From Macquarie:
Australia’s economy starts 2017 with a stumble. But that’s not how we see the year ending. Our overall forecast for 2017 is for GDP growth of 2.0%, but the outlook for the year ahead looks like a tale of two halves. Our forecasts for the second half of 2017 are more representative of the economy’s forward outlook.
Beyond 2017 our read on the Australian macro picture is a favourable one. We are forecasting a pickup in GDP growth to 2.8% in 2018, and 3.1% in 2019. Getting there is the challenge, as it has been for the past few years.
On the surface, 2017 is set to look like another year of muddle through. But by the end of the year the mining investment downcycle should be complete. And the non-mining investment upswing (both public and private) is likely to have broadened outside of NSW. The first half of 2017 looks set to be a period of consolidation from the slowdown that’s becoming evident at the end of 2016.
Familiar growth story, but slight mix shift: Resource exports and population growth remain the key growth fundamentals. Fiscal consolidation and continued delay in the non-mining business investment upswing are key drags on the domestic demand pulse. Points of difference in 2017 are a slightly slower start for the consumer and a levelling off of the growth contribution from the upswing in residential construction. The incrementally better public investment profile is an important offset to the overall picture.
Strong supply, modest demand, subdued prices: We expect a pickup in headline inflation, but that is largely a function of higher petrol and tobacco prices, as supply tension diminishes or remains subdued in the labour, and other (e.g. rental) markets. Volatile oil and tobacco inflation should be trimmed out of underlying measures that are the focus for policy. Underemployment and soft near-term labour market conditions are likely to weigh on wages and household incomes, containing costs, but also limiting pricing potential.
Phenomenal nominal: Whilst our near-term outlook for the real economy is somewhat subdued, the nominal economy looks set to deliver the strongest growth since 2011 thanks to commodity price gains. Based on our commodity team’s forecasts, we estimate a +7% increase in Australia’s terms of trade in 2017 (+14% FY17). Our 2017 nominal GDP forecast is 5.2%. Combined with weak domestic cost pressures, this represents a positive margin environment for corporates despite the weak domestic inflation environment.
Missing links: The links in the economic chain that sees the terms of trade deliver a stimulatory boost to domestic demand are damaged or broken this time around. Any additional revenues for the Budget will be focussed towards fiscal consolidation, or infrastructure – if they are not merely offsetting the budget impacts of weaker domestic economy. We expect a lift in mining capex, but not in time to deliver enough near-term demand support. The A$ may find support from firm commodity prices, but without associated demand support the currency drag may hamper the domestic economy’s rebalancing.
Reluctant rate cuts: We remain of the view that the new year is set to see a new RBA low. Our base case is for a 1.00% cash rate, with the current mix of economic data supporting a February move at the RBA update (downgraded) forecasts (2nd in May). The focal points for the cash rate are the labour market and the A$. A supportive A$ is needed to keep the labour market healthy.
And for equities:
Outlook: 2016 was about navigating downside growth risks. 2017 will be about how quickly these drags reverse. We are optimistic that the economy is bottoming and this will drive broader cyclical stock outperformance.
Market: Australian equities will trade 7.5% higher in 2017 (ASX200 at 5875) supported by a gradual improvement in the domestic economy and as risk taking behaviour remains supportive for equities over bonds. A modest index return expectation hides a significant return skew as cyclicals outperform rate sensitives, value outperforms growth and large caps outperform small-mid caps.
Earnings: Australian corporates are lean as years of uncertainty and weak top line growth have driven an intense focus on lowering operating costs and financial leverage. We expect ~10% EPS growth as leverage finally begin to work in reverse. Consensus expectations for deep consumer cyclicals will prove too pessimistic and along with resources and capex related stocks offer upside earnings risk.
Valuation: Historically the start of a Fed tightening cycle has not been a drag on equities. At 16.1x 1 year forward earnings, the market is not expensive but the lesson of 2016 is that high PE stocks require bulletproof growth or low rates to paper over the cracks. We assume low rates are not coming back. Banks are a low risk / high conviction expansion story. Energy is a high risk / low conviction expansion story. We are entering the phase of re-rating deep cyclicals and the last domino to fall will be a reversal of scepticism around an improving consumer (hiring and incomes).
Positioning:
Value & Large Caps to outperform: Positive EPS momentum for Miners and PE expansion for Banks to underpin the 2016 Value cohort. Large Caps to close the valuation discount with Small-Mid Caps as relative growth differentials narrows. Hunt for yield in Banks over Telcos.
Overweight Commodities, CAPEX & Consumer: Upgrades for Materials has remained too FY17 specific. FY18 earnings are too low and CAPEX stocks will be beneficiaries. Consumer (wealth sensitive) stocks have fundamental support now, but Consumer (income sensitive) stocks are our preferred plays for gaining more fundamental support through 2H17. Rotation will not be into rate sensitive areas – they do not have either EPS upgrade potential or valuation support – but into cyclical areas where the consensus is betting the drags of the past few years remain.
Underweight rate sensitive: Rate sensitives will underperform even if bond yields are well behaved as cyclicals catch up a multi-year downdraft. The rulebook is being re-written. Conditions that drove rate sensitive outperformance are now tail risks (i.e. a return to deflation fears and/or a China collapse). Avoid chasing tactical swings.
Top picks: Aristocrat Leisure (ALL), BHP Billiton (BHP), Incitec Pivot (IPL), Link Administration (LNK) and Qantas Airways (QAN).
Won’t say I totally disagree but it’s close. I see 2018 as worse than 2017 as:
- the bulk boomlet retraces;
- the dwelling boom starts to fall (and why would wider investment lift during that?);
- the weak labour market spreads East from the West, and
- the car industry shutters.
Most importantly, the income and nominal growth boosts from the bulk boomlet are going to be very high but only in very limited economic areas, so the wider impact will be muted unless the government recycles its corporate tax gains with household tax cuts – that is create another structural problem for the budget – and that will cost it the sovereign rating.
I will just ask, if Macquarie is so enthused about a widening of local profits gains, why are all of its top picks offshore dollar-exposed firms? On that, at least, we agree. Put your money elsewhere!
