Bassanese: A Tough Mix
The Australian economy is not in a great place right now, as a lack of competitive pressure in many sectors is adding to inflation, while a lack of growth drivers is keeping unemployment relatively high.
This awful combination is likely to keep the Reserve Bank on the sidelines for some time, keep corporate earnings under downward pressure, and make it hard for the overall share market to keep posting solid gains.
Only a few weeks ago we got an upside inflation surprise, with the Reserve Bank’s preferred measure of underlying CPI measure – the trimmed mean - rising by 0.8 per cent in the June quarter, and 2.9 per cent over the year. The hope was that last December quarter’s equally discomforting large CPI rise was a “rogue result”, especially in light of the lower than fear result in the March quarter.
But the bounce back in inflation last quarter now suggests the March not December quarter result was instead the real rogue - and inflation is likely to remain firm despite high unemployment and quite weak growth in wages.
Why? Clearly, the impact of last year’s drop in the $A is starting to show through into import prices – which will make the RBA a tad nervous about what might happen once the overvalued $A starts falling more heavily. And meanwhile, sectors sheltered from foreign – and even local – competition, in the areas of health, education and utilities continue to lift prices with abandon.
As if that were not bad enough, this week we learnt that the unemployment rate last month surged to a 12-year high of 6.4 per cent. Many economists are quibbling with the numbers – suggesting there’s an element of statistical noise – but my own analysis suggests large monthly gains in unemployment are usually sustained, and herald a new lurch higher.
Indeed, the Federal Treasury’s once pessimistic looking forecast for unemployment to reach 6.25 per cent and stay there for a year or two is not looking so pessimistic now. With the economy likely to endure below trend economic growth for some time, it’s hard to see the unemployment rate falling back down notably anytime soon. That will pressure consumer confidence and household spending.
High unemployment and stubborn inflation are a tough mix for policy makers to deal with. And especially given continued frothiness in Sydney and Melbourne house prices, the RBA is likely to continue to sit on its hands.
What does this mean for investors? To my mind, stocks can still go up – caught in the slipstream of rising global prices. But the gains will be moderate, and focused on yield plays. Indeed, the major market theme is likely to remain a “chase for yield” among sturdy defensive stocks that can still pay decent dividends i.e. Telstra and the CBA.
Falling global interest rates have made it cheaper for banks to raise money overseas, and the once fierce competition for local terms deposits has dropped off. Terms deposit rates over the past year – even with the RBA failing to cut interest rates – have dropped by around 0.25% to 0.5%. Increasingly, those seeking income need to search elsewhere for decent returns.
And despite recent share market gains, the S&P/ASX 200’s dividend yield is still around 4.1%, or just below its 10-year average of 4.3%, It’s would not surprise me to see this slip further, possibly to around 3.75%. Over the past 10-years, this yield once got as low as 3.3%.
If you think we might be in a period of modest market gains, moreover, investors might also consider enhancing returns by selling calls against their portfolio. This provide enhanced yield from the sales proceeds of the calls, in exchange for risking some upside should the market surprisingly rise quite strongly. And to make things even easier, there’s now even an exchange traded product on the market that will implement this strategy for you.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.