Introduction

The slowdown in June quarter GDP growth to just 0.5% quarter on quarter, or just 2% on a US style annualised basis, against the backdrop of weak commodity prices, the end of the mining investment boom and rising unemployment may add to consternation regarding the Australian economic outlook. And yet the local share market has been performing well. Is the outlook as bad as some fear or have shares got it right? Yet again the share market seems to have taken comfort from recent earnings results so I’ll start there.

Profits not booming, but look reasonable

The June half profit reporting season that just ended was preceded by nervousness associated with the falling iron ore price and the blow to consumer confidence associated with the Budget. In the event though solid growth was confirmed for 2013-14 and consensus earnings expectations for the current financial year were affirmed. In terms of specifics:


Australian profit results relative to market expectations

Source: AMP Capital



Share price response relative to market on day of results

Source: AMP Capital


Key themes have been:

Consensus expectations for the current financial year are for 5% earnings growth, which is unchanged from the start of the reporting season and presents a relatively low hurdle.

Australian share market EPS growth

Source: UBS, AMP Capital


This reflects a slowing in resources profit growth to just 3% as lower commodity prices feed through partly offset by higher export volumes; bank and financials seeing profit growth slowing to 5%, but a pickup in profit growth for industrials ex-financials to 8.5%. Clearly the latter is dependent on some pick-up in economic growth.

Soft June quarter GDP, but ok outlook

The slowdown in economic growth seen in June quarter may add to concerns about the economy. Particularly so with Australian Bureau of Statistics (ABS) business investment intentions data pointing to a fall in business investment this financial year of 9 to 10%. However, the broad outlook remains for a gradual improvement in growth. The poor GDP growth seen in the June quarter is pay back for the much stronger than expected 1.1% rise seen in the March quarter. This reflected noise in the timing of exports and imports such that trade boosted growth by 1.4 percentage points in the March quarter and detracted 0.9 percentage points in the June quarter. Given this it makes sense to average the two quarters giving average quarterly growth of 0.8%, or 3.2% annualised, which is actually pretty good.

Of course, spending growth averaged over the two quarters is just 2.2% annualised which is hardly great. However, signs continue to mount that thanks to the fall in interest rates to record lows and to a lesser degree the lower $A, the economy is rebalancing towards more broad based growth.


Building approvals are about as strong as they ever get

Source: Bloomberg, AMP Capital


Source: Bloomberg, AMP Capital


Business confidence leading consumer confidence up

Source: ABS, NAB, AMP Capital



NAB survey points to improving capex

Source: ABS, NAB, AMP Capital


Drawing these factors together our assessment remains that underlying demand and growth in Australia is gradually on the mend and should be running around trend of just above 3% through next year.

Not "dog days"

The key to the Australian economy right now is rebalancing. The mining investment boom and associated surge in interest rates and in the $A that were necessary to make way for it, led to a dramatically imbalanced economy with half of growth coming from mining investment at one point. This clearly adversely affected big parts of the non-mining economy. With mining investment now fading, lower interest rates and in time further declines in the $A are allowing the non-mining economy to bounce back. This process is slow – and it would be aided by a reinvigorated economic reform agenda – but the indicators above suggest it’s underway.

Implications for investors

First, the outlook for the economy is not nearly as gloomy as frequent headlines suggest. Profits are likely to record modest but reasonable growth over year ahead.

Second, interest rates are likely to remain on hold. Growth is not bad enough and there are enough signs rate cuts are working to argue against rate cuts. But the high level of uncertainty regarding the economic outlook, the still too high $A and low inflation argue against rate hikes. The most likely outcome is that rates will be on hold well into next year.

Finally, the combination of rising economic growth and continuing low interest rates should underpin a pick-up in non-resources earnings growth over the year ahead, which in turn should support further gains in the Australian share market. Our year-end target for the ASX 200 remains 5800.



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This video must be taken in its entirety and any given chapter viewed in isolation does not represent the entire message.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

 

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.