The big macro trends shaping investment returns

Photo of Paul Xiradis, Ausbil By Paul Xiradis, Ausbil

min read

Latest reporting season confirms emerging drivers of portfolio performance.

The focus during the profit reporting season was understandably on earnings and dividends, but Ausbil Investment Management has also studied a range of market trends. These include increasing pressure on consumers and the growing importance of culture and staff engagement within listed companies.

As a starting point, it is worth noting that housing prices have been resilient to date and this strength has created a positive wealth effect, but we believe Australian housing has peaked and this is a key overarching theme that will affect everyone.

There is evidence of housing prices cooling. The spring selling season started early and it has been quite flat. One reason is that the banks have been adjusting their approach to lending, by granting fewer interest-only loans.

Another is that the level of income required to buy a home has never been higher. The discovery of fraudulent loan applications, where borrowers have overstated disposable income and underestimated living costs, has the potential to soften housing demand.

Although housing construction levels may be topping out, we think the baton is being passed to infrastructure, where we forecast spending to double to record levels over the next five years. This is obviously positive for the economy and parts of the sharemarket.

Consumers under pressure

Household income, meanwhile, is an important area of our focus. The rate of household income growth is slowing as disposable incomes fall. The consumer is clearly under pressure, being enveloped in a pincer movement of rising costs of fuel, utilities, healthcare, insurance and education. This is an ongoing area of concern and the ramifications on areas of the market could be substantial.

Being careful with money is the predominant consumer sentiment. Almost everything is expensive in Australia – not just coffee and avocado on toast – and consumers are becoming more discerning in their spending habits.

Consumers, however, are savvy shoppers. They are still spending on travel, luxury items and restaurants, but buying more of the basics from the likes of Aldi and Amazon.

During the last reporting season, subdued trends were evident across the consumer space. There was a general softening in trading conditions and further pressure on profit margins, despite some clearance-driven sales strength in some categories in May and June.

But retailing conditions are expected to remain challenged into the Christmas period as the squeeze on real incomes intensifies.

Another headwind came at the start of July when headline electricity prices increased 16-20 per cent in NSW and Queensland. This was soon after 4-6 per cent cost increases across healthcare, education and childcare – all against a backdrop of negative growth in real wages.

Debt-to-income ratios are also very high. Anecdotally, many have underestimated their living costs, with up to 50 per cent of mortgage holders reporting they have zero savings.

Clearly, the consumer is “the risk” in the Australian economy, which leads us to think that the traditional seasonal 17 per cent retail spending lift every November/December could be under threat this year.

We had an inkling of this when many stocks in the consumer discretionary sector reported reasonable results but were sold off because of concerns about consumers and the pending entry of Amazon. JB Hi-Fi and Super Retail, for example, had strong results but were sold down. Correspondingly, we are underweight the retail sector in client portfolios.

Rising utility costs hurt

Frustration with government is another issue because of rising utilities bills and private health insurance premiums (and the cost of healthcare generally), inadequate transport infrastructure and slow telecom services.

Rising energy costs are not just affecting consumers, they are also eating into corporate profit margins, which highlights the importance of focusing on energy efficiency, especially in the manufacturing and construction materials sectors.

Culture is king

Two other key themes to emerge during the reporting season were the abnormally high turnover of chief executives and the growing emphasis placed on culture within listed corporate entities.  Both issues fall under the remit of ESG – environmental, social and governance. Ausbil integrates ESG factors to make better-informed investment decisions.

Turnover of chief executives and chief financial officers has been dramatic this year and very high by international standards. The average tenure of an Australian CEO was 4.3 years last year, but we are certain it is lower again this year.

There is a greater focus on short-term and long-term incentives as corporate Australia finally gets the message that short-term bonuses are meant to reward extraordinary performance, rather than be a standard part of an executive’s salary.

Clearly, executives should only get bonuses when they beat expectations and objectives. Importantly, bonuses should not be viewed as a given part of fixed turn-up-to-work pay.

Elsewhere, our internal ESG research team highlighted that companies are increasingly talking about culture and staff engagement, which we regard as positive given that many corporate scandals and failures in the past have partly been related to questionable culture. In addition, culture can be a key positive value-driver and is often an integral part of profitability improvements.

Major cultural transformations can be particularly good at unlocking value. It is important for investors to identify early signs of cultural transformation, both positive and negative.

The impact from ESG insights on individual stocks varies, but ultimately it is tied to Ausbil’s investment philosophy that earnings and earnings revisions drive share prices and also that we have a preference to invest in companies with sustainable earnings and quality management.

Sometimes ESG insights can result in adjustment to earnings forecasts and at other times can impact our conviction about a company’s management or strategy. Changes in momentum in ESG performance can serve as good lead indicators of earnings sustainability as well as being a proxy for management quality.

In the last reporting season, we believe 44 per cent of companies we analysed had net overall positive momentum on ESG factors, while 33 per cent were neutral and 24 per cent were negative. This is in line with what we would expect, whereby the majority of companies should be improving.

About the author

Paul Xiradis is CEO and Head of Equities at Ausbil Investment Management. Ausbil is a foundation member of the mFund Settlement Service.

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