The past month has been a challenging one for investors, both here and abroad. For those who call Australia home, our social fabric has been challenged by a bruising referendum campaign and the heightened geo-political tensions following Hamas’ attack on Israel. Australia’s economic outlook was also downgraded sharply by the International Monetary Fund (IMF), while the Reserve Bank of Australia (RBA) now appears likely to hike rates again on Melbourne Cup day in early November, following an upside surprise in Q3 inflation.
Add on consumer sentiment that is consistent with recessionary conditions, ongoing rental and housing stress, and a record proportion of Australians taking on multiple jobs to make ends meet, and it can be difficult to paint an optimistic picture for the local economy.
However, many of Australia’s challenges are shared by other developed economies, and while we believe that macro-economic risks are skewed to the downside globally, we think that Australia does hold some important cards in its favour. In this month’s Core Offerings, we detail key drivers for the Australian economy and why it is likely to outperform its G7 peers over the year ahead. In the relative world of financial markets, this has implications for Australian assets and is partly why we have tactically increased our overweight to (Australian) government bonds this month, while also remaining overweight Aussie equities.
Australia has been a long-term economic outperformer, outpacing the G7 and most other developed nations.
Taking a step back, it is important to recognise that Australia has been an economic outperformer over the long term, with real GDP growth since 1985 averaging 3.1% annually, outperforming the G7 and most other developed nations (chart below).
This outperformance is expected to continue (albeit in a less pronounced manner) going forward. In 2024, while growth is expected to slow further to a below-trend pace, CBA still forecasts the Australian economy will continue to outperform developed market peers in 2024. Looking further out, the IMF (even with its latest downgrade) expects Australian real GDP growth over the next five years to average 2.0% per annum, remaining at the top end of expectations for developed markets.
Apart from strong growth in labour productivity and a secular rise in participation rates (due to increasing female participation in the workforce), a key driver of Australia’s historic economic outperformance has been population growth and immigration. According to United Nations (UN) statistics, Australia’s population has grown by 1.4% per annum since 1985, with around half of that growth (0.7% per annum) driven by net overseas migration. This compares to a total average population growth rate of 0.4% per annum in other developed nations over the same period (less than Australia’s net overseas migration growth alone).
The US has been a similar winner from population growth and immigration, averaging 1.0% population growth per annum since 1985, with just under half of that coming from net migration. Given this, it is no surprise that the US, despite starting from a much larger base, has also outperformed its developed market peers economically.
Like the US, strong population growth and net inward migration has been a key component of Australia’s economic outperformance.
CBA has noted that the large financial year 2023 budget surplus is likely to assist the RBA in bringing inflation back to target and is “good news for Australia’s AAA credit rating”.
This has supported aggregate economic growth (boosting business revenues), underpinned housing demand, and provided a strong supply of both skilled and unskilled workers to the labour force that has helped ease labour shortages. While international students have driven the bulk of inward migration, there has also been a pleasing uplift in the proportion of skilled and work visa holders, which has risen to record high levels of around 170,000 on an annual basis.
Apart from the immediate boost to aggregate demand, skilled migrants (and students who remain in Australia post-graduation) are generally younger and very productive, contributing strongly to the economy and budget bottom line over the course of their working lives. The latest Intergenerational report estimates the average primary skilled migrant contributes around $300,000 to the budget bottom line over their lifetime.
Looking forward, while the budget is expected to slip back into deficit territory, the IMF continues to forecast a budget balance and net debt position that compares very favourably to Australia’s G7 peers. This healthy fiscal starting point reduces pressures on the economy and gives the Government significant flexibility to respond to potential downside scenarios and invest for the longer term.
| Average government deficit as a % of potential GDP | Government net debt |
Australia | -1.6% | 34% |
US | -7.4% | 112% |
UK | -3.1% | 96% |
Japan | -3.1% | 153% |
Italy | -3.0% | 131% |
Germany | -0.7% | 42% |
France | -3.7% | 100% |
Canada | -0.4% | 14% |
Source: IMF World economic outlook, October 2023, LGT Crestone.
If labour market demand remains resilient, this will provide another important pillar of support for consumer spending.
While some increase in unemployment toward 5% is likely over the coming year or so, this would be an historically modest response to the recent sharp increase in interest rates. A likely resilient jobs market—aided by structural forces such as ageing—will be a key support for both the economy and consumer. A further potential support lies in excess pandemic-era stimulus savings, though it is unclear how much Australian households have left in the tank or if this stock has almost been exhausted.
While a somewhat longer-term growth driver, to the extent the Government can provide clear policy direction—and the private sector mobilises to capture the opportunities—this is likely to manifest itself through stronger business investment, higher government tax receipts (further bolstering the fiscal position), and employment growth in the mining and mining-related sectors.
Australia is uniquely positioned to benefit from the global energy transition.
The outlook for Australia is not all rosy, however, and we see several key risks facing the domestic economy:
However, Australia faces no shortage of challenges. These include infrastructure and housing, productivity, sticky inflation, and global economic risks.
While the year ahead is likely to be tricky, the Australian economy appears well positioned to outperform developed market peers.
Australia faces no shortage of challenges, but has key competitive advantages and a respectable foundation to continue outperforming its developed market peers. To be clear, we are not expecting a significant re-acceleration in the domestic economy. We remain cognisant of the challenged global economic outlook, which is likely to weigh on domestic conditions in absolute terms. Navigating a path through these risks will be a challenging endeavour and key test for Australia’s fiscal and monetary policymakers.
However, with key competitive advantages, a respectable starting position, and an ounce of good fortune, we think there’s a strong chance that the Australian economy can continue to outperform its developed market peers on a relative basis over the year ahead. This may look like moderating inflation toward the top of the 2-3% inflation target, a near-term peak in cash rates below 4.5%, only a moderate rise in unemployment to 4.5-5.0% and sub-trend growth of 1.5-2.0%, ahead of a recovery through 2025.
The domestic equity market is cheap compared to global peers, and should benefit from macro outperformance.
Over recent years, the Australian economy has transitioned from a high growth / high inflation dynamic (2021), to decelerating growth with higher inflation (2022), and economists are now forecasting a period of slower growth and modest but sticky inflation.
Such a middling environment has historically been supportive, noting that Australia is now at the bottom of a 2.5-year trading range (6,900–7,600) for the S&P/ASX 200 index. Historically, the sectors that outperform following the RBA's final hike have been the defensive and non-cyclical growth segments, such as consumer staples, healthcare, and insurance sectors.
With China growth expectations and investor positioning highly negative, tentative signs of stabilisation for China’s economy over recent months may also be enough to see the major miners on a stronger footing for the year ahead. The energy complex remains attractive given geo-political uncertainties and the major banks have seen earnings expectations stabilise of late, with both CBA and NAB launching buybacks, given strong capital positions.
The bottom line is the S&P/ASX 200 trades at 14.5x, in line with its long-term average, but at a 10% discount to the MSCI World ex-Australia index. Australia’s relative valuation to the rest of the world is now in the bottom decile of readings since 2008, providing an element of valuation protection not seen in other major markets. From a sector perspective, real estate, retailers, and financials are favourably leveraged to a growing population longer term, though these sectors will need to navigate a potentially tricky year ahead as consumers grapple with the impact of tight monetary policy.
We have increased our overweight to Australian government bonds, which are offering attractive yields, backed by a stable AAA rating and strong fiscal position.
We favour Australian government bonds over developed market government bonds and have made a move within our tactical asset allocation framework to increase our overweight to government bonds through Australia. We note that much of the rise in domestic government bond yields over recent months can be attributed to global factors, in particular the sharp rise in US Treasury yields over the same period.
We believe the Commonwealth Government’s fiscal position is much stronger compared to most developed market peers, and we see the combination of its stable AAA rating and solid budget starting point as supporting ongoing compression in the Australia-US Treasury yield differential going forward. This is especially the case when comparing to the significant budget deficits that the US is likely to experience on a structural basis.
Within other areas of fixed income, we continue to recommend a 50/50 split between fixed and floating rate notes with a focus on major bank subordinated Tier 2, which currently offers returns between 6.25% and 6.50%. The Australian Prudential Regulation Authority has been very constructive in ensuring the banking sector in Australia is well capitalised, with the major banks able to increase their total loss absorbing capital via eligible Tier 2 instruments. The combination of increased supply has kept Tier 2 spreads above long-term averages.
Australian infrastructure provides a linkage to domestic inflation, leverage to the Australian economy, and opportunities to benefit from the energy transition.
Within alternatives, we continue to favour a global approach (both internationally and domestically) to senior private debt opportunities, while remaining cautious on real estate debt. Infrastructure is our most favoured sub-asset class, and we particularly like Australian infrastructure assets for their linkage to domestic inflation, leverage to the Australian economy, and opportunities to benefit from the energy transition and supply-chain resiliency thematics. Greater volatility and dispersion of returns across asset classes, combined with a higher rate environment, should also improve prospects for hedge funds and their role in portfolios as a true diversifier.
Global growth outside the US has continued to slow alongside core inflation, while a spike in geo-political uncertainty has raised concerns for the outlook of headline inflation and monetary policy.
While near-term uncertainty has risen, we continue to believe that we are at—or close to—peak interest rates and risks are skewed to further moderation in growth over a six to 12-month horizon. Taking advantage of the US-driven rise in global bond yields, we have increased our overweight to government bonds, where we favour Australia. We continue to monitor for opportunities as we navigate the uncertain investment environment.
Inflation volatility is likely to persist—Inflation is now falling meaningfully. However, the fading impacts of globalisation and structurally tight jobs markets suggest a more volatile inflation outlook.
‘Sticky’ interest rates—Falling inflation is likely to foster a near-term peak in central bank rates. But fewer deflationary forces than in the past are likely to limit the extent to which rates can fall.
Geo-political risks on the horizon as we enter 2024—Israel-Gaza, Russia-Ukraine, and elections in Taiwan and the US are near-term risks. Ongoing decoupling across technology, trade alignment, as well as military and energy security, are all key potential drivers of growth and volatility.
Diversification matters—In a world of heightened volatility and divergence, it is important to maintain portfolio diversification, avoiding over-exposure to individual markets, sectors, and other specific return drivers. Unlisted investments are likely to become more attractive.
The energy transition—The world faces a trade-off between net-zero commitments, cost, and energy security. This is setting the scene for both old and new forms of energy to play a role.
Sustainable investing—As the world becomes more connected, it is also becoming more socially aware. The intersection of finance and sustainability will govern a significant reallocation of capital.
The search for income—The exit of ‘zero-bound interest rates’ has resulted in a resetting of income expectations across all asset classes, including equities, fixed income, and income-generating unlisted assets.
Multi-polar world—Brexit, trade wars, and conflicts in Eastern Europe and the Middle East are symptoms that we are entering a more multi-polar world order, with significant implications for economies and markets.
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About this document
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