A prudent view on economic growth
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Andrew Fleming is the deputy head of Australian equities at Schroders.
We continue to think that amid volatile and heterogeneous markets - the rally seen through the front half of last year featured second tier resource names, whereas this year it has been led by industrial stocks - two characteristics will be common to the best-performing equity investments in the long run; those that reflect price-making ability and those that reflect productivity improvements, sustainably.
It's hard and rare, which is why it is valuable, to deliver on both fronts for shareholders. It's also completely independent of the growth rate of the market you are operating in, which is increasingly a cause for concern for Australian equity investors.
Amid global froth and bubble, and then turmoil and trouble, the past decade has been a consistently blessed period for corporates and consumers in Australia. It's hard to detach from that mindset, but critically important.
We recently had a discussion with the chief executive of an Australian construction materials company, who said while he was closing capacity quickly - leading the industry in doing so - and setting his business for a mid-cycle of 135,000 housing starts in Australia, down from 145,000, he feared that going any lower would leave him prone to claims of "throwing the baby out with the bathwater".
We suggested a number closer to 120,000 or even lower may be prudent. After all, on a per capita basis relative to the US experience of sub 600,000 starts in recent years, the Australian equivalent is closer to 40,000 starts. This observation was unwelcome.
This chief executive was not alone. It is easy to see why many chief executives remain, in our opinion, bullish, as recency bias affects many forecasters. The recent forecast briefing by the Australian Construction Industry Forum (ACIF) had global growth reverting to 2003-2008 levels at between 3 per cent and 4 per cent every year for the next decade, despite the last couple of years being peskily lower.
In turn, the ACIF forecasts that through the next decade, unemployment in Australia doesn't get above 5.5 per cent and residential building, after an unhealthily low growth period through the last few years while work done has been flat in nominal terms, will resume an aggressive upwards trajectory.
This forecast also had construction for retail and wholesale trade, which has dropped materially in recent years, to "return to pre-GFC [global financial crisis] trend in spite of structural issues including high Australian dollar and the shift to online retail".
We doubt many of these assumptions. Nonetheless, Stockland (SGP) shares the forecaster's optimism, albeit when unveiling a downgrade through March, it asserted that two factors depressing housing activity right now were the weather and, surprisingly, banks making credit difficult to obtain for creditworthy buyers. Let's think this through.
Banks are seeing loan growth plummet, and in turn, mortgage discounts off the standard variable rate are as high as they have ever been through the March quarter, seeing reported margins pressured. Mortgages are the only source of growth in bank's loan books year on year as increasingly large corporates access markets directly (and more cheaply) and the small and medium enterprise (SME) sector continues to deleverage.
Does that really sound like an environment where undue credit rationing in the mortgage market is occurring? Not to us. A more cogent and troubling explanation may be that presented by one of our analysts Daniel Peters.
Peters observed that using the ABS [Australian Bureau of Statistics] household income and cost-of-living data, it is only the most affluent quintiles that are saving, and that's even with the current 5.3 per cent levels of unemployment and the oft-cited benefits to income arising from the record terms of trade.
This is a structural issue, that when coupled with lower levels of confidence, is likely to underpin subdued levels of building demand and consumption in Australia, in our opinion, for many years yet.
If unemployment reaches northern hemisphere levels at some point through the next cycle, then we will have a much better feel for the impact of cyclical declines upon a variety of sectors in Australia than we do currently.
In the meantime, mistaking the structural for the cyclical is one of the worst sins a board and management can make. Just ask any Fairfax (FXJ) shareholder.
Nonetheless, if embracing an "omni-channel retailer" strategy is the answer, we think David Jones is asking the wrong question.
Why are we circumspect on economic growth rates for an extended period? As the ever cheerful Indian innkeeper in The Best Exotic Marigold Hotel assures his increasingly sceptical (English) guests, "It will be alright in the end. If it is not yet alright, it is not yet the end".
The stoicism shown in the face of any adversity, including economic, is an enduring trait of the English.