Economists and commentators were in a flap when interest rates didn’t go up three days after the grand final replay, as so many had many predicted. They should have relaxed, because it happened on Melbourne Cup day a month later.
What was even more dramatic was a prediction from HSBC’s new economist, Paul Bloxham, who has just come from 12 years in the bowels of the Reserve Bank. He reckons interest rates will go up 1.25 per cent by the end of next year.
My own view has also shifted with that of the market. The risks are still there but any question marks about the Australian economy have been removed. Specifically, any concern that the private sector would not step up and take over from the government’s fiscal stimulus in driving economic growth were dispelled by the June-quarter national accounts.
The transition from public to private spending in Australia has been incredibly smooth, and while there will no doubt continue to be a political debate about whether the stimulus was unnecessarily large, that’s irrelevant and academic now.
As a result of the June national accounts and the data since then, I’m feeling as positive about the Australian economy and sharemarket as I ever have.
The one negative is our currency, which is already nestling comfortably in the parity range as a result of all this bullishness (although it may be due for a near-term correction). Over the next one or two years, rising Australian interest rates and the need for the US to get its currency down will definitely result in the Aussie remaining at parity and heading beyond. An Australian dollar above parity will hurt some companies, but for the big miners the effect of this will be swamped by booming demand for bulk commodities and the staggering amount of investment in the pipeline.
According to the Australian Bureau of Statistics, mining companies expect to increase their capital investment by 48 per cent in the year ahead. RBA governor Glenn Stevens has called it the greatest minerals and energy boom in Australia since the late 19th century.
Over recent years the investment in mining and energy facilities has not really been matched by booming exports: when prices soared, volumes fell, so that net exports have been a drag on growth, not a boost. While investment in resources projects has doubled over the past five years, minerals and energy export volumes have increased by only 15 per cent, and imports have gone up more.
That’s about to end. Volumes and prices both look set to be strong over the next few years, and although this is likely to be offset to some extent by weaker manufacturing and farm exports because of the higher currency, net exports will be a big contributor to growth for the foreseeable future.
With the gold price set to keep rising, gold exports will contribute to that story as well.
What does all this mean for your portfolio?
Well, I think Australian gross domestic product growth is likely to exceed 6 per cent for at least three years and that, as a result, Australian shares are very cheap.
That might sound like a big call, but in fact the only thing that will prevent that sort of economic growth is a wages and inflation breakout, followed by a much bigger increase in official interest rates than is currently priced in.
Inflation is rising and is likely to remain at the top of the RBA’s 2-3 per cent target band. But Australia is much more competitive than it was even a decade ago, thanks to the efforts of the Australian Competition and Consumer Commission. Companies just don’t have the pricing power they had and, at this stage, wages are no longer national, so pay rises in the mining industry in Western Australia and Queensland won’t inevitably flow through.
So even though unemployment is likely to fall below 5 per cent, there is no reason to think inflation won’t stay more or less under control.
If I’m right, and nominal GDP growth is more than 6 per cent for a few years, analysts will start to adjust their sales growth targets. Currently the median sales growth forecasts are between 5 and 6 per cent.
Citigroup’s analysts have “bottom-up” sales and profit forecasts for the ASX 200 companies of 8 per cent and 24 per cent respectively for 2010-11 (these are an addition of the individual forecasts for each company from the specialist analysts).
But that’s dominated by mining; for industrials the forecasts are a more subdued 5.5 per cent and 7.5 per cent growth. And that’s where the operating leverage from stronger economic growth can come in.
Stronger-than-expected GDP growth will result in higher sales growth, which will go straight to the bottom line. Yes, costs will also grow but nowhere near as much as sales and, more importantly, the benefits of the big cost-cutting programs of the past two years are still flowing through.
In other words, Australian companies are entering a sweet spot of rising sales and margin expansion.
It means that Australian shares look genuinely cheap right now – not as cheap as they were last March, perhaps, but two years after the collapse of Lehman Brothers, instead of just six months, the world also looks a safer place.
That’s not to say there are no risks; there are plenty of risks related to the debt overhang associated with the credit bubble, which should prompt a healthy allocation towards fixed interest (although with rates set to rise further and more rapidly than expected, you should keep your durations short).
But it’s also a great time to buy Australian equities. That’s because the world can’t quite believe how good things look in this country, so prices haven’t yet caught up with Australia’s new reality.