Mar 25

What to watch in 2014

Australian growth

The Australian economy remains in very good shape, both in the context of its own historical performance and when compared to other developed economies. Very few developed nations can match Australia’s combination of vital economic statistics: low unemployment (5.6%), solid credit rating (AAA rating), low government debt/GDP, low inflation (2.4%), solid economic growth rate (3.1%) and strong relationships with global economic powerhouses. We expect to see reasonably strong GDP growth in the domestic economy driven by export growth and a gradual recovery in consumer demand in 2014. Interest rates remain at historically low levels and the Reserve Bank of Australia has shown little inclination towards a tightening of monetary conditions in the short to medium term.

State and federal governments are expected to take advantage of the low interest rate environment to embark on a number of infrastructure projects. This, along with productivity improvements as corporates maximise operating leverage, will support employment growth stability.

Economy in transition

The stability of the Australian economy is dependent on a transition from mining capex led growth to an increase in domestic consumption. And while the transition is unlikely to be orderly, we believe all the necessary ingredients are in place for a gradual lift in the non-mining economy.

Australia’s prosperity is not about resources alone. The services industry continues to grow in Australia in sectors such as tourism and financial services, while manufacturing and agriculture still make a meaningful contribution to GDP as Australia embarks on niche products and value add production lines. Despite Australia having likely witnessed the peak in mining capex, bulk commodity and LNG exports are forecast to grow significantly in 2014 pushing the balance of payments into surplus. Retail sales are showing signs of improvement from a fifty year trend low with the 2013 Christmas period expected to be very strong.

Contributing to the improved retail outlook has been the increase in household wealth. The savings rate remains above historical averages. Combined with an average 10 per cent increase in house prices, there is a strong ‘wealth effect’ for Australian households with significant pent-up demand. The very high savings rate in Australia is likely to fall, funding an improvement in discretionary spending.

China is now the third largest source of inbound tourists to Australia and increasingly a significant investor in the Australian housing and commercial property market. The falling Australian dollar will see this trend strengthen and also encourage domestic travellers to holiday within Australia. A substitution of domestic for international tourism will also provide a fillip for the non-mining economy.

Australian equities for income

After a strong 2013, we are still positive on the outlook for Australian equities in 2014. We believe the market is still attractively valued given a price-to-earnings ratio of 14.7x which is around the historical average. The dividend yield of the market also remains highly attractive versus other asset classes with a gross franked yield of 6.2 per cent, significantly better than cash (2.6 per cent) and bonds (4.3 per cent). We expect to see continued improvement in market earnings revisions and growth as indicators for world economic growth are strong into 2014 and the domestic benefits of lower interest rates and Australian dollar flow from house prices to construction to broader domestic activity. We view the tapering of quantitative easing as confirmation of a lower macro risk environment which will see higher returns from higher beta, or more cyclical stocks, that have not been rewarded in the last few years of high uncertainty, especially in Australia. Australian equities as a global source of income wwill remain a very strong theme. Income will be a large percentage of total return in 2014 with high quality companies with minimal income risk a key focus for the income portfolios.

If you would like to discuss the market further or any other investment and financial planning matters, please do not hesitate to contact our professional and award winning team.

Source: Legg Mason, February 2014


About The Author