improvement in productivity which again is positive for the future growth of their economy. In essence, many lower-level jobs are being replaced by technology releasing people to work at a higher level of skill in an area of greater interest to them. While this adjustment can be painful it should lead to more purposeful work and greater opportunities for the wider community.
Interest rates have now dropped in many of our comparable jurisdictions including Canada, the U. K, Europe, however all coming off a higher base rate. As Australia retains a free-floating exchange rate the AUD will increase relative to some of these other jurisdictions until we drop our own rates. Good for clients traveling, not so great for imports and really a case of a double-edged sword. By this I mean If interest rates dropped too quickly, this will reflect concerns that the economy is slowing down rapidly while if they do not drop quickly enough, he economy will move into a formal recession, leading to higher unemployment and thus greater government benefits being paid out.
The second largest global economy, China also dropped rates significantly earlier this week as part of a coordinated attempt to drag their own economy out of a serious recession. In response, the Chinese equity market CSI Rose 4% and this will be particularly helpful for their banking sector with lower deposits required to buy purchases such as property. This is very important for Australian interests and should be positive for our exports into the region particularly Iron Ore. The immediate effect of this is a rotation in investing in Australian stock from banks into resources.
The Chinese economy was very heavily focused on property and this bubble has had to deflate over a period and be replaced by more sustainable investments. At the same time the population of China is shrinking now and requires some central stimulus to get their consumers’ confidence back and investing in productive activities.
Comparable economies interest rate movement (Source: Challenger, MacroBond, Bloomberg)
Domestic Equities
The annual reporting season has concluded and in general results were better than expected. The banking sector was the standout, as reflected in a significant increase in share prices led by CBA. The four major banks paid out in aggregate 50% of the total amount of dividends of the entire Australian stock market which in all amounted to $A 98 billion for the half year.
The resource sector was subdued but with these stimulus measures in China, there will be some level of rotation out of banks into resources. The consumer sector did quite a lot better than was anticipated and companies such as JB hi-fi did extremely well. I think the message is that the consumer is more educated and discerning in their buying asevidence by heavy discounting on some products and specials at restaurants and bars. In conjunction with this, it was sad to see the ACCC commence proceedings against Woolworths and Coles for allegedly price gouging.
The net effect of the earnings season and the expectation of interest rates dropping led to a new all-time high on the ASX, which appears to be sustainable at the moment. While welcome, it is important to see this in context and that over a 5 year time frame time equity markets should outperform cash and bonds based on a higher level of risk. Again, much of the increased valuation is a function of the benefits of artificial intelligence in driving greater efficiency in business, and thus reducing costs and improving profitability.
ASX over 20 years (Source: ASX)
Global Equities
It has been a similar story in global equities, and in particular, artificial intelligence. Technology companies, all of which reach global new highs as the US dropped interest rates. Time will tell if there will be a pullback of 5 – 10% which is quite common and certainly this happened several times so far this year. While the initial growth has come in shares such as Nvidia and Microsoft, we’re now seeing a broadening of returns to companies who will benefit from the use of this technology.
As rates drop smaller companies will look more attractive. This is subject to the economy not slowing down and moving into an unemployment driven recession. Equity markets are of course, a forward-looking indicator and seek to value shares at a future time when interest rates and thus the cost of capital should be significantly lower. It should not be assumed that share prices will naturally just go up. And much of this may already be priced in. There is of course an election for the US Presidency in 6 weeks and two active wars at the moment, all of which could impact on market sentiment very rapidly.
Global 500 Equities over 20 years(Source: Google Finance)
Domestic Property
The saga continues with the requirement to improve supply and provide accommodation for new entrants to Australia including students. Currently, Federal Government legislation to co-invest and take a 40% equity in people’s homes has not passed Parliament and there’s a general stagnation in making the decisions required to improve the supply particularly closer to the cities.
There have also been some suggestions in the media that the current government will seek to change some of the policy settings for capital gains tax and negative gearing. This will be extremely contentious as has been the case in the past and it is more likely that there would be minor adjustments to policy rather than something really sweeping that would change the entire dynamics of purchasing property for investment purposes in Australia.
The most likely scenario now is that the growth in property prices should slow down somewhat, reflecting limitations in investors borrowing more money and there should be a period of relative calmness at least until the federal election is called by the end of May at the latest.
Change in Dwelling Rents (Source: Corelogic)
As you would expect, the firm remains very busy and seeking to use technology to serve Client needs as efficiently and quickly as possible including through the use of TEAMS, ZOOM, DocuSign, etc. coupled with a growing level of automated reporting on a regular basis when requested by clients. This should provide us with more time to talk to you face to face and really understand your personal circumstances and needs which do change over time. The intention being to give you confidence that your financial affairs are being properly managed in a competent way and free you up to enjoy living your life as you choose.
Do feel free to refer your immediate family and friends to the firm and we will take good care of them info@virtueandpartners.com.au
With our thanks for your ongoing support.
Tony and Fiona
