First the good news. The big surge in US and global interest rates in recent months has not, as many had feared, triggered a global recession, a surge in unemployment or a contagious plunge in American share prices. In Australia the Reserve Bank’s monetary policy tightening has not, as many had feared, plunged the economy into recession. To borrow a quip from a now long-dead American author, reports of the economy’s death have been greatly exaggerated.
Now the bad news. The Chinese economy is in deep trouble. Youth unemployment is surging, most of the country’s housing developers are bankrupt and a string of regional governments – the equivalent of state governments in Australia – are drifting towards zombie status. President Xi’s crack down on the Shanghai tech bros has led to vast sums of capital fleeing the country.
As Australia bears some semblance to a tiny caboose attached to the rear end of the Chinese freight train, our nation’s export incomes are about to be truncated. Thankfully China’s woes, so far, do not appear bad enough to cause insurmountable problems. Immigration, returning foreign students and tourists, and $230 billion in excess savings accumulated during COVID, are keeping things ticking over. Australia Ltd is slowing, certainly, but there are no signs of the abyss.
For investors the current economic set-up means several things. Firstly, it means that interest rates are likely to stay higher for longer. For the first time in years fixed income investors should be able to receive 5-6% income returns without taking big risks. Most Australian bank hybrid yields are above 7% grossed-up, which for super funds in pension phase is a decent return.
For equity investors the game is more difficult. As the long-awaited “major correction” keeps drifting over the horizon most major industrial stocks with modest earnings growth are on PE ratios of 20 or more bargains are few and far between. When stocks on a PE ratio of 20 of higher disappoint the market their share prices can be smashed. During the current reporting season many stocks have seen share prices down 2-5 times the extent of their earnings downgrade. The message here is to be vigilant and cut and run before the rest of the market does.
Debt re-pricing is another theme that I expect to gather pace in coming months. Dozens of ASX-listed stocks have high debt levels with much of the debt financed during the free money era and will over the next year or two be forced to re-finance at much higher interest rates. My perusal of recent analyst reports show that many market forecasts seem to assume that Australian companies can borrow at rates below the US 10-year bond rate. This isn’t going to happen. My message is not to be standing in the way when the debt refinance locomotive comes roaring through town.
In short, this is not a market in which to be brave, and defensive equity strategies will probably work better than others over the next 12-18 months. Investors that are overweight ASX 200 companies with strong franchises and unshakeable balance sheets will probably outperform this year and the next. Anyone who gets to the end of 2024 and has made a total shareholder return of 8% will be considering themselves lucky.
