While most Western markets have made good progress since the beginning of the year, the Australian market is doing well in the first months of 2023. So should we stay invested in this country?
Real estate poses a significant risk
The disinformation of the Australian market is primarily a currency issue. If it has been flat since the beginning of the year, the local dollar - overvalued for a long time - is losing a few feathers to the euro, destroying the small gain recorded in local currency. This is because the European Central Bank remains on the path of interest rate hikes, while in Australia, the central bank has ended a long period of tightening.
It must be said that the consequences of higher credit costs have been severe for the Australian economy. For decades, local households have invested heavily in residential real estate. As a result of this enthusiasm for stone, housing prices nearly doubled over the decade ending in the first quarter of 2022.
But since the cost of credit began to rise, the data has fundamentally changed. The ten policy rate hikes since May 2022 to combat inflation pushed the benchmark interest rate from 0.1% to 3.6%. This inflates debt loads and forces households to make tough choices. According to the central bank, interest rates at their current level reduce the available yield of Australian families who have opted for a variable-rate mortgage by about 20%.
In addition, in 2023, the (short) fixed-rate period of many mortgages in the country will mature for more than 800,000. Mostly, these loans still date back to the pandemic period, when real estate prices soared, as did the granting of credit at meagre rates (about 2% for a fixed rate of short duration).
These loans will now have to be refinanced on otherwise more onerous terms (about 5.0%-6.5%, depending on the type of loan and the duration), which will only be possible for some.
This is depressing consumer sentiment, reaching historic lows, and is not likely to boost domestic demand. On the other hand, after a decline of 8% since their peak in early 2022, real estate prices are showing signs of stabilisation. Still, in the current economic climate, any recovery in the sector remains very uncertain.
Private demand is resilient
Despite the real estate problem, the situation could be more dramatic for most Australian households. On the one hand, the labour market remains very buoyant. At only 3.5%, the unemployment rate remains extremely low; at 64.4% in March, the employment rate is approaching its all-time high. On the other hand, the sharp rise in real estate prices over the last decade means that most households still have a good surplus value on their property.
In most cases, the property's value exceeds the outstanding balance on the loan. Moreover, the savings rate has remained above the levels in vogue over the last ten years. We are, therefore, in a situation different from the one experienced by the United States, precipitating the economic and financial crisis.
The same is true for Canadian businesses, whose profits are at record highs, having more than doubled since 2016. So the private sector remains resilient. And since inflation started a slow decline (7.0% in the first quarter against 7.8% in the previous quarter), the Australian central bank was able to stop the hike in key interest rates.
Under these conditions, GDP growth should still wait for 1.5% in 2023, a slow pace for this country but probably higher than Europe and the United States will experience.
What relationship with China?
The other significant variable for the Australian economy is its foreign trade. On this front, it is impossible not to mention China, Australia’s leading trading partner, accounting for almost a third of Australia’s exports, primarily made up of raw materials and other agricultural products.
The Chinese recovery has been sluggish in the months following the reopening of the economy after the pandemic, and is suffering from a still hesitant domestic market and will not have the dynamism of the past. In addition, consumers in the Middle Kingdom are now more focused on services than goods. The construction and real estate sectors still need to catch up in the face of financing problems in recent quarters that have weighed on housing prices and investor confidence.
Given these factors, the Chinese recovery will likely benefit Australia less than in the past. But make no mistake: after a period of complex relations between the two capitals, the arrival in power of Anthony Albanese marks the beginning of relaxation. As a result, this raw materials giant's relationship with its primary customer is gradually normalising, leading to a new dynamic for Australian exports and Chinese investment.
Likely, the days when the Australian economy benefited from the Chinese boom are far from over.
Having been one of the few Western countries to have avoided a recession during the 2008-2009 economic and financial crisis, Australia must find its way back into the post-pandemic period.
The surge in inflation and the rise in rates needed to combat it has brought to a halt a booming housing market that weighs on the domestic market. The slow exit from the zero-covid policy in China and the deterioration of relations between the two countries did the rest.
Significant challenges remain. Nevertheless, Australia still has a great deal to offer. Rarely cheap, the Australian stock market is only suitable for some, especially since the economy will face significant risks in 2023.
This country represents an exciting diversification for less risk-averse investors and should be present in any dynamic portfolio.