By Thomas Streater
What a shocker! If you need a reason for why the Australian
dollar and interest rates are likely to remain under pressure, then
the third quarter growth data from Down Under is it.
The Australian dollar was treated with extreme prejudice on
Wednesday morning, with the currency tumbling more than half a U.S.
cent to a fresh 4 ½ year low in the moments after headlines flashed
the disappointing news that year-on-year growth of 2.7% had missed
market expectations of 3.1% growth. Worse still, nominal GDP
contracted 0.1% in the quarter, the first decline since 2009.
Welcome to life after the commodities boom. The waning of the
massive investment in new mining and energy projects weighed
heavily on the third quarter GDP numbers, so too moves by many
miners to defer planned projects given the hammering of iron ore
and coal prices. The impact of weaker commodity prices is reflected
in Australia's terms of trade, a measure of the relative price of
exports in terms of imports, which declined 3.5% in the
quarter.
Australia has long been viewed as a liquid, AAA-rated way to
play China's turbocharged, yet resource intensive, growth. However,
as China's growth has slowed, so too has the interest in all things
Down Under. The Australian dollar, once chased as a high yield
play, has come tumbling back from its mid-2011 record high of $1.10
to find itself struggling to hold the $0.84 mark on Wednesday
evening. Many economists and currency strategists believe there is
more weakness ahead for the 'Aussie' given the unspectacular
outlook for growth and the possibility of interest rate cuts in
2015 at a time when the Federal Reserve may be raising U.S.
interest rates.
The changing economic landscape has forced leading economists to
reappraise their outlook for interest rates and the Australian
dollar. Goldman Sachs, which had previously forecast no more
interest cuts, rejigged its forecasts on Wednesday and now expects
the Reserve Bank of Australia to deliver a quarter of a percentage
point rate cut in March and another in August. Not surprisingly,
the broker acknowledged that its 12 month forecast for the
Australian dollar to trade at $0.82 "may look too optimistic
relative to the change in our interest rate forecast". However,
Goldman said the outlook for the currency will depend on the
outlook for capital flows and commodity prices into 2015.
It's unlikely the RBA will be disappointed by the currency's
weakness. The central bank has tried to jawbone the Australian
dollar lower, noting recently that the currency's value "remains
above most estimates of its fundamental value". It added that a
lower exchange rate is likely to be needed to "achieve balanced
growth in the economy".
Not that a weaker currency is all bad news. The lower Australian
dollar will be welcomed by domestic manufacturers, given the
elevated currency had crunched already tight margins squeezed by
high labor costs and lackluster productivity. Given Australia
ranked last in Boston Consulting Group's Global Manufacturing Cost
Competitiveness Index, the currency's fall will be welcomed.
A decline in the Australian dollar will be a plus for
Australian-listed companies with significant U.S. operations. These
include building materials group James Hardie Industries (JHX.AU),
packaging firm Amcor (AMC.AU), shopping mall operator Westfield
(WFD.AU), blood products supplier CSL (CSL.AU), and share registry
group Computershare (CPU.AU). Westfield is up 35% so far this year,
while CSL has notched up gains of 25%.
A long term decline in the value of the Australian dollar will
make things worse for households according to Freya Beamish, an
economist at Lombard Street Research. While many talk of a "two
speed" economy schism between mining and non-mining activities, the
reality is that the two parts are connected. The fall in the terms
of trade caused by lower commodity prices will translate into lower
income for Australia, while a weaker currency meaning Australian
face higher import costs and possibly higher inflation.
Credit Suisse strategist Hasan Tevfik believes slower Australian
growth will lead to lower interest rates. That could be a boost to
the Australian stockmarket, with Tevfik estimating the benchmark
S&P/ASX200 Index could rise 13% to 6,000 points by the end of
2015. Stocks will receive a boost from the "lowest cost of debt in
a generation".
The prospect of lower interest rates may prompt Australia's
superannuation fund to seek out higher yielding investments, such
as stocks. Australia's superannuation, or compulsory retirement
savings scheme, is worth around $1.8 trillion. Self-managed
superannuation funds, which are estimated to own around 16% of the
Australian sharemarket based on Tevfik's estimates, have a
preference for higher dividend paying stocks.
On the weakening dollar theme, Tevfik likes ResMed (RMD.AU), a
manufacturer of medical devices to deal with sleeping disorders
thanks to its mostly US revenues. Its cash holdings could make it a
potential candidate for activist investors pushing for
buybacks.
However, owning Australian stocks with overseas exposure doesn't
come cheap. Goldman Sachs, while also bearish the Aussie dollar,
notes that Australian stocks with developed market exposure trade
at an average forward P/E of 20 times compared to 13.5 times for
domestic cyclical and prefers dividend growers over defensive yield
names.
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Email: thomas.streater@barrons.com
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