This article first appeared in the AFR on 31 July 2023
Often when recessions hit, they arrive with a bump - sudden and surprising. That certainly hasn’t been the case of late. We’ve been talking about the possibility of recession for the better part of 18 months, and it still hasn’t come to fruition. And while our baseline case is that Australia will probably avoid recession, growth will inevitably slow.
Earlier in the year I remember a commentator speculating that although times were tough, ‘The consumer was yet to get the memo’. And while that was certainly true at the time, things changed in May and over the last few months we’ve seen a more cautious consumer. This probably reflects a combination of factors. The period between May and July, saw a large number of mortgage holders come of fixed rate mortgages, official interest rates continued to rise, and some conservatism entered the economy. Consumers are being stretched and it’s likely we’ll see some of the impacts in the upcoming August reporting season.
I always look forward to reporting season and I think this year will be an interesting one.
One area of focus will certainly be retailers. Throughout Covid we saw a surge in consumer goods spending - with people locked away, there was little else to spend money on.
Post Covid, we’ve seen a resurgence in services spending as people looked to re-connect through travel and entertainment. In the latest inflation numbers, service inflation seems to be the major issue and if we do have any more official interest rate hikes, it will likely be an attempt to bring service spending under control.
Discretionary goods are at the pointy end of the consumer slowdown, and we’re likely to see this area be the most negatively impacted during reporting season. Businesses that sell essential products (supermarkets, healthcare, telecommunications, banking and insurance) are largely resilient to an inflationary environment so we’re expecting solid results. Discretionary goods, on the other hand, are expected to slow, with products that consumers can delay purchasing, particularly larger ticket items the most impacted. This is reflected in the latest figures where we saw inflation levelling off due to slowing demand.
An additional stress for many retailers is that commercial property rents are generally linked to CPI (inflation). So, retailers have the double hit of increasing rent coupled with reduced revenue from sales.
Another interesting area during reporting season will be resources which may see some impact of China’s slower than expected recovery, although this is likely to be short-term. Conversely, the education and tourism sectors will be early beneficiaries from China’s re-opening.
Insurance should be a good performer. Capital is very tight in the insurance sector due to past weather catastrophes which means that insurance companies have needed to significantly increase premiums to cover past payouts. The strong rate cycle should significantly benefit the majority of the insurance sector. Much like supermarkets and telcos, insurance companies are generally considered ‘essential’ and can pass on costs to the end consumer by raising prices.
While there is plenty to worry about at the moment with higher interest rates, inflation, threat of recession, higher taxes and geopolitical risks, the majority of these risks have now been priced into the market, which is good news for long-term investment returns.
We’ll be watching the retail and consumer space very closely over reporting season, and depending upon share price movements and results, a weaker environment in the second half of the year could represent some excellent buying opportunities. We’re always looking for businesses that are in cyclical decline but have good long-term structural growth prospects and there should be some good opportunities for investors in the second half of the year.
