Why you should ignore the economic noise

Right now, I think many investors are spending too much time focusing on whether a recession is imminent and how many more interest rate rises are likely before the Reserve Bank of Australia (RBA) taps out. I think they would be far better off trying to identify quality companies that are winning market share, raising prices and margins, and expanding into new regions.  And there are plenty of those.

In my view, investors need to focus on growing, quality companies and adopt a long-term view that appreciates the basic arithmetic surrounding valuation and returns, which you can find here. And keep in mind, amid the concerns about the economy, inflation and interest rates, there are companies generating excellent returns for their investors. To refrain from investing in anything, amid concerns about the economy and the broader market, is to condemn oneself to missing out on any prospect of sound returns.

For those who are wedded to their concerns about the state of the broader economy, the primary macroeconomic issue in Australia currently has got to be the trajectory of consumption.

While rising rates have hitherto revealed an unexpected durability among consumers, we have recently alluded to – here and here – signs of tiring beginning to surface. Numerous companies are reporting emerging weaknesses and their reporting compels investors to be selective. 

Typically, a pullback in consumer spending would be a positive signal for the RBA, given its ongoing struggle with inflation.

In assessing the forthcoming progression of consumption, it’s essential to consider the probable rise in interest payments. According to some analysts, mortgage interest payments over the next year are projected to inflate by approximately $40 billion. This has led many to form the view that a Fiscal Cliff is about to hit consumers and throw the economy into recession. But that’s not a universal view. Other analysts note wage growth is forecast to grow approximately $80 billion, an additional $25 billion will be received by consumers in the form of interest payments, and they’ll also receive an additional $24 billion in welfare payments from the government. Households will, according to these high-level numbers, continue to be swimming in cash irrespective of whether they dive into their accumulated savings.

The Australian households’ considerable pot of savings, accrued during the COVID years through government stimulus, is now estimated at between $250 and $280 billion. Arguably, only a fraction of these funds has been utilised, leaving a significant reserve for future spending. Witness, for example, the full international flights departing Australia, despite airfares that can only be described as exorbitant.

The economy’s resilience, thanks in no small part to being awash with cash, is bolstered by the aforementioned, and decade-high, wage growth, as well as robust job creation across healthcare, aged care, clean energy investment, and infrastructure. It’s estimated these sectors have bolstered the economy by adding over 850,000 jobs over the past two years. And this is a trend that is expected to persist.

This should all be favourable for markets – the combination of economic growth and disinflation has been historically a powerful driver of share price growth – especially for innovative growth stocks. 

The only problem investors should watch out for is the risk that a resumption of accelerating inflation replaces disinflation. In Australia, at least, there is growing evidence of shifting wage and price-setting behaviour, indicating inflation may become entrenched.

Uncertainty clouds the outlook for investors focused entirely on timing their purchases on the back of macroeconomic signals – something we don’t propose is wise.

As I have previously suggested, the Australian economy may maintain its vigour for an extended period, which is good. But the intensifying inflation problem compels the RBA to continue its efforts until the labour market is effectively checked, which is bad.

The lack of clarity underscores the necessity for investors to exercise caution and be very selective. More importantly, history and arithmetic suggest investors should be compelled to add to holdings of high-quality businesses, and/or those with improving prospects. So, rather than adopt an underweight stance on both Australian and Global Equities, investors should instead think about a constructive posture towards companies winning market share, raising prices and margins, expanding into new regions and or acquiring competitors on favourable terms. And there are plenty of those. 

Despite all the challenges, there is no guarantee that overall spending will significantly drop.  That raises the prospect of further rate rises, or a long period of elevated rates.  Investors need to focus on those companies successfully navigating the tension between financially strained households (mortgagees and renters), who are expected to reduce consumption, and the more affluent households (landlords and those benefitting from higher interest rate-derived income), which will probably sustain or boost their spending.

At the moment, Australian households are compelled to dip into savings to maintain their consumption rates, with savings decreasing by $7 billion in Q1 according to some estimates. However, total savings remain vast and almost $300 billion above trend, which leaves plenty of room for continued spending.  And along with strong job growth, wage growth, and government subsidies, the proposed Fiscal Cliff and the RBA pause are anything but certain.


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