September 2024 Market Update

Key Themes from the ASX Reporting Season

Most companies reported their financial year 2024 earnings in August.

Overall Australian companies have again delivered positive earnings surprises in the face of challenges from rates being held "higher for longer" plus ongoing cost of living pressures. The key driver of the better-than-expected earnings was profit margins, suggesting many companies still have pricing power.

The growth sectors of Technology (+50%) and Health (+42%) had the most positive earnings surprise in August. Global Cyclicals (-23%) were the most disappointing group, in part due to slowing global growth plus the headwind from the rising AUD.

Another key feature was conservative outlook statements due to uncertainties over rates and the US election. 40% of companies guided below consensus expectations for FY 25. This resulted in earnings downgrades for the year ahead. Resources are the biggest disappointment with a forecast fall of 3% compared to an expected rise 20%+ back in April. Banks are the only group with upgrades of +2.1% for FY25.

AI was mentioned by many companies and seems destined to become a key differentiator in company performance in future years.

Many companies remain positive on Australia’s longer-term prospects (population growth, abundant commodities, healthcare system, education, strong employment). However, many referred to shorter-term headwinds – specifically a lack of skilled workers in certain areas, high wage costs, housing shortage, and the impact of high interest rates on a portion of consumers.

The Australian banking system is in very good shape, but currently lacking growth prospects. Potentially AI can make a difference from a productivity perspective.

Global Inflation is Past the Peak

Global inflation is past the peak, in part courtesy of goods price deflation from China.   In China the combination of rising productivity growth and a lack of domestic demand means price declines on many Chinese manufactured products. China’s rapid pace of automation sees it now rival Japan in relation to use of robotics per 100 workers. This has resulted in productivity growth for the Chinese economy of nearly 6% per annum since 2015. The impact of China’s continued, large productivity advances will be enormous for the rest of the world. Chart 2 shows that China may stay in a deflationary environment for longer, and this will likely sustain global goods deflation.

Chart 1 - US Underlying Inflation Downtrend

Chart 2 - China Inflation Downtrend

Source – Alpine Macro

Australia’s Inflation Remains Elevated

In Australia inflation remains elevated. As chart 3 shows both goods and services inflation remain high.

Chart 3 - Goods and Services Inflation (%)

Source - PriceStats

Service inflation is tied to wages and labour markets.   Australia’s unemployment rate is currently 4.2%, which remains below the RBA’s natural rate of unemployment of 4.25%. This means a tight labour market, as demand is greater than supply. In June, Australia's Fair Work Commission (FWC) announced that Award and Minimum wages will increase +3.75% on 1 July 2024. The decision will impact ~25% of employees and ~11% of the total wages bill in Australia. The outcome was well below last year's increase of +5.8% and supports the view that wage-sensitive services inflation should ease over 2H2024, particularly across the hospitality sector.

In relation to goods inflation a stronger Australian dollar would help stamp it out. To get it, the RBA could either raise rates or sit tight while others (most importantly the US Federal Reserve) cut first.

Central Banks Dual Mandate

The RBA recently noted that Australia has added 2.7 million people to the workforce over the past decade. Easing in labour demand is expected to push Australia's unemployment rate up to 4.6% by end 2024. Both the RBA and the US Fed continually refer to their dual mandate, of wanting to get inflation down while maintaining employment growth.

The US recently joined NZ, Canada, UK and several European economies in cutting rates.

In Australia the major banks are split on their projections, with Commonwealth Bank and Westpac forecasting the RBA to slash the cash rate in November this year. National Australia Bank expects easing in May 2025 and ANZ in February next year.

Needless to say, equities will move higher if inflation declines, the economy avoids recession, and the US Fed steadily cuts interest rates.

New Capex Supercycle

In Australia twin peaks of population growth and baby boomer spending have insulated the economy and investors against rate hikes. Now a new tailwind is emerging. Australian business investment rose to a near nine-year high in the March quarter as telecoms companies ramped up spending on data centres, while plans for future investment were also upgraded in a boost for the longer-term economic outlook.

The new capex supercycle is being driven by five factors: $96.5 billion worth of federal government infrastructure spending over the next decade; the complex and expensive energy transition; onshoring of supply chains, supported locally by the government’s National Reconstruction Fund; massive defence spending; and the artificial intelligence and automation boom.

Chart 4 - Drivers of the next capex 'supercycle'

Source - Goldman Sachs

In the US, Chart 5 shows that the strong upswing in private capital investment in technology related hardware and software is mimicking what happened in the 1990s. The internet lifted U.S. labor productivity by about 1-1.3% per year from the second half of the 1990s to the first half of the 2000s, creating a sustained disinflationary boom. It appears that AI could do a similar trick for the U.S. economy. U.S. non-financial sector productivity is rising at a 3.5% annual rate, a very high level for a well-developed economy.

Chart 5 - AI driven CAPEX Boom in US Private Fixed Investment in Computer Systems

Source - Alpine Macro

Investment Strategy – There are Always Opportunities in Stock/Sector Selection

Considering the market's robust start to 2024 and the concentrated strength in specific stocks and sectors, attention is now drawn to areas that have been relatively overlooked. Healthcare, which has recently underperformed, presents a low-risk entry point for new capital. Defensive sectors, including Consumer Staples, and Resources, have lagged offering potential opportunities.

We continue to hold a balanced portfolio structure across Growth (Information Technology, Logistics, Healthcare, International), Defensives (Consumer Staples, Infrastructure, Gold) and Cyclicals (Resources, select Financials).

*Please note that the above information is general advice only. We recommend you seek advice from a specialist relevant to your personal situation. This information is relevant at the time of publishing and is subject to change*