The performance of Australian equities has been dismal: Aussie share prices have lagged the global benchmark by over 30% since 2010. According to our Global Investment Strategy service, relative valuations have not cheapened enough to sufficiently compensate for pending economic headwinds.
The monetary conditions index for Australia is tightening due to the waning effect of previous interest rate cuts and currency depreciation. Granted, AUD/USD has weakened of late but the trade-weighted Aussie dollar is slightly up for the year. In addition, there is clear evidence that the Australian economy will weaken further, with deflationary pressures becoming the dominant economic force:
- The leading economic indicator has fallen sharply, predicting that growth will slow next year.
- Consumer sentiment has plummeted, while wage growth has dropped sharply.
- 10-year inflation expectations have also declined to five-year lows.
- Capital investment, which boomed last decade, has stalled. It is possible that a large divestment cycle is progressing, especially if commodity prices stay weak.
To make matters worse, the current government is committed to slashing the budget deficit in 2015, despite the recent hit to fiscal revenues from falling commodity prices and a weakening economy. Fiscal austerity at a time of tightening monetary conditions is the wrong antidote for an economy going through a negative terms-of-trade shock. This mix has and will continue to constrain aggregate demand, and will keep the Australian dollar from falling enough to jumpstart economic growth. Hence, it is unlikely that the Australian economy will suddenly spring back to life. Odds are that the stock market will continue to underperform.