Macro & Markets Guide: Australia

Country Overview

Sporting an annual size of US$1.33 trillion, Australia’s economy is the 13th biggest in the world. At its core is a robust services sector, which makes up a chunky 70% of the economy. Additionally, Australia's resources sector is a key global player, exporting coal, iron ore, copper, and gold. And then there’s smaller-but-still-important agriculture, exporting beef, wool, wheat, and wine all over the world

Australia's economic record is one for the books, showcasing two decades of robust, uninterrupted growth before COVID-19 hit. And even the pandemic couldn't keep it down long: the economy rebounded quickly, thanks to strong government policy, a skilled labor force, and effective control of the virus. When it comes to trade, Australia has important relationships in Asia, and particularly with China, its largest trading partner – a link that brings both potential windfalls and risks.

Economic Update

The economy’s slowing, but not stopping

Australia's economy has shown remarkable resilience since the global pandemic, consistently delivering growth of at least 2% annually. The country’s unemployment rate has also recovered to below pre-pandemic levels.

However, the economic forecast for the rest of 2023 suggests a slowdown, with a potential rebound in 2024. But it's not likely to be smooth sailing: further interest rate hikes could dampen household spending and put further pressure on house prices, a key economic driver. Plus, a sluggish global economy could pose a threat to demand for Australian exports.

On the other hand, the return of international students and tourists, along with robust population growth, could offer a much-needed boost. So, while the economy’s growth may be slowing, it's certainly not stagnating or shrinking. And with leading indicators possibly rebounding, the Aussie economy might just positively surprise economists.

The economy’s slowing, but not stopping

Inflation is on the decline, but still too hot to handle

Inflation seems to have hit its high note, with the annual growth in prices slowing to 7% in the first quarter of this year. But “core inflation”, which strips out the rollercoaster ride of food and energy prices, is still running hot and could trigger the central bank to dial up interest rates even further.

Looking ahead, inflation is expected to keep on its downward trajectory throughout 2023. But investors, noting the economy's surprising resilience, have revised their inflation expectations upwards, predicting it'll stay above 4% by the end of the year. The hope is that by the end of next year, inflation will have cooled off enough to fall within the central bank's target range – but for now, it's still a bit too hot to handle.

Inflation is on the decline, but still too hot to handle

Interest rates might have to rise further, threatening the economy

The Reserve Bank of Australia (RBA) has been on a mission to tame inflation, hiking its cash rate from a 0.1% to 3.85% within a year – and it’s probably not done yet. Projections suggest the cash rate could hit around 4% by mid-2023 and stay there until deep into 2024. This trend towards higher interest rates might be a bit of a downer for the economy.

And it seems investors are already buckling up for a bumpy ride. The yield curve, which plots interest rates on government bonds of different maturity dates, is currently “inverted”. That means short-term interest rates are higher than their long-term counterparts – a classic sign that investors are preparing for potential economic turbulence.

Interest rates might have to rise further, threatening the economy

Stock Market Overview

The S&P/ASX 200 index might seem like a bit of a throwback compared to its American cousin, the S&P 500. It's a market-cap-weighted index with a heavy tilt towards financials and materials, and less of a focus on tech and healthcare. In fact, you could say it's more "old economy" than "Silicon Valley".

The main exchange-traded fund (ETF) is the iShares MSCI Australia ETF (ticker: EWA, expense ratio: 0.50%). The ETF’s top ten holdings include mining giant BHP, biotech CSL, banks Commonwealth Bank Of Australia, National Australia Bank, Westpac, ANZ and Macquarie, oil and gas company Woodside Energy Group, and retailers Wesfarmers and Woolworths. With the top 10 stocks representing 60% of the index, it is quite concentrated.

The S&P/ASX 200 index has a heavy tilt towards financials and materials, and less of a focus on tech and healthcare.

Fundamentals suggest Australian shares are cheap and high-yielding, but more leveraged than US stocks.

Australian stocks are serving up a dividend yield of 4.7% – that's more than double what you'd get from the S&P 500. And they're not just generous payers, they're also reasonably priced. With a price-to-earnings (P/E) ratio of 14, a price-to-cash-flows (P/CF) ratio of 14, and a price-to-book (P/B) ratio of 2.17, they're offering value for money versus US stocks.

And it's not just about the price: Australian stocks are delivering a solid return on equity of 17%, on par with US stocks. But before you dive in, bear in mind that Aussie companies are carrying a fair bit of debt. So, while they're offering a high yield at a fair price, make sure you're comfortable with the risk.

Fundamentals suggest Australian shares are cheap and high-yielding, but more leveraged than US stocks.

Australian stocks have resumed their underperformance this year

After outperforming US stocks last year, Australian stocks haven’t matched the rally in US stocks this year. This year, the iShares MSCI Australia ETF is up 4.5% while the S&P 500 is up 15%, with most of the underperformance explained by the fact that the index is less exposed to tech stocks, which have rallied strongly in the US this year.

Australian shares are up this year, but not as much as US ones.