In a similar theme to our research note in August ('RBA - I say, therefore it is'), the Q2 Australian GDP figures show an economy that is basically 'stalled' at 0.2% for the quarter, with the two key engines completely divergent. The private domestic economy is contracting whereas the public sector contributed postively to growth. The RBA and Government are for all intensive purposes in significant policy conflict.

The RBA will be unswerving in its policy objective to bring inflation back within range of 2% to 3%.  Whilst this very weak GDP result is data that helps the rate reduction argument, the RBA have been clear - it will not occur until 2025. We have argued for some time that the RBA's monetary policy stance is certainly sufficiently restrictive. We can see this in the capitulation in household consumption (which is of some concern), the savings rate at the lowest level in nearly 20 years, and an overall contraction in the private sector economy. Overall, this sees economic growth of 1% pa, a level last seen in the early 1990's (putting aside the COVID pandemic).

For some time we have noted that Australia is in a GDP per-capita recession, that is GDP or economic output divided by population is declining. We can see this in Chart 1. In its basic interpretation, Australia's standard of living is declining. Obviously the COVID pandemic was a one-off exogeneous shock, which we can adjust for (though its ongoing economic impacts are still significant and pervasive). The concern is this per-capita recession has accelerated and looks likely to continue well into 2025/2026. It should not surprise. The household has been shocked by monetary policy (policy has moved from 0.1% to 4.35%). This lays bare other weaknesses at the household level; negative real wages growth & the exhaustion of surplus household savings. Significant short-term population growth has exacerbated this.   

Were it not for the public sector, Australia would squarely be in recession. This would see the RBA achieve its inflation reduction aims more easily and quicker, but it would come with job losses and higher unemployment; an outcome that Government finds unacceptable. Neither is likely to yield. Governments at State and Federal levels could do more to curb if not defer certain spending (particularly infrastructure and capital spending) which would assist in reducing demand for capacity. This is not going to occur, and all tiers of government are doubling down on their own fiscal policy and electoral ambitions. This all  underpins the RBA's position of monetary policy easing being a 2025 discussion. The (very) unfortunate result is likely further contraction in the private domestic economy.  

Over the medium term, we note the role of government in Australia's economic future is ever growing.  Refer Chart 2. In 2000, as a % of GDP, government was 22% of GDP, whereas today it is 30% (and growing). With defence, education, aged care, health, debt servicing and a growing public service all enlarging, the cost of public sector economy (and taxes to finance it) invariably lay at the feet of the private economy.  

In our August note (RBA - I say, therefore it is), we stated our view that Australia and the US may diverge in their bond rate settings. In Australia, this GDP result adds to the position that longer rates  may head lower through 2025 than market expecations are factoring. This has implications for duration and seeking out quality. Further, with a worsening private sector economy, earnings come under pressure. This underscores quality, both in fixed income, equities and commercial property. 

For equities and commercial property, there is the potential for counteracting influences - lower bond rates which are valuation supportive, counteracted by lower corporate earnings. Obvious weakness points are discretionary expenditure (consumer spending), technology and high multiple firms. We do not think banks at current valuation provide an effective alternative. This leaves sectors with reduced exposure to the discretionary consumer in telecommunications, healthcare, non discretionary staples and quality industrials.

For fixed income, we are mindful that credit spreads have contracted significantly. This sees us carefully approach even higher quality issuance and selectively take advantage of this contraction in credit spreads (as capital values have advanced).

Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business. 

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