Against the backdrop of the Federal Budget with expectations of an earlier return to surplus and some recent positive economic data, we continue to assess the relative attractiveness of Australian markets.
While these headlines may send a positive message, unfortunately we face a number of structural headwinds in the medium to longer term. These include:
- A decline in global competitiveness (led by our rigid labour market and comparatively high corporate tax rate)
- An aging population
- Elevated household debt levels
- An increasingly narrow industry base (centred around banks and resources) and
- A fragmented political environment, acting as a headwind to undertaking key reforms
Combined with the challenges faced by a number of domestic industries, we believe that many Australian companies will find it difficult to grow profits. These challenges include:
- Banking and financial services - the current Royal Commission and likelihood of further regulation
- Resources - relatively high commodity prices
- Grocery retailing - increasing competition from large global players like Aldi, Costco and shortly, Kaufland
- Discretionary retailing - loss of share and pricing power from online retailers
- Telecommunications - technology changes and increased competition
While some industries are better placed to deliver sustainable growth, they remain expensive (see chart below - note: REITs are listed property trusts).
In the context of current valuations and a narrow domestic equity universe, investors may be paying more for less. Instead, we need to act cautiously and be patient, while also continuing to look for opportunities offshore.