There is a growing chorus of market experts predicting lower sharemarket returns for the years ahead based on the current record highs and seemingly stretched valuations of most major sharemarkets. This is a sentiment that we agree with, as we believe monumental changes lie ahead for the global economy. We are in the midst of a synchronised normalisation of interest rates from all-time lows, unwinding of inflated balance sheets, slowing commodity demand, increasing inequality, protectionist trade policies and volatile currency markets. So as investment advisers, what should we do in this situation? In an increasing interest rate environment, we are simply not comfortable ‘buying the index’ via an exchange traded fund, as these investments are always fully invested and perform the worst during market downturns. What we seek to do at Wattle Partners, is to identify emerging themes that can generate long-term outperformance for investors even in poor markets. Rather than looking globally for growth, which has been our preference in recent years, we thought it worth considering where the future lies for the Australian economy. Australia – Today In order to understand where the future is for the Australian economy, it is important to consider where we are today. Whilst the general views of economic commentators and ‘expert’ forecasters remain positive, with trend growth and inflation to return soon; the data suggests all is not as rosy as it seems. The S&P/ASX 200, which is a leading indicator of the strength of the economy, has actually lost ground over the last decade, to the tune of -1.33% per annum in price terms. When all dividends are reinvested, the return is marginally better at 3.20% per annum; not quite the 10% per annum most of us expect from sharemarkets. Interestingly, the growth in the ASX 200 has closely mirrored the growth of Australia’s GDP per capita, or person. In 2006, our GDP per capita was $50,952, in 2016 it had increased to $55,670. That’s an improvement of just 10% over the same 10-year period. Whilst we remain among the richest countries in the world, it seems the last decade of ‘GDP Growth’ has actually come from increasing the size of our population, and has not resulted in any improvement of the wealth of the population. Interesting, given we experienced both a commodity export and property construction boom for the ages. In our view, Australian’s have become far too infatuated with investing into residential property, supported by various tax benefits, and this is having negative implications on the economy. Recent statistics indicate that property now makes up close to 60% of the value of the assets of Australian’s and the property market is substantially larger than the sharemarket, which includes businesses that employ the majority of Australians. When you combine the preference for property with retiree’s obsession for franking credits, the result is a corporate sector starved of capital for investment into research and development, expansion and innovation. We believe it is these reasons that are now seeing wage growth at its lowest level in 20 years, at just 1.9% in 2017, and three consecutive months of negative or zero growth in retail sales. Australia’s trend growth for the period 1992 to 2016, was close to 3.3% per annum, yet we now sit at just 1.8%, slower than Europe, 2.5%, and the US, 2.3%. Consumption continues to be the primary driver of Australia’s growth, representing 56%, however, the threat of increasing interest rates is putting pressure on household budgets and may see us experience the first recession in two and half decades. We are seeing the end of an era in Australia as the final remnants of our past, including smelting plants, vehicle and basic manufacturing are closed down, replaced by cheaper overseas imports. The performers of the last decade, our commodity producers, are beginning to recover, yet they remain cyclical and profitability is determined by the whim of the Chinese Government and their fiscal spending. This is certainly not a sector we should be banking on to improve the wealth of Australian’s for the years to come. It isn’t all bad news……. There are definitely reasons to be negative on the future of the Australian economy; but there are also plenty of reasons to be positive on the outlook for Australian businesses. Australia has consistently fought above its class to the benefit of the population, with our ranking as the 13th largest economy, just behind Russia, but ahead of Spain, and its 46 million people. Australia has just recently achieved its 26th year of consecutive economic growth, albeit at a slowing pace, and remains a successful service driven economy with a history of being ahead of our competitors in a number of specialised areas, which will be discussed below. Australia – Tomorrow Yes, it’s true that the companies of yesterday are closing down or leaving our shores. To be honest, this probably should have happened earlier given the borderless, globalised world we live in. The concept of competitive advantage suggests that in a connected world, countries should focus on producing what they are best at, or that which they can deliver at a lower cost than their trading partners; as one of the wealthiest countries in the world there is simply no chance we can compete with the likes of Asia or Africa for basic manufacturing. So, where will the growth come from? Where should we invest? It isn’t all doom and gloom, at this juncture Australia has two options, to move along the advanced or value added manufacturing path of Germany and Japan, or transition towards an even more service driven economy. Given the multi-decade head start already afforded to Germany and Japan, we believe our future is in the latter. And more specifically, the increasing export of our services, expertise and experience to our closest neighbours in the north; Asia, China and India. Over many decades, Australia has built a reputation of world leading knowledge and success in several key areas (Why Australia? Benchmark Report 2017) that we believe have the potential to benefit investors in the future. They are: Resources and energy – including renewables; Agribusiness – including land and technology; Financial services – including insurance, pension and investment management; Education – including tertiary and vocational; and Tourism.…

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