Stagnation might be OK at this point

We have frequently commented on the lack of ambition in Australia, the poor productivity, the flawed policy settings and the slow creep into mediocrity. In our view, nothing on that front has changed. If anything, it has become even more entrenched.

Notwithstanding those somewhat ‘sanguine’ thoughts, it’s worth noting that the composition of the Australian equity market (ASX 200) actually maps very differently to that of the domestic economy. Conveniently (and this won’t always be the case) the sectors under the greatest amount of pressure in the economy are under-represented on the stock market.

By way of example:

• The Consumer (under-represented) – the Australian consumer is under extreme pressure (i.e. high interest rates, inflation, energy prices, falling property prices, miserable confidence) and it likely already feels like a 'consumer recession' for many. The sector is 52% of GDP, but represents less than 10% of the ASX 200 (by market capitalisation). In fact, BHP (ASX:BHP) is more important to the ASX than all consumer related stocks put together. Myer and David Jones might attract a lot of headlines, but neither company sits inside the ASX 200.
• Housing Construction (under-represented) – the sector is consistently between 3-6% of GDP and heading into a policy induced slump, but conveniently the building materials sector is less than 1% of the ASX 200. The transmission of a weak housing market (i.e. falling prices and volumes) is pretty limited through the ASX 200 outside of what it means for Consumer stocks. It will crimp Bank credit growth (we still believe mortgage credit quality is robust), but is unlikely to create a banking crisis.
• Offshore Education & Tourism (under-represented) – Australia's #2 and #3 exports are under severe pressure and that will be further compounded by migration cuts (particularly in university education), but these two sectors are barely present on the ASX (<1%).
• Mining & Energy (over-represented) – while clearly important to the economy at 13% of GDP, these sectors are twice as important to the market at almost 30% of the ASX 200. We believe the general outlook is promising, with demand resilient, supply constrained and capex inflation/delays favouring incumbent low cost producers (which Australia is spoilt with).
• Financial Services (over-represented) – the outlook for Australian banks is uninspiring but not dangerous, meanwhile the insurers look completely boring. They currently represent 30% of the ASX 200 vs. <10% of the economy which could prove to be a distinct advantage.
• Australia Companies with Material Offshore Earnings (over-represented) – these businesses clearly don’t feature in GDP numbers but are north of 20% of the ASX 200 (e.g. ResMed (ASX:RMD), CSL (ASX:CSL), QBE Insurance (ASX:QBE)). Overall, they have promising prospects and the potential to outgrow Australia's mediocre short-term prospects.
• Data Centers & AI (not relevant) – clearly a raging debate has emerged around the sector, with politicians oscillating between its virtues and evils (sometimes even on the same day). In any event, even if you round up, its directly listed cohort represents less than 1% of the ASX 200.

In a world where wars rage, French bond yields are literally melting up, 'revolutionary' business models like neoclouds look broken and real fragility has crept into AI stocks (the world’s most crowded trade), Australian equities could look like a port in a storm. It’s clearly a tactical rather than structural argument, but one which could carry some weight amongst global asset allocators in the period ahead. Being underweight Australia has been consensus – it’s easy and somewhat obvious – but that might now change.

The key driver the ASX's underperformance vs. global markets has been its underrepresentation in IT hardware/AI and earnings stagnation. However, these factors may actually be a catalyst for outperformance if the stress we are currently observing persists or accelerates. It comes as the ASX 200 is approaching fair value and realistic F27 earnings expectations are in place (refer below).

Chart 1. The ASX 200 is approaching fair value

Table 1. Realistic F27 earnings expectations are in place

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Yarra Ex-20 Australian Equities Fund

Australian Shares

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