Australia has enjoyed 25 years of sustained economic growth—unheard for developed markets—but the tide is turning. Here are five themes to help investors navigate rougher waters down under.
Morgan Stanley Blue Papers, a product of our Research Division, involve collaboration from analysts, economists and strategists across the globe and address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe.
For the past quarter century, Australia's economy has enjoyed robust growth—even as many other developed markets cycled through boom-and-bust cycles. Despite the 2008-09 global financial crisis, Australia still managed to float above the fray, aided mainly by three trends: a boom in commodities, strong consumer spending fueled by rising household debt, and consolidation in key sectors.
Now, as these forces stall or shift over the next five to ten years, Australia must confront weaker growth, according to a March, 2016, Morgan Stanley Research Blue Paper, “Australia in Transition: Ten Winners from Five Structural Themes.” Australia’s annual average GDP growth rate could slow to 2.5% from 2016 to 2021, down from a 3.3% average since 1991, says Lou Pirenc, lead author of the report, as growth in consumption, a mainstay of the economy that since 1996 has averaged 3.6% per year, slows by as much as a full percentage point.
That's not to say opportunities down under have dried up. Rather, companies and investors will need to hone their focus, adjust for a wider margin of error in transition, and become far more selective in how, and to what, they allocate assets and resources, says Morgan Stanley Australia Strategist Chris Nicol. “The pool of genuine growth stocks has continued to shrink as the economy matures," he says.
To that end, Morgan Stanley's analysts and strategists have identified five key economic and investment themes for Australia: global expansion; new export opportunities; leveraging new economic infrastructure; shifting to meet the demands of the country’s ageing population; and technological disruption and innovation.
Australia has been one of the biggest beneficiaries of China’s economic boom over the past 30 years. Australian coal, copper and iron-ore mines and its natural-gas fields fed China’s voracious industrial appetite, as China first became the factory floor of the world and later the planet’s biggest construction site. Commodities collectively boosted Australia’s annual real income by 1.2% from 2003 through 2012, Nicol says.
Meanwhile, domestic trends also worked to Australia’s economic favor. “The past two decades have been marked by rising household leverage—without a housing or banking crisis," says Pirenc. Over the past 20 years, Australia's household debt-to-income ratio has doubled, from 95% to 185%, among the highest such levels for developed nations. That debt helped fuel a boom in consumer spending, which accounts for nearly 60% of Australia’s economy.
Note: Chart is based on data as of Mar 10, 2016.
At the same time, corporate Australia consolidated. Mergers among private and publicly traded banks, insurers, resource companies and supermarkets, among others, created supersized competitors with dominant domestic market share, helping fuel earnings-per-share growth and driving up valuations relative to global peers.
All three of these trends have either weakened or reversed. Commodities prices have fallen, amid China’s slowing growth. At home, “with the supercycle in household leverage behind us, we see a more subdued outlook for private consumption,” says Pirenc. Meanwhile, Australia’s incumbent corporate giants face shrinking domestic growth opportunities, a tightened regulatory environment and competition from foreign entrants.
“Australia is changing, and so will the focus and composition of the investor's portfolio," says Nicol. Here are five themes to keep in mind:
With domestic growth prospects dimming, more competition from foreign rivals, and fewer opportunities for consolidation, Australia’s companies need to look abroad for growth. Not all of them will succeed. “Australian companies have a mixed record offshore," says Nicol. “So it's understandable that the market remains skeptical." Still, Australia does have some standouts that have successfully take their business models global.
Australia's economic infrastructure continues to evolve in several sectors. For example, in renewable energy, Australia stands to capitalize on its position as a leader in solar: Morgan Stanley’s analysts expect household adoption of rooftop solar generation and residential battery storage to more than double over the next 20 years, offering plenty of potential for energy, infrastructure, financial and technology players across the spectrum.
The rollout of Australia's National Broadband Network should also spark eCommerce growth, as it opens up new business opportunities online, particularly in remote areas where high-speed Internet access has been spotty. The same can also be said of a new financial payment platform slated to roll out in late 2017.
Even before demand for commodities fell off a cliff, it was clear that Australia needed to find alternatives for its resource-driven economy (45% of its exports). “Australia is not 'late' cycle in its natural industries, it is 'last' cycle," says Nicol. As the Blue Paper illustrates, Australia will need to boost its exports by more than A$30 billion (US$23 billion) to fill the gap, through alternative channels, including agriculture, tourism, education and health-care services. The good news is that demand for each of these sectors is growing, especially in Asia.
Recent studies suggest that Australia lags other nations on innovation—largely because its corporate culture seems to put less emphasis on disruption and global focus, and start-ups can find it harder to get funding in Australia than do peers in other developed market, according to the Blue Paper. For companies that do innovate, however, “Australia's corporate concentration and receptive consumers make it an attractive market for technological disrupters,” says Pirenc. The coming upgrades to broadband access and payments systems should also help.
As is the case in many developed and even some emerging markets, an ageing population has both positive and negative implications. While health-care and age-related services stand to benefit, housing and consumption growth will likely suffer. Older consumers tend to stay where they are and they don’t spend as much. “This is a global issue, and many argue that Australia is better positioned than many other countries," says Pirenc. “But we believe changing demographics is underestimated."
For years, Australia has offered investors an uncommon investment environment: emerging-market growth rates in a developed market. Australia accounts for 21.6% of the MSCI AxJ benchmark and has outperformed the region for 17 of the past 21 years. But it will be difficult to replicate that kind of performance going forward. Investors will need to choose carefully. Growth–while still within reach–won't be a given.