David Walker

Written by David Walker, Senior Analyst, StocksInValue

Original article first published in StocksInValue


The Reserve Bank was right not to cut the cash rate on Melbourne Cup Day and investors should tilt their portfolios towards stocks set to benefit from the economy’s transition to growth in the non-mining sector and other themes we discuss below.
Since 2011 Australia’s economy has worn the pain of the end of the commodity price and mining investment boom. But the debate has now emphasised the negatives for the sharemarket for long enough. It’s time to restore some balance by presenting the reasons for a glass half-full take on the Australian economy and the companies which could benefit if GDP forecasts are upgraded. Recently we upgraded our one-year GDP growth forecast from 2.25 per cent to 2.50 per cent – a small upgrade but with significant reasons. We see a gradual acceleration as the economy navigates the challenges of lower commodity prices and falling mining investment while benefiting from stimulus from low interest rates and currency depreciation.
The new forecast is still significantly below what used to be considered the economy’s trend (long-term average annual) growth rate of 3.00-3.25 per cent. Estimates of the trend growth rate continue to be downgraded as population growth slows and support from the mining sector diminishes. Our point is not the economy is about to enter a new boom but that the balance of risks to consensus GDP forecasts is shifting moderately to the upside and this will start to appear in the guidance statements of companies which benefit.
Clearly the RBA thinks the need for more monetary stimulus is fading fast. Assuming the currency does not rally back to US80 cents, we agree.
The out-of-cycle rate hikes by banks, which pass on to customers some of the cost of holding more regulatory capital, are incremental negatives for consumer spending but not body blows. Most owner-occupier borrowers are ahead on their repayments, so higher variable rates shouldn’t result in higher actual repayments. Also, mortgage rates after the bank increases remain very low.
Bears on the economy think dwelling investment, which has been an important support to GDP lately, has peaked and will detract from GDP this year. We think this view is too pessimistic and ignores the reality of strong demand for housebuilding materials reported by CSR and Brickworks, which proves current activity and the pipeline are buoyant.
Booming bulk commodity export values and federal budget surpluses masked the reality the mining boom imposed a tax on the rest of the economy in the form of an elevated exchange rate, pushing many exporting and import-competing sectors into recession for years. We vividly remember the pattern of earnings downgrades, layoffs, company closures and regional recessions A$ strength caused and are disappointed by the media consensus all Australians never had it so good in the mining boom years. This pattern is now reversing. The car manufacturing industry has closed but the regional tourism industries which contracted when the A$ was high are now growing, as is export education.
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We think the non-mining, non-dwelling related, non-bank domestic sectors of the ASX are set for gradual consensus earnings upgrades as part of a new pattern of market earnings per share estimates ending financial years higher than they began.
As usual the debate about ASX investing remains excessively focused on banks and resources stocks rather than which stocks will lead the market next and change the composition of the index. The banks and large miners will always be in the ASX 20 but their weighting in wider indexes will fall in favour of other sectors set to benefit from these trends:

  • Growth in Australia’s domestic services sector
  • Growth in non-mining business investment
  • Growth in employment, especially in labour-intensive industries (because wages growth is historically slow) like construction, retailing, transport and other services
  • Population ageing
  • Changes in the way retirement is funded
  • Inbound and domestic tourism as the Australian dollar stays at or below its post-float average
  • Suppliers of goods and services where the competitive advantage is Australian brand values or expertise not easily replicated elsewhere
  • The appreciation of the rural land which is most resilient to changing rainfall patterns and able to supply strong growth in foreign demand for Australian agriculture
  • Expansion in the technology venture capital industry
  • The ability to use data in algorithms which create network effects
  • Disruptors which change the way demand for goods and services is met
  • Innovations which create new products and services consumers will buy
  • More imports of goods formerly manufactured in Australia
  • Government-funded or –sponsored public infrastructure
  • Less over-servicing in healthcare
  • Efficiency drives by large companies with unsustainable legacy cost structures
  • Consumer categories which benefit from higher disposable income due to price deflation in categories which are commoditising
  • Turnarounds of underperforming large companies or M&A if this cannot be done.

 

ASX 200 stocks to benefit from the above themes and/or growth in non-mining activity

 

ThemePossible beneficiaries
Growth in non-dwelling constructionABC, BLD, BKW, BSL, CIM, CSR, DLX, LLC
Demand for business vehicles and partsAHG, ARB, BAP
Greater consumption of packagingAMC
More business lendingANZ, BEN, BOQ, CBA, NAB, SUN, WBC
More consumer and business advertisingAPN, NEC, OML, QAN, SWM, TEN
Increase in business travelCTD, CTX, MTR
New business assets to insureIAG, QBE, SDF, SUN
Inbound and domestic tourismMTR, QAN
More goods moving through the economyQUB, AIO
More business telco plansTLS, TPM
Increased consumption of industrial goodsWES

 
And this list does not include the property trusts which would gain more tenants and more secure tenants.
Our GDP forecast upgrade does not diminish the argument for increasing allocations to overseas equities. The best consumer brands, growth opportunities and returns on equity are still available outside the ASX.
Disclosure: Clime Asset Management owns ANZ, CBA, NAB, WBC, CTX, IAG, QBE, TLS, WES, ABC, BKW, CSR, QUB on behalf of various mandates where it acts as an investment manager.