Insights

It’s gonna be alright

Even the Australian Bureau of Statistics (ABS) appears to have fallen under the spell of Pennsylvania’s favourite daughter. In its latest retail sales release, the ABS implied that Taylor Swift’s seven concerts in Sydney and Melbourne boosted retail sales by 20 basis points in February 2024. Overall retail sales were 0.3% higher in February than in January (consensus was 0.4%). In trend terms, looking past the positive effect of Miss Swift on spending, underlying growth was 0.1% month-on-month (mom). Compared with February last year, sales were up 1.6%.

Clothing and Footwear was the strongest category by far, up 4.2% mom, which the ABS sees as largely a function of demand for ‘Taylor Swift inspired outfits and related do-it-yourself accessories’. This seems a little hyperbolic to us, but even if it’s true, we believe the strength in this category provides a positive signal about the underlying consumer behaviour. Young (and no so young) shoppers appear to have adjusted to higher prices. It seems the initial shock of the cost of living crisis has eased into a more stable, but selective, approach to discretionary expenditure. Good news for fashion businesses like Universal Store (UNI, ADD) and Accent (AX1, ADD) perhaps. Despite the cancellation of Splendour in the Grass.

Retail sales were up 0.3% mom

On a seasonally-adjusted basis, retail sales were up 0.3% mom in February and up 0.1% in trend terms. Total retail sales in the month were $35,869m (trend: $35,799m). The best performing categories were Clothing & Footwear (+4.2%) and Department Stores (+2.3%) – a positive for Myer (MYR), alongside UNI and AX1. These are highly discretionary categories and, Taylor Swift notwithstanding, positive growth is a good signal that the consumer is not distressed. Compared with January, there was a minor pullback in Household Goods spending (-0.8%).

The year-on-year growth was 1.6%

Clothing & Footwear was also by far the strongest growth category in February on a year-on-year (yoy) basis, up 4.0%. Overall retail sales were 1.6% higher yoy. Eating Out continues to do well. It’s been the best performing category yoy on average over the past 12 months. Household Goods was the worst performer, down 2.2% yoy, having also been the worst performer in January 2024 and December 2023.

What this all means for the sector

After a period of volatility towards the end of CY23, retail sales appear to have stabilised since the beginning of CY24. Consumer sentiment remains well below historical averages (with the latest index data showing a retreat after the strong jump in February). Sentiment is an important factor driving the performance of consumer discretionary shares and the conditions do continue to look favourable for this index to pick up – unemployment is down to 3.7% and real wages are in positive growth territory. Much will depend on what the RBA does next.

Figure 1: Australian retail sales (A$m)

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• Morgans research analysts re-set their sector views, strategies and best ideas as dynamic forces continue to challenge markets.
• Our approach in equities currently favours stocks with compelling risk/reward profiles among quality cyclicals, small-cap growth stocks and A-REITs.
• Preferred equity sectors include staples, healthcare, financials, retail, travel, resources and energy.

Result season snapshot and 2024 outlook

February results again showed that Australian listed companies remain in good shape. Earnings expectations for FY24 actually ratcheted 0.5% higher led by the Banks, Healthcare and Retail. This suggests ongoing conservatism in market forecasts, offering some margin of safety against rising share prices.

The market’s surprise rally since late 2023 appears a bigger hurdle to further market upside than earnings or economic fundamentals look to be. The implied risk premium (earnings yield) and dividend yield premiums in equities has compressed to historical lows, manifesting in narrow discounts to consensus price targets among the market leaders (ASX20) and narrowing the path for further upside.

So we’re not calling the start of another bull market, but we do think there are plenty of reasons to be optimistic. A likely reduction in interest rates later in the year, cooling inflation and plenty of dry powder should offer solid tailwinds for equities. Below the ASX20, we think the best opportunities lie among smaller caps and those positively leveraged to declining interest rates and stickier inflation, including select cyclicals, small-cap growth and A-REITs.

Small/mid-cap growth and cyclical stocks were the big story in February. They provided a higher proportion of results beating expectations, with a higher-than-average number positively surprising on margins and revenue. Earnings forecasts also held up well in key cyclical segments.

Notably, cyclicals (Retailers, Industrials) represent a larger proportion of the small cap index than for large-caps. So, if the economic slowdown proves to be milder than anticipated and earnings hold, then valuations provide plenty of support here. We expect plenty of ongoing opportunities in small-caps as the segment continues to re-base. Fresh small-cap opportunities being called out by Morgans analysts include Helloworld, NextDC and Universal Stores.

In this note, Morgans sector analysts have upgraded their ASX sector ratings on Consumer Discretionary to Overweight (from Neutral) and Agriculture to Neutral (from Underweight). Downgrades have been applied to sector ratings on Telco to Strongly Underweight (from Underweight) and the Banks to Underweight (from Neutral).

ASX sector & size returns: February trading demonstrated the ongoing rotation away from expensive defensives and into growth and cyclical stocks (Small-caps, Retail, IT, Industrials) as risk appetite recovers

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• Rate cuts expectations are firming. Recent months have seen some mixed economic data but we are seeing clearer guidance from central banks. Major central banks are on track to start their cutting cycles in June which will further support risk assets.
• Moving to a risk-on strategy. We continue to put our cash to work and move to a risk-on stance with a overweight position in global equities, fixed income and real assets (real estate, infrastructure). The US remains our favourite equity market, supported by the prospect of Fed rate cuts, resilient growth and rapid tech innovation.

A favourable backdrop for investment returns

In recent months, debate has shifted away from ‘recession risks’ towards a ‘soft landing’ or even the possibility of ‘no landing’ in the US; inflation has remained on a mild downward trend; and China’s increased stimulus is reducing downside risks both domestically and globally. The US election does not materially change this outlook as it remains a 2H 2024 story, and either continuity under a Democratic President or expected tax cuts under the Republicans could support risk appetite. We therefore see opportunities to put cash to work, and we recently adopted more of a risk-on bias by moving global equities, real assets, and fixed income to mildly overweight.

We continue to prefer the US market, as US earnings and margin resilience, its innovative tech sector and North America’s Re-industrialisation all provide support. This should also continue to provide support for the US dollar. While strong employment conditions in Australia should underpin consumption, high prices for the ASX 20 will mean investors will need to look beyond large-caps for returns. However, the favourable investment environment goes beyond equities. Bond yields remain elevated, and we continue to believe these should be locked in. There was some volatility in bond markets earlier this year as rate cut expectations were pushed out, but they are now in line with ours. We continue to expect rate cuts and falling real yields to bring down bond yield in coming months.

Of course, risks remain in our complex world, but as we have seen, markets are happy to take some uncertainty in their stride as long as the earnings and rate fundamentals remain constructive. We agree with this attitude and believe risks should be managed rather than keep investors away from the market. We believe our investment priorities find the right balance between exploiting the opportunities while focusing on quality and limiting exposure to areas where risks are mispriced (e.g., unlisted commercial real-estate, growth private markets or lower-rated credit).

What’s not to like?

We are underweight cash in our tactical asset allocation and are overweight in both bonds and equities, so we have a clear risk-on strategy. But that doesn’t mean that we are indiscriminate. Across our portfolio we continue to focus on quality. In the bond market, this is principally because credit spreads are too tight to compensate even for a small pick-up in defaults. In equities, we think the cyclical and structural forces continue to support the winners. We also expect a broadening out of performance in asset classes that have lagged (Real Estate, Infrastructure and developed market small-cap equities).

Q2 2024 asset allocation update

We continue our recent trend of putting cash to work to increase our real assets (REITs and listed infrastructure), global equity, and fixed asset allocation. We move to a neutral position in Australian equities. See our asset class views for more (page 2). Expect market narratives to shift rapidly so prepare for shorter cycles. A volatile macroeconomic environment demands vigilance.

Figure 1: Q2 2024 Asset Allocation – Tactical Tilts

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