Insights

I've spoken before about how central banks view employment and how looking at growth rates of employment, particularly year-on-year growth rates, gives you a feel for how central banks, particularly the Federal Reserve or the RBA, are feeling about the economy.

This is not our model of short rates; our model is based on inflation, unemployment, and inflation expectations, which is completely different. However, if you look at when year-on-year employment is growing faster than the long-term median, you'll see that central banks tend to increase official rates during such periods. Conversely, when year-on-year employment growth is growing slower than the long-term median, central banks will tend to cut rates.

Currently, we have a picture of the year-on-year growth of US payroll employment. The long-term average for the last two decades is 1.6%. Recently, there was significant media coverage of the employment number, and the market fell heavily, with some attributing it to the bad employment numbers. At that time, year-on-year employment growth in the US was 1.6%, exactly the same as the long-term median, so there was no reason to panic.

Since then, we've seen more discussion about downward revisions of US employment growth. The current chart shows a very small downward revision, with the rate of growth falling from the long-term median of 1.6% to 1.5%. That's a decline of just 0.1%, which is hardly anything to panic about.

Looking at the history of US employment, there have been significant variation since 2019. In 2020, employment growth in the US slumped by 13.4% in one year, reaching its lowest point in April 2020. It then recovered by 11% in April 2021. By October 2021, the rate of growth had declined to 3.8%, and it then increased to 5% for the year to February 2022. After that, there was a long-term gradual decline in growth rates, reaching a bottom in February of this year with a growth rate of 1.7%. Around that time, the Fed was optimistic about cutting rates, but the following month saw a surge in employment, which increased the growth rate to 1.9%.

As we enter the second half of the year, employment growth is slowing. Six months ago, there were 157.7 million employed, inn August there were 158.7 million employed. While there is still positive employment growth, it is now increasing at a rate of only 0.7% over the six-month period. Year-on-year growth is now marginally below the long-term average. This allows us to confidently forecast that when the Fed meets again and Jay Powell presents on the 18th of this month, he will announce a cut in the Fed funds rate of 25 basis points.

In addition to this rate cut, the Fed will also release its Summary of Economic Projections. This summary will provide insight into where the Fed thinks interest rates are headed in the period ahead. Once this information is available, I'll provide further analysis on where the Fed believes the US economy is going and how that impacts future rates.

There's a lot of commentary about the results on Australian GDP for the June quarter, which compares it to very low levels of growth that we saw way back in the 1990s.

I think to understand what's happening, it's really good to look at the experience that the Australian economy has been through since 2019 and the enormous variation in growth that we've experienced. These variations in GDP are by far the largest variations in the Australian economy in my working lifetime.

We had, in 2020, a slump in activity as the economy was shut down, where GDP fell by 6.1%. This is easily the biggest slump since the 1930s. The economy then recovered. The growth rate for the year to June 2021 was 10.6%. This is overwhelmingly the largest growth rate in either wartime or peacetime recorded since the national accounts have existed in Australia.

What then happens is you'll see in the chart that 10.6% growth is the big bump, but what's really important is that the second bump you see is in 2022, which is actually in the third quarter of 2022. Two important things happened directly before that in that little low patch of growth just before that second peak.

What happens in the first quarter of 2022 is that Anthony Albanese is elected Australian Prime Minister. What happens directly after that is that the Australian commodity index published by the Reserve Bank of Australia (RBA) reaches its all-time highest level in the second quarter of 2022. That means not just resource earnings but the revenue that the government receives as a result of commodity exports reaches its highest level following that peak.

That's really important for understanding what then happens in Australian economic policy. So we have the re-acceleration of growth in the third quarter of 2022 to 5.8%. Then you have a budget the following year. In the budget the following year, you've got the highest revenues ever for the federal government.

What's actually happening here is that income goes up by about 2% of GDP, which is about $50 billion a year more than you would normally expect in a normal cycle.

Now, in a similar circumstance back in the early 1950s, when the Menzies-Fadden government was faced with the previous biggest-ever commodity boom in Australian history after World War II, some people call it the “Wool Boom,” some people call it the “Korean War Boom.” What the government decided to do was to run a budget surplus of 2% of GDP. When we scale that to the current size of the Australian economy, that extra $50 billion of revenue that the Australian government was getting from that all-time record peak in commodity prices would have been saved and gone into a surplus because, as everybody knows, long-term commodity peaks can't last.

What's actually happened is that the Albanese government decided to increase their spending to the level of the revenue. You can see that in the budget papers where Jim Chalmers announces that he's making a surplus, but if you look at it, it's a wafer-thin surplus. He's making all this money and he's spending all this money, and there's a very shallow, tiny surplus of a fraction of 1% of GDP.

Then what happens is that commodity prices start to fall, and as commodity prices start to fall, the revenue that the government is receiving also starts to fall as the economy slows. What happens is that the peak of 5.8% in the third quarter of 2022 is followed by year-on-year growth which falls very sharply to 2.6% for the full year 2022; in 2023, for the full year, growth is 1.6%, and for the year to June, which we've just seen, growth is only 1%.

So the economy has slowed down, commodity prices have fallen, and in the most recent budget papers, we've seen that Jim Chalmers is budgeting for a deficit of 1% of GDP. Now we have that debate opening up between the Treasury and the RBA. What's actually happening is because the Treasury has decided to spend the money as extra stimulus, at least 1% of GDP.

I think structurally that there is a long-term structural deficit built in of around 2% of GDP by the government. As we move forward, that structural deficit will start to appear in the budget papers. Which means that for an economist, this is a really interesting time to live in now in terms of what's actually happening in GDP.

One of the things I did during the beginning of the pandemic, together with another economist called Brendan Markey-Towler, was some research into what I call “nowcasting” the Australian economy or “nowcasting” GDP from employment numbers.

Now, I've shown over previous weeks charts of employment growth and how when it's higher than the long-term trend, you expect rates to go up; when it's lower than the long-term trend, you expect rates to go down.

Well, in terms of GDP, we're not using employment growth, but we're looking at the growth in or the movement—the increase in hours worked—because hours worked plus productivity is equal to GDP.

There's been a modest increase in hours worked of about 0.9% over the last year. When we build a model on that, and in chart number two, you can see the red line is the model based on all the nowcasts based on hours worked.

You can see what it's showing is that growth is slowing down to around 1% of GDP. This is a really good thing because even if some people criticise Jim Chalmers for not doing his job, it does show that the RBA is doing its job, because that very low level of growth that we have is what's called “The Narrow Path.”

Growth is very low, but it is not negative. That is what is meant by a “Soft Landing” or the “Narrow Path.”

Hopefully, what will happen is growth will continue at this low but slow positive level. As it does so, unemployment will ratchet up. We think unemployment will be around 4.8% by the end of the year.

That high level of unemployment will put downward pressure on prices, downward pressure on wages growth, and that will bring inflation down to a level of say 3% or less.

The RBA, which has the lowest interest rates in the English-speaking world—our rates are 1% lower than the Federal Reserve, 1% lower than the Bank of England, and lower than even the Reserve Bank of New Zealand. The current state of the Australian economy may feel very frustrating in terms of slow growth; this is certainly frustrating for some politicians, but this is the “Narrow Path.” This is the slight level of positive growth which allows you to get inflation down and avoid a recession.

With the market heading back to record highs, it leads me to ponder my next move.  

Is the market so buoyant and frothy that I need to be concerned about a bubble?  

There is some evidence in the tech and AI space in the US, where many of the big names have doubled in price in the last 12 to 18 months. Companies like Amazon, Apple, Google, Meta (Facebook), Microsoft and NVIDIA, all have trillion-dollar (+) valuations. True, they have changed the way we communicate, connect and do business. However, have short-term expectations outpaced what can realistically be achieved in the near-term?  

Even here in Australia, the big banks, retailers and technology companies are enjoying valuations rarely seen. So, what should investors be doing?  

At times like this I ask myself three question(s): What’s my strategy? What am I trying to achieve? And does it matter if a share price, and or even the market, falls 30% tomorrow? Sure, it wouldn’t be nice, but does the risk of such a possibility change my strategy?

To answer these questions, I apply the following framework.

1. Do I have enough cash and cash flow to be a patient long-term investor?

You don’t want to be a forced seller, but if you are, better to face up to that fact while the market is buoyant, as opposed to waiting for a correction to bring home the reality of your position.

2. Do I own quality businesses?

Good management, sound balance sheet, innovative and productive culture, able to compete and grow. If so, they’re not for sale, but unfortunately not every business that I buy will retain its ‘quality’ status, and a buoyant market is often the best time to weed out businesses with operational issues.

3. Do I have a diversified portfolio?

As a rule of thumb each holding should be between 3% and 7% of the portfolio. Too many small holdings are hard to follow, and large holdings can have too much influence over a portfolio’s returns and strategy. A buoyant market can be the opportunity I need to trim large holdings in mature businesses, although I will be more patient with businesses delivering strong growth.

4. Is the portfolio capable of achieving my return objective?

Typically, this means the portfolio will be generating income of around 5%, plus 5% EPS growth (Earnings Per Share), and be trading close to fair value, at least based on the Morgans analyst’s valuation. A portfolio will typically include quality stalwarts that produce reliable income + higher growth companies to deliver the EPS growth that the portfolio will need to grow over time.

5. Should I be investing some of the surplus cash that I might have?

Price always matters. Cash is a valuable asset, and it gives you the capacity to buy things when the price is right. I’m not talking about waiting for a crash, they do happen, but there is no guarantee that I will have the understanding or conviction to act when they do. Plenty of wealth has been created by simply buying quality businesses at a fair price and compounding reasonable returns over time. A fair price is not about ‘knowing’ the future share price, it’s about considering historical valuations metrics, current conditions and opportunities and making a judgement call as to whether the current price is fair and reasonable?

I also like to review past performance, after all, that’s all we have to go on. It is true, no-one knows the future, including me, and arbitrary things can and do happen, and for better or worse mistakes will be made, but statistically the optimists have won. Despite the uncertainty and the inevitable crisis or two, the market has continued its relentless climb.

If an investor had bought the ASX 200 on the 1/7/1994 and held the ASX 200 for 30 years, until 30/6/2024, they would have received the income stream illustrated in the chart below. To be clear the investor takes and spends the income each year (the dividends haven’t been re-invested). Some years their income is cut, as it was during the GFC and during Covid. Some years it’s flat. But overtime the income stream has grown at 5% compound and that initial investment of $400,000 has grown to be worth more than $1.7million.

True investment returns do not come from trading securities, in some zero-sum game, but from owning businesses that produce the goods and services society needs and will pay for. Investors are savers and their savings have come from their work and it is because they have worked, saved and invested that we have the goods and services we need today for our lifestyle and living standard.

I am cautious about the level of the market, but more because I am used to volatility, as opposed to there being a specific issue; it could be inflation and interest rates, it could be the politics in multiple jurisdictions, or it could nothing at all. Just staying vigilant and asking the question, do you have enough cash and cash flow to be a patient investor?

More Information

Ken Howard is a Private Client Adviser at Morgans. Ken's passion is in supporting and educating clients so they can attain and sustain financial independence.

If you have any questions about your financial plan or your share portfolio, your strategy, investments or would just like to catch up, please do not hesitate to give Ken a call on 07 3334 4856.

General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.

Our 'Best Calls to Action' aim to navigate you through the current reporting season by showcasing stocks with strong buying potential. They also offer insights into stocks that might not be ideal for growth right now. These recommendations come from thorough analysis of market trends, financial health, and growth potential, ensuring you access high-value investment opportunities.

Happy to buy today

IDP Education (ASX:IEL) - Difficult test, but uniquely placed to take market share

IEL reported FY24 underlying NPATA of A$154.3m, down 1% on the pcp. 2H24 reflected the impact of policy changes, with 2H NPATA down ~34% on pcp. Tighter and uncertain policy settings saw 2H24 IELTs volumes down ~24% HOH. Student Placement was solid (2H flat on pcp), although policy hadn’t fully impacted. IEL expects the international student market (new admissions) to be down ~20-25% in FY25. IEL expect to outperform this via meaningful market share gains. We think FY25 is likely to be the trough year for ‘student flows’, impacted by tighter policies and the associated uncertainty. We expect IEL’s earnings to fall ~12%, with some benefits from pricing; market share gains; and solid cost control.

We upgrade to an ADD rating.

Airtasker (ASX:ART) - Positive cashflow the likely new norm

With the recent quarterly trading update, ART had largely pre-released key operating metrics, with the FY24 result itself largely per expectations. However, it was a resilient performance by the marketplace overall, with an improved revenue profile despite top of funnel (GMV) headwinds. The business also achieved its planned target of being free cashflow positive (+A$1.2m) for the full year.

We maintain our ADD rating.

Alliance Aviation Services (ASX:AQZ) - Just too cheap

AQZ reported another record result in FY24, with underlying NPBT up 52% on the pcp and slightly ahead of MorgansF/consensus. We forecast earnings growth momentum (PBT growth of 10%) to continue into FY25 driven by deploying more E190 aircraft and increases in utilisation. We back this founder led management team with a strong track record to continue to execute from here.

We maintain our ADD rating.

Ai-Media Technologies (ASX:AIM) - An Olympic AI effort justifying investing for growth

AIM’s FY24 result showed the business is tracking well with revenue up 7% yoy, gross profits up 15% yoy and EBITDA up 25% yoy. Revenue and gross profit were inline with our expectations while our OPEX expectations were not high enough and consequently EBITDA was below our forecast, but still up 25% yoy. The AI transition risk is largely behind AIM now and operating conditions invert from headwinds to tailwinds. This has given management confidence in long term targets and on public conference call they talked to aspirational target of $150m of revenue and $60m of EBITDA in the next five year (FY29).

We maintain our ADD rating.

Trim/Funding Source

Wesfarmers (ASX:WES) - Kmart Group momentum continues

WES’ FY24 result was slightly above our forecast but in line with market expectations. Key positives: Kmart Group delivered strong earnings growth as its value proposition continued to resonate with customers; Group EBIT margin rose 10bp to 9.0%. Key negatives: Bunnings sales growth in early FY25 remains subdued, impacted by weakness in housing activity; Management expects Catch to be loss-making again in FY25, albeit at a reduced level relative to FY24.

We maintain our HOLD rating.

Tabcorp Holdings (ASX:TAH) - FY24 earnings: Off-track with costs

TAH’s FY24 result was one to forget. While the company’s topline slightly exceeded our estimates, it was overshadowed by a cost blowout and abandonment of TAB25 strategic targets. The company reported a statutory net loss of $1.36bn, mainly due to impairments. An unfranked 0.3c dividend was announced, bringing the total to 1.3c for FY24. While no quantitative trading update was provided, the company acknowledged that conditions remain challenging.

We downgrade to a HOLD rating.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Our 'Best Calls to Action' aim to navigate you through the current reporting season by showcasing stocks with strong buying potential. They also offer insights into stocks that might not be ideal for growth right now. These recommendations come from thorough analysis of market trends, financial health, and growth potential, ensuring you access high-value investment opportunities.

Happy to buy today

NEXTDC (ASX:NXT) - Laying the foundations for platform growth

NXT’s FY24 result was slightly stronger than expected while FY25 guidance was slightly lower than expected due to a slower ramp-up in revenue and faster ramp-up in scale-up costs, positioning the business for significant expansion.

We maintain our ADD rating.

Flight Centre Travel (ASX:FLT) - Margin improvement will underpin strong growth

FLT’s FY24 result was in line with its recent update. The highlights were the increase in its revenue margin to 11.4% vs 10.4% in FY23, the 2H24 NPBT margin of 1.7% and strong operating cashflow up 170% on the pcp. FLT said that its outlook is positive however in line with usual practice, FY25 guidance won’t be provided until the AGM in November.

We maintain our ADD rating.

Karoon Energy (ASX:KAR) - Market confidence also needing maintenance

KAR posted a broadly steady 1H24 result, close to our estimates but appeared to come in below Visible Alpha consensus estimates. Management flagged additional maintenance planned for Bauna in an attempt to protect its flagship operation. KAR announced a maiden dividend of 4. cents per share fully franked, representing an annualised ~5% dividend yield.

We maintain our ADD rating.

Mach7 Technologies (ASX:M7T) - Better visibility prompting accelerated development

M7T posted its FY24 result which was broadly in line with expectations. With the recurring sales book now providing significantly better visibility into cashflows, we view this has given the Company the confidence to accelerate investment back into the products to improve the offering and implementation times. Key points: record sales order book (up 52%); ARR covering 72% of op costs; FY25 guidance of 15-25% revenue and CARR growth, and lower operating expenses than revenue growth. The notable omission in outlook was around operating cashflow positivity, which likely ties in with an acceleration of product development.

We maintain our ADD rating.

Camplify Holdings (ASX:CHL) - Plenty of wheels in motion for FY25

CHL’s FY24 result saw GTV increase ~13% on pcp to ~A$165m (~5% under MorgansF), however a higher than expected group take-rate (~28.9% vs MorgansF ~28%) saw revenue broadly in line with our estimate (~A$m, +~25% on pcp). Whilst the PaulCamper integration impacted bookings/revenue in the period, this is largely completed, with CHL expecting a return to a more normalised performance in FY25.

We maintain our ADD rating.

Trim/Funding Source

APA Group (ASX:APA) - Lenders and taxman to absorb FY25 EBITDA growth

The FY24 result was broadly in-line while FY25 EBITDA and DPS guidance was mildly below expectations. FY25 DPS guidance implies 7.3% cash yield. HOLD retained, given 12 month potential TSR of ~2%

We maintain our HOLD rating.

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Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Our 'Best Calls to Action' aim to navigate you through the current reporting season by showcasing stocks with strong buying potential. They also offer insights into stocks that might not be ideal for growth right now. These recommendations come from thorough analysis of market trends, financial health, and growth potential, ensuring you access high-value investment opportunities.

Happy to buy today

BHP (ASX:BHP) - Copper Gains and Iron Chains: BHP’s Balanced Brains

Another strong result from BHP, posting an FY24 EBITDA margin of 54%, close to its decade-average of 55% (10 percentage points above its next closest peer). Strong opex performance, with earnings coming in slightly ahead with a final dividend of US74 cents, for an annualised dividend yield of 5.6% fully franked.

We maintain our ADD rating.

Lovisa (ASX:LOV) - FY24 result: Untarnished

There are not many global retailers achieving 17% sales growth and 21% EBIT growth in the current challenging consumer environment, but this is exactly what Lovisa did in FY24. A long period of stellar growth has trained investors to have very high expectations for the business and, while its comparable store sales growth should have been better in FY24, it has continued to deliver and will, in our opinion, continue to do so in the years ahead.

We maintain our ADD rating.

Woodside Energy (ASX:WDS) - A lot to be optimistic about

A strong 1H24 earnings and dividend result comfortably beating Visible Alpha consensus estimates. WDS maintained an 80% dividend payout ratio, for a solid 1H24 interim dividend of US69 cents. Strong inbound interest from potential partners on Driftwood LNG has given WDS confidence it can assemble a strong partnership on the project.

We maintain our ADD rating.

Worley (ASX:WOR) - Delivering margin uplift, against macro headwinds

WOR delivered a solid FY24 result, which came in broadly inline with MorgF and consensus, with EBITA of $751m (+24% YoY), driven by Aggregate revenue growth 18% and solid underlying EBITA margin expansion. The group is flagging a year of more moderate growth in FY25, with the group expecting slower revenue growth but at higher margins.

We maintain our ADD rating.

Trim/Funding Source

Coles Group (ASX:COL) - Executing well

COL’s FY24 result was ahead of expectations with the performance of Supermarkets a key highlight. Key positives: Group EBIT margin rose 10bp to 4.7%; Own Brand growth was 2x the rate of proprietary brands as customers continue to seek value; Coles 360 media income jumped 20.5% with opportunities to grow this higher margin segment over time. Key negatives: Liquor performance was weaker than expected with market conditions remaining challenging; Cash realisation ratio fell to 98% vs 102% in FY23 due to higher working capital.

We downgrade to a HOLD rating.

Guzman y Gomez (ASX:GYG) - Spec-taco-ular start to listed life

GYG’s maiden result as a listed company was strong as we were expecting and ahead of prospectus forecasts, driven by higher than expected comp sales. Importantly GYG has had a strong start to FY25, with its comp sales growth for the first 7 weeks ahead of its comp sales guidance for FY25. We note, the comps GYG has to cycle also get easier from here. Despite the strong start, GYG said it expects to achieve its prospectus forecast (Visible Alpha is already above).

We downgrade to a HOLD rating.

Helloworld (ASX:HLO) - Near term uncertainty

HLO posted a solid 4Q which saw it deliver just under the mid-point of its FY24 EBITDA guidance. The highlights of FY24 were the acquisitions exceeding their investment cases, the group EBITDA margin, materially stronger than expected cashflow and HLO’s strong net cash position. Despite this, when the acquisitions are backed out, in the 2H24, the base business went backwards vs 1H24 and the 2H23.

We downgrade to a HOLD rating.

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Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.