Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Thematic (Sector/Industry)

Australia Consumer discretionary / Thematic (Sector/Industry)

Stay Underweight Consumer Discretionary and Consumer Staples. In our 2018 Australian equity market outlook, we argued that the country is in grip of a technology-driven disruption cycle that is depressing pricing power and compressing margins.  In this note, we quantify and put into context the size and scope of the boom.  The consumer remains constrained and the disruption to “Bricks and Mortar” retail has been particularly savage.  It’s far too early to go back into this space, despite a few stocks reporting better-than-expected foot-traffic over the holiday period. Retail Structural Headwinds Are Unrelenting. The industry is responding to its challenges by introducing new goods and services, improving marketing, and improving operating efficiency.  There is also evidence that innovation is being felt further up the supply chain.  Despite all of its challenges, Retail saw strong employment growth last year and it remains a large employer (10% of the workforce).  Indeed, the innovation boom is a two-edged sword for the industry.  It constrains wage cost growth and helps protects margins, but the weak wages growth it generates also reduces demand for the goods and services it produces because it’s such a large employer.JBH and PMV are innovating and surviving the battle. One way to measure how efficient companies are operating is by calculating their Return on Assets (RoA).  The increase in RoA these stocks have achieved has been due, at least in part, to trimming the wages bill.  This is sign they are operating efficiently, and in our view, has supported their relatively good performance against the rest of the sector.In contrast, FLT, DMP, and GXL are seeing a falling RoA and rising wages bill. This suggests they are bucking the industry trend and not innovating sufficiently to meet the challenges they are facing.  In other words, they are being left behind by better-managed stocks in the sector.  These stocks have also seen relatively poor share price performance vs the rest of the sector.  The recent rally in FLT could mean it is faring better than the other two stocks.Manufacturing is Being Crunched by Innovation. Innovation is displacing labour at a rapid clip in this industry, which accounts for 7% of the workforce.  However, it is also displacing labour in Utilities, Wholesale Trade, Communications, Finance and Insurance, and Rental and Hiring services. Wages Growth Should Remain Tame and Keep Inflation in Check. The industries at the forefront of the innovation boom account for about 32% of the labour market.  This is large enough to affect macro variables such as wages growth and inflation.  Of course, other factors such as high levels of household debt, the rising price of non-discretionary services, and slowing house price growth are also playing a role in suppressing consumer spending.  We expect inflation to remain around the bottom of the RBA’s 2-3% target band for most of this year before drifting up to the middle of the target band next year.

Stay Underweight Consumer Discretionary and Consumer Staples. In our 2018 Australian equity market outlook, we argued that the country is in grip of a technology-driven disruption cycle that is depressing pricing power and compressing margins.  In this note, we quantify and put into context the size and scope of the boom.  The consumer remains constrained and the disruption to “Bricks and Mortar” retail has been particularly savage.  It’s far too early to go back into this space, despite a few stocks reporting better-than-expected foot-traffic over the holiday period. Retail Structural Headwinds Are Unrelenting. The industry is responding to its challenges by introducing new goods and services, improving marketing, and improving operating efficiency.  There is also evidence that innovation is being felt further up the supply chain.  Despite all of its challenges, Retail saw strong employment growth last year and it remains a large employer (10% of the workforce).  Indeed, the innovation boom is a two-edged sword for the industry.  It constrains wage cost growth and helps protects margins, but the weak wages growth it generates also reduces demand for the goods and services it produces because it’s such a large employer.JBH and PMV are innovating and surviving the battle. One way to measure how efficient companies are operating is by calculating their Return on Assets (RoA).  The increase in RoA these stocks have achieved has been due, at least in part, to trimming the wages bill.  This is sign they are operating efficiently, and in our view, has supported their relatively good performance against the rest of the sector.In contrast, FLT, DMP, and GXL are seeing a falling RoA and rising wages bill. This suggests they are bucking the industry trend and not innovating sufficiently to meet the challenges they are facing.  In other words, they are being left behind by better-managed stocks in the sector.  These stocks have also seen relatively poor share price performance vs the rest of the sector.  The recent rally in FLT could mean it is faring better than the other two stocks.Manufacturing is Being Crunched by Innovation. Innovation is displacing labour at a rapid clip in this industry, which accounts for 7% of the workforce.  However, it is also displacing labour in Utilities, Wholesale Trade, Communications, Finance and Insurance, and Rental and Hiring services. Wages Growth Should Remain Tame and Keep Inflation in Check. The industries at the forefront of the innovation boom account for about 32% of the labour market.  This is large enough to affect macro variables such as wages growth and inflation.  Of course, other factors such as high levels of household debt, the rising price of non-discretionary services, and slowing house price growth are also playing a role in suppressing consumer spending.  We expect inflation to remain around the bottom of the RBA’s 2-3% target band for most of this year before drifting up to the middle of the target band next year.

Going into Survival Mode: The Rush to Innovate