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20 lessons in 20 years – Part 20 (1)

Tuesday, April 9th, 2019
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Investing in good quality companies on the Australian stockmarket will remain a sensible strategy for the patient investor looking to build long-term wealth

By Anton Tagliaferro, Ben van den Tol |  26 March 2019

Investing in the Australian stockmarket exposes investors directly to the endeavours of Australian company management and the growth of the Australian economy, with an expanding economy generally leading to rising corporate profits.

The Australian economy has grown steadily over the last 20 years and unlike many economies overseas has avoided any recessionary period. In fact, Australia hasn’t had an official recession since the severe downturn of 1991 – a period when unemployment jumped to over 11%.

The generally good health of the Australian economy and low interest rates over the last two decades has helped underpin returns from the Australian sharemarket, which despite its ups and downs – as evidenced during the correction of 2001 and the global downturn of 2008 – has returned investors almost +9% per annum compounded, as measured by the ASX 300 Accumulation Index over this period.

This return compares very favourably to the returns of other markets over the same period:

Source: Factset; 1 July 1998-30 June 2018

So, what does the future hold for the Australian economy in the years ahead?

The future is always difficult to predict and while we are not seeking to be economic forecasters, we believe that many of the key drivers of economic growth that have been in place over the last 20 years appear to be in place for the foreseeable future and should continue to help Australia’s economy grow. However, the future is never without its challenges and we believe these are increasing for many of our domestic industries, thus one must be both selective and discerning to continue to benefit over the long term from the Australian sharemarket.

Two key areas have helped Australia’s economy expand in the last 20 years – these are Australia’s population growth and the emergence of China, transitioning from what was virtually a backwater economy in the late 1990’s to the world’s second largest economy today.

Population growth

The chart below shows how Australia’s population has grown steadily over the past 30 years – from 16 million people in the late 1980’s to almost 25 million people today, thanks in no small part to increased immigration into Australia and higher than average birth rates.

Chart 1: Australia’s growing population

 

Source: Worldbank.org; As at 5 March 2019

This population growth has helped contribute to the growth of Australia’s economy and contrasts markedly to several other countries around the world, such as Japan and some countries in Europe, where populations are actually in decline.

Australia’s strong population growth has supported just about every sector in the Australian economy, both directly through increased revenue for many companies as well as through the indirect flow on affects to other companies throughout Australia. Thus, our major supermarket chains and building material companies have benefitted directly with the increased spend on groceries and the demand for new housing. Toll road operators like Transurban have also benefitted as the populations of Sydney and Melbourne have continued to grow.

This population growth has also led to a growing infrastructure spend by both the private sector and Governments throughout the country as new hospitals, schools and roads have been built to help facilitate services for Australia’s growing population. The increased consumption and growing pool of labour from a rising population has also helped increase tax revenues to Governments throughout Australia and Governments have used these growing tax receipts to fund a variety of expenditures and this has also helped Australia’s economic expansion.

Assuming no major reversal of government policy, Australia’s population is forecast to continue growing, with the Australia Bureau of Statistics currently forecasting that Australia’s population will exceed 30 million by 2030.

The emergence of China

The Australian economy has also benefitted greatly from the rapid growth of China over the past 20 years, transforming itself from virtually a back water to the world’s second largest economy today. Our relative proximity to China and our abundance of mineral wealth has seen many Australian based companies in the Resource sector ramp up production strongly over the last 20 years and as a result Australia has become a major exporter of raw materials to China.

As the charts below illustrate, Australian exports of items such as iron ore and Liquified Natural Gas (LNG) have grown very strongly in the last 20 years as Chinese demand for commodities to build new infrastructure and to fuel its growing energy needs have grown strongly.

 

Source: IML, Bloomberg and Factset; as at 5 March 2019

As can be seen above Australia’s exports of iron ore have increased from around 150 million tonnes in 2000 to over 800 million tonnes in 2018, while our LNG exports have grown in a similarly strong manner in recent years with Australia set to overtake Qatar as the largest exporter of LNG in the world by 2020.

The large increase in Australia’s mining exports has helped significantly by bringing valuable export dollars to Australia and creating many jobs in the mining industry and related areas. The ramping up of production also required Australian Resource companies to spend tens of billions of dollars to facilitate this growth in production –  all of which have contributed strongly to Australia’s economic growth. On top of this, it has led to both State and Federal Governments earning billions of dollars in extra levies and taxes from the mining industry as the Resource sector has expanded.
While at some stage China’s economy will slow to more sustainable levels, which may affect the volumes and prices of materials such as iron ore, it remains apparent that China will remain a large export destination for Australia for many years to come.

Other drivers of growth

Other areas that have contributed to the growth of Australia’s economy over the last 20 years have been areas such as tourism numbers and agricultural exports.

As can be seen in the charts below the number of international arrivals into Australia has jumped from around 4 million in 1990 to over 20 million in 2018 while Australia’s exports of agricultural goods such as beef, salmon and cereals have expanded from around $A15 billion in 1990 to over $A52 billion in 2018.

Both these industries are forecast to continue growing over the long-term. As the wealth of Asia’s middle classes grows so will their capacity for travel and their desire for better foods.

International arrivals into Australia

Source: Factset; as at 25 March 2019

Total agricultural, fisheries and forestry exports from Australia 

Source: ABS; as at 25 March 2019

 

Other sectors that look certain to grow fairly strongly in Australia for the foreseeable future as our population ages are the aged care and healthcare sectors – this is a common factor in most countries around the world with the population ageing as life expectancy increases thanks to continued medical advances.

 

Is it all blue sky and upside for the Australian economy and stockmarket in the years ahead?

While the long-term outlook remains positive, there are challenges emerging which the Australian economy must come to terms with if it is to continue to grow as steadily and strongly as it has in the past. Clouding the outlook for many areas of the economy going forward are factors such as high consumer debt, policy stagnation and increased competition due to globalisation and technological advancement.

Consumer debt

Years of record spending and borrowing by consumers, and a strong rise in house prices, mean that today Australian consumers are some of the most highly geared in the world. In simple terms Australia’s total household debt has risen from around $200 billion in 1990 to almost $2 trillion today. Having said this Australia’s population has grown strongly over this period and asset values – especially house prices – have also risen significantly.

While continued strong employment will help reduce this debt and prevent it from dragging on growth, in the short-term this factor will likely slow consumer demand somewhat in many areas of the economy.

Household liabilities (ratio of debt to household disposable income)

Source: ABS;RBA; March 2019

The chart above shows how Australia’s consumer debt has risen sharply as depicted as a ratio of debt to household disposable income.

Policy uncertainty

Australia’s recent record of changing policy settings and increased regulation in sectors such as Energy, Telecommunications, Banking and Finance, Aged Care and Mining has caused major uncertainties in these industries.  It is becoming increasingly difficult for companies in these sectors to plan for the future and many Boards and management teams are currently reluctant to invest in light of uncertainty.

Thus if we look at the Mining Industry, as discussed earlier, much of Australia’s prosperity has come courtesy of Australia’s resource exports. Increased regulation and opposition and lobbying from various groups is now making it far harder to open up new export mines and the truth is that Australia has to continue to open new mines to replace older mines as these deplete if we want our exports to remain relevant.

This sort of policy uncertainty, as well as threats of increased regulation across many other industries will detract from Australia’s growth prospects if not resolved soon.

Competitive landscape

The outlook for many companies in Australia is also further complicated as competition in many sectors has intensified due to the advent of new entrants. While increased globalisation in the last 20 years has enabled many Australian companies – such as CSL, Brambles, Amcor and Sonic Healthcare – to successfully expand their footprint overseas, it has also meant that many foreign competitors have entered Australia and are competing hard in areas which were traditionally the domain of local companies. This has put additional pressure on the margins of what were traditionally very profitable sectors.

For example, in the supermarket industry, competition has increased markedly in the last decade as Woolworths and Coles are competing now with the likes of Germany’s Aldi and US chain Costco. Kaufland, another German supermarket chain, is also planning to enter the Australia market in the years ahead.  In the telecommunications industry, the once dominant Telstra now faces major competition from Singapore Telecom’s local subsidiary Optus as well as from Vodafone, along with a number of smaller players in the industry.

In addition, with technological advancement and the advent of the internet, changing consumer habits have also brought new challenges in the Media sector and what have traditionally been very profitable local companies such as Channel 9 and Fairfax. Discretionary retailers such as Myer and Harvey Norman have also been forced to cut costs and rejig their business models in order to effectively compete with the likes of Netflix, Amazon, eBay and Kogan.

Conclusion:

In our view, while the long-term prospects of the Australian economy and sharemarket remain positive, there are several challenges and uncertainties in the years ahead.  We believe the patient investor looking to grow their wealth and benefit from the growth in the Australian economy, will have to be very selective when putting together their portfolios of Australian companies.

We believe that earnings growth will be a lot harder to come by for many Australian companies in the years ahead. It is thus very important to identify companies that can grow their earnings in the next 3 to 5 years against a more competitive and challenging economic backdrop. This is something we have been focusing on in our portfolios at IML.  

In Part 2 of Lesson 20, we will discuss the sectors and companies IML is including in its portfolios and the reasons why we believe they have the potential to grow in a potentially more challenging environment in the years ahead.

 

 

 

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock.