Summary: Macquarie forecasts that the Australian dollar will fall to US67 cents by year end and will not recover in the medium term. The US should be doing much better and China will struggle to achieve its growth target. Meanwhile, individual companies, not industries, are doing well in a world where it is hard to see industry-wide growth. More mergers are likely.
Key take-out: Forecasts can be wrong but if you have not reached your international allocation, you are not too late.
Key beneficiaries: General investors. Category: Strategy.
Here’s a wake up call: Last night I was planning a piece drawing together trends I can see around the world and locally. But this morning across my desk came a forecast by Macquarie that the Australian dollar will fall to US67 cents by year end. (Their earlier forecast was US77 cents but that has already happened.) And then in 2016 and 2017 they expect levels of around US68 and US71 cents. In other words there is no recovery for three years. Longer term they are more optimistic.
That forecast can be wrong but it’s an alert that if you have not reached your international allocation then you are not too late. Australian shares with large overseas exposures like CSL and Computershare are going to do well.
But with that sort of sustained currency fall the price of goods will rise, especially as we have foolishly abandoned so much of our manufacturing and servicing including building materials, motor and call centres. Be ready for price rises for imported goods and services. Tourism and airlines will boom but I do not think inflation is dead assuming Macquarie is right that by year end our currency will be around US67 cents.
That currency alert puts extra emphasis on the trends I isolated last night.
Wherever you look in the world it is hard to see industry-wide growth emerging. Instead what we are seeing is individual companies, not their industries, that are doing well because selected enterprises are exploiting particular changes.
In due course we are going to see more mergers as companies attempt to achieve growth via the economies that come with rationalisation. I will return to that later. The conventional wisdom has been for some time that during 2015 and 2016 the US will lift interest rates which will send the American dollar higher and confirm the recovery in the US.
And of course that is one of the trends Macquarie uses in its lower Australian dollar prediction. Nevertheless in the US not everything is going to plan. My friend in the US, veteran economist Al Wojnilower, points out that US economic prospects are less bright than a few months ago. There are gains in capital spending, but vehicle sales and building starts – which had been spearheading the business expansion – have been leveling off. Military outlays seem hemmed by budgetary “sequestration”. At the same time employment continues to grow rapidly but wage and inflation rates remain subdued. Business profits and margins hover near their peaks.
In other words while the US is one of the best performing economies in the world, given its stimulation, it should be doing much better. There is a clear danger that the actual raising of interest rates may lead to serious turmoil in securities markets because there has been massive high-risk lending by investment banks trying to take advantage of the very low interest rates that have been enjoyed in the US. A large chunk of these high risk loans have been poured into the oil industry and are now in grave jeopardy given the continuing fall in oil prices. The high leverage of the US oil industry is one of the reasons why it continues to pump out production which in turn is reducing world prices.
Part of the problem of the US is that too many of the jobs being created are low paid jobs and they are not giving the economy enough stimulation. The US bond market is telling us that interest rates in the US are not going to rise sharply and it seems the members of the Federal Reserve are almost having their internal debate in public – perhaps trying to convince their fellow board members of their positions. This is not a recipe for decisive action but of course we will learn more tomorrow morning when the Federal Reserve is expected to make a major policy announcement.
In China they are going to struggle to achieve the seven per cent growth rate and there are now commentaries suggesting it might be between five and six per cent.
That’s one reason why oil and iron ore continue to fall (higher production is another) and this will help force our currency lower (see Out before the flood?, March 18).
Here in Australia we are going to lower interest rates but as the currency falls it will moderate that lower rate pressure.
Lower interest rates will obviously help our bank shares and our income producing assets. And of course, in anticipation, they are rising higher and higher in price and are vulnerable when this phase ends.
If I am right on industry trends and we are going to see very different performances from individual companies, then those investing in the stock market are going to need a lot more analysis. So you will need to equate what directors say with what they actually achieve. And look for companies that are finding a way to develop growth strategies within this time of change. And we are going to see an increase in mergers globally and in Australia.
This week we saw the proposed telecommunications industry merger of TPG and iiNet to create a company with combined revenues of $2.3 billion. (For more on this M&A activity see iiNet takeover not over yet ... But it has lit a fuse, March 18.)
There is an argument about price, but on paper that should be an excellent merger because it gives the combined group scale to tackle Telstra, Optus and Vodafone. The danger in such mergers is that the companies being thrust together have an entrepreneurial culture. The management skills that are required to bring two companies in the same industry together and achieve economies of scale without killing growth are very different to building up a company.
That style of merger is going to be repeated in other industries where regulators allow it and will always require the right management skills.
As I pointed out last week (see Wall Street rules, March 11) you would have thought Gerry Harvey would have made a success of the takeover of Clive Peeters, but instead he lost $100 million. The management of Harvey Norman was not sufficiently flexible to handle the difficult merger. And of course Clive Peeters was in a lot more trouble than Harvey Norman realised. Those companies that can engineer a growth strategy in this current environment will be highly sought after.
What is unlikely to happen around the world is for the natural growth in the economy to provide momentum so momentum is going to come via management. In Australia there is one possible exception to that – if we allow a rapid rise in population. We are currently seeing unprecedented development in Melbourne and to a lesser extent Sydney funded by Asian capital, particularly Chinese. The Asians are benefiting from the lower Australian dollar but have an underlying belief Australia is going to see a considerable rise in population and this will see their investment in dwellings become profitable and will see diversification from their home countries.
Yesterday I was in the company one of the players in this industry and he sees Melbourne as a city of seven million people in 25 years rather than the current level of just above four million. A lot of dwellings are going to be needed if he is right. He may not be right, but, frankly given that infrastructure is stalled, this is the biggest thing happening in Australia at the moment.
Despite the population assumptions of my friend I feel that a short-term glut is likely which will take short-term shine off our real estate markets particularly in Melbourne. But longer term those apartment developments will make a lot of sense if the population continues to rise strongly as the Asians clearly think it will.
The attraction of Australia as a destination is one of our big growth opportunities so look for companies that have strategies to take advantage of this. But beware of companies that leverage themselves to the hilt on the basis of the low interest rates because one day this will change.