PIMCO: Australian growth model tapped out

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Via Robert Mead at PIMCO:

Bond markets, which are forward-looking in their pricing, are clearly telling us that the prospects for Australia’s economy are expected to be weaker than the US’s, for the next few years, at least.

For the first time in 20 years, short-term bond yields in Australia are approximately equal to, and arguably going to move lower than, comparable rates in the US, with the two-year government bond in both countries offering a yield of approximately 1.77 per cent as at November 21. Investors should not underestimate the significance of this change.

In the decades since, through a series of alternating booms – housing, then mining, then housing – Australia has avoided a recession and expanded faster than the US in terms of aggregate real GDP. Yet nothing much appears to have changed in our corporate sector.

To illustrate the point, Australia’s top six listed companies by market capitalisation remain almost unchanged since 1997. Today, it is the four major banks plus BHP Billiton and Rio Tinto, whereas 20 years ago it was the four major banks plus BHP and 21st Century Fox (which was subsequently delisted). Unsurprisingly, mining and housing have remained our only two key growth engines in recent years.

Whereas in the innovative US, compared with 1997, only Microsoft remains in the top six companies by market cap today. General Electric, Coca-Cola, Exxon Mobil, Merck and Citigroup have been replaced by Apple, Google, Amazon, Facebook and Berkshire Hathaway.

Over this same 20-year period, Australian households have amassed significantly more debt than their US cousins. Household debt to GDP has increased from around 60 per cent to 80 per cent in the US, while Australian household debt relative to GDP has risen from around the same starting point to more than 130 per cent.

…Given this reduced resilience of the Australian economy, we believe it makes sense for investors to consider whether their portfolios have a sufficient allocation of actively managed bonds and sufficient diversity away from the ageing boom sectors of housing, banking and mining.

Quite right. We’re only at the beginning of this. Australian households will have to deleverage and so will the Chinese economy, in it’s own way, which will mean both the housing and mining drivers of the Australian economy will grind to a halt ahead.

We’re seeing it priced into bonds. The 2 year yield spread to the US is just 3bps today and inversion is imminent:

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Yet the markets remain mis-priced with Australian yields higher out the curve than US:

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Even though US growth prospects are clearly superior with:

  • looming tax cuts;
  • cheap energy and shale oil revival;
  • hurricane reconstruction;
  • strong asset markets;
  • recovering housing markets;
  • soaring consumer confidence, and
  • moderate output.

Versus Australia’s:

  • falling and stalling house prices;
  • downdraft in dwelling construction;
  • sorry consumer and retail recession;
  • energy shock;
  • weak asset market;
  • tax hikes and
  • weak output.

That makes Australian bonds a buy with pretty much everything else Australian a sell.

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David Llewellyn-Smith is chief strategist at the MB Fund which is currently long local bonds and international equities that offer superior growth and benefit from a falling AUD so he is definitely talking his book. 

Here’s the recent fund performance:

Source: Linear, Factset

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The returns above include fees and trading costs on a $500,000 portfolio. Note that individual client performance will vary based on the amount invested, ethical overlays and the date of purchase. The benchmark returns do not include fees. October monthly returns are currently at 4.9% for international and 4.2% for local shares. 

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The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. The MB Fund is a partnership with Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.