Solid, Enduring Growth

Last week we were flying down the Queensland coast, coming overnight from Tokyo, and the colours of the pre-dawn light were uniquely Australian. Yet when you looked out the window as we flew over Mackay and Rockhampton, all you could see were rows of ships waiting out to sea.

I thought it was quite ironic: I was on a Qantas flight full of Japanese inbound tourists, and we were flying over rows of Japanese ships waiting to load export coal from the Bowen Basin to take back to the heartland of Japanese industrial production.

Anyway, I've been away for a couple of weeks, and it looks as though you've all generally been well behaved in that time. Most share prices are at similar levels to before I left, despite trading volatility, yet most large caps are ex interim dividends. Commodity prices are higher than when I left.

The reporting season was very solid, with average earnings per share growth of 16%, average cashflow growth of 22%, and average dividend growth of 19%. The strong run in domestic equities from October to January was justified by what corporate Australia delivered in the interim reporting season, but was particularly justified by dividend and capital management growth. Five companies together '” BHP Billiton, Qantas, Commonwealth Bank, Telstra and AMP '” will pay out $5 billion in total dividends, and that's before share buybacks are taken into account.

Corporate Australian balance sheets are in tremendous shape, and that is driven by unprecedented cashflow growth. Australian management is doing an excellent job, and it can't be long before the world realises we have world-class management in this country, right through from political to corporate.

The strong interim numbers were generated out of a period of lower-than-average domestic economic growth, particularly from the NSW economy. NSW represents 35% of Australian GDP, yet NSW has been a genuine drag on overall Australian economic growth over the past 12 months.

However, I think that's historic, and NSW is showing signs of life under new political management. For all the noise written about the December quarter GDP data, nobody wrote that despite just 0.5% GDP growth in the quarter, corporate Australia generated record cash flow, earnings, and dividend growth.

While the non-believers focus on the historic GDP data, I would focus on the results generated despite the below-average GDP growth. I would be focusing on the "what if" scenario of re-accelerating domestic GDP growth, and the effects you will see on corporate earnings for the full 2005-06 and 2006-07 years. You make money looking forward, not analysing the past, and that's why I remain very optimistic about the prospects for domestic earnings growth over the next 18 months.

Business investment is at 15-year highs, and corporate Australia is investing for future growth. Annualised business investment is running at $130 billion, and that will drive GDP growth out of the trough.

Considering I have just returned from Europe and Britain, where the current forecast for Eurozone GDP growth for this year has been raised from 1.5% to 1.9%, I was very encouraged to see the Reserve Bank's view of the Australian economy.

It is forecasting the domestic economy will grow at 2–3% for the next few years, slowing from the previous 4–5% growth. This is consistent with my view that Australian economic growth bottomed in the weak September quarter last year. However, I think the real positive is the change in the composition of GDP growth, from consumer spending driven by the housing boom, to the more sustainable growth path of investment spending and export growth. Farm sector GDP grew by 8.2%, which was encouraging for our rural friends. Compared to Europe, Australia has high-quality problems.

The Reserve Bank reiterated its positive view of the global economy, with growth expected to reach 4.5% this year, the fifth consecutive year of expansion. This could prove conservative with the latest Japanese GDP growth figures of 1.4% in the December quarter, representing annualised economic growth of 5.5%. It is worth remembering that despite the importance of China, Japan still remains our biggest export market. I also think India will surprise on the upside and, interestingly, investors I spoke to in Britain were more interested in India than China. The positive outlook for global growth supports our continued bullish view on the highly consolidated resource sector, and Australian industrials with foreign earnings leveraged to the strength of the global economy. Think global; act local.

The other positive news for the domestic economy was the lowering of inflationary expectations in the Reserve Bank’s Statement of Monetary Policy. The forecast for the peak in underlying inflation was lowered to 2.75% by the end of 2006, from the previous forecast of a 3% peak by mid-year. We think this confirms our previous expectation that interest-rate policy will remain on hold, supporting our overweight call on the banking sector. The Commonwealth Bank interim result revealed that banking industry fundamentals remain sound, with margin deterioration stabilising and loan growth resilient.

PROPERTY’S GOOD NEWS

It was also very encouraging to see the first signs of a recovery in the NSW property market, with Sydney auction clearance rates recently registering 62.7%, the best result in two years. Figures from the Australian Bureau of Statistics reveal the property market has bottomed, with national house prices rising 2.1% in the December quarter, the biggest quarterly rise since the December quarter of 2003. Sydney house prices have also recovered, increasing 1% for first time in eight quarters of negative growth.

In addition, I expect the prospect of personal income cuts (c'mon Peter) and welfare payments in the budget; will further stimulate a recovery in discretionary spending. Certainly, the comments of Reserve Bank governor Ian Macfarlane are encouraging, "yes, we can afford some changes to taxes or some changes to expenditure, or a mix of the two", without any impact on inflation, provided the surplus remained at the same proportion of GDP.

It also appears that the Reserve does not share the current consensus view that domestic equities are fully priced. It said share valuations were only marginally ahead of their average over the past 50 years, and the dividend yield of 3.6% is slightly better than the long-term average. "These measures indicate that the rise in share prices has been underpinned rise in profits." This remains the basis of my bullish view on resources, that because of the strong underlying profit growth, the price/earnings multiples of BHP Billion and Rio Tinto have not changed in two years. The Reserve was also positive on the outlook for the equity market: "The outlook for the domestic and global market economic environment appears to be very favourable for corporations."

Finally, I think Macfarlane's response to a question from Bruce Baird, the chairman of the House of Representatives economics committee, sums up our sentiments perfectly. Baird’s asked, considering Australia is "the only major market that is currently above earlier peaks levels, so do you think that it is sustainable?" Macfarlane responded: "I do not think the fact that we are above peak levels makes us vulnerable. It really just means we did not have a bubble like everyone else did in 2000."

WEMBLEY WINNERS

I loved this article: Wembley builders have admitted cashing in at the bookies over the stadium's failure to finish on time. More than 60 workers placed bets with Paddy Power after it became clear that work wouldn't be complete for the FA Cup Final on May 13. After yesterday's announcement that the fixture would now have to be held at Cardiff's Millennium Stadium, one 'insider' punter scooped £1300, having laid out £800 on odds of 13-8. "We should have reacted quicker when we saw men in hard hats placing bets in the Wembley area," a Paddy Power rep told The Sun. "Another clue was that we didn't take a single penny that the stadium would be ready."