Economic and Market Outlook January 2024

Economic and Market Outlook January 2024 Current as of 1 January 2024

ppswm.com.au

Australian economy The resilience of the Australian economy in the face of 425 basis point rise in the official cash rate has been well documented. Much of this resilience can be attributed to the extraordinary monetary and fiscal stimulus pumped into the economy during the pandemic. Until recently, this fiscal stimulus had been estimated at about $330bn but a new analysis by respected economist, Chris Murphy, suggests that the actual magnitude was closer to $430bn, or around 16% of GDP. Budget Cost of COVID-era fiscal policy measure ($ billions) Policy measure

2019-20

2020-21

2021-22

2022-23

2023-24

2024-25

Total

Accelerated depreciation until 2022-23

0

5

17

17

3

6

49

Boosting cash flow for employers

15

20

0

0

0

0

35

Bring forward of stage 2 income tax cuts

0

7

17

2

0

0

26

COVID payments & business support

0

0

21

0

0

0

21

JobKeeper

35

55

0

0

0

0

90

JobSeeker supplements

6

15

2

2

2

2

29

Other policy measures

3

52

47

35

28

15

180

Total

58

155

104

55

33

24

429

Source: Sydney Morning Herald1

Much of this stimulus was initially saved by households as shown by the household savings ratio chart below.

After peaking at almost 24%, this buffer has been rapidly depleted over the last few years as the potent combination of high interest rates and high inflation have caused households to raid their savings in order to make ends meet. The September quarter National accounts show that the ratio has now fallen to only 1.1% 2, the lowest level since 2007, and is on track to be fully depleted by mid-2024.

1

92 Billion more than thought pumped into economy during pandemic: analysis, Sydney Morning Herald, 1 September 2023: https://www.smh.com.au/politics/federal/92-billion-more-than-thought-pumped-into-economy-during-pandemic-analysis-20230901p5e1cv.html 2

National Accounts: September quarter 2023, Australian Treasury, 6 December 2023: https://ministers.treasury.gov.au/ministers/jimchalmers-2022/media-releases/national-accounts-september-quarter2023#:~:text=People%20are%20stretching%20their%20incomes,sales%20going%20backwards%20in%20October.

2 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Household savings ratio (Sep-03 to Sep-23) 25%

Household savings ratio

20%

15%

10%

5%

0%

-5% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Source: Bloomberg

It is no coincidence that recent economic data has begun to weaken as this buffer has been progressively eroded. The economy grew by just 0.2% in the September quarter. Data since then has been no better.

October retail sales fell by 0.2% 3. Unemployment in November rose to 3.9%4 due to a higher participation rate as more people began looking for work. A recent survey by the National Australia Bank showed that 44% 5 (well above the series average of 37%) of participants experienced some form of hardship in the September quarter. Over a quarter said the hardship was due to insufficient funds to cover an emergency and 20% did not have enough for food and basic necessities. Those most impacted were those on low incomes and/or large mortgages.

The Federal Government is acutely aware of these cost-of-living pressures and has begun unwinding policies that have been contributing to inflationary pressures as it is only when inflation is contained can price rises ease and interest rates be cut. In our October commentary, we were critical of the government’s immigration policy, which had allowed over 500,00 new entrants in the year to June, putting upward pressure on rents and housing prices, as well as general aggregate demand. So, while the RBA was deliberately trying to slow the economy by increasing interest rates, the Government was actively working against it.

In recognition of this unintended consequence, on 11 December the Government released a new migration strategy6 designed to slow net migration back to pre-pandemic levels (235,000 per year by 2026-27). In addition, a day earlier, the Government announced7 further measures to curb foreign property investors to partially address housing supply and affordability issues. These measures include tripling fees for foreigners who buy established houses in Australia and a doubling in penalties for those who leave dwellings vacant.

Importantly, the Government has not extended these restrictions to new housing developments and is encouraging foreign investment in build to rent projects. It is aware that increasing the supply of new housing remains the key to solving the housing crisis and to prevent spiralling rents.

3

Retail Trade, Australia, Australian Bureau of Statistics (ABS), 28 November 2023: https://www.abs.gov.au/statistics/industry/retail-andwholesale-trade/retail-trade-australia/latest-release 4

As above

5

Financial Hardship Report Q3 2023, NAB Consumer Insights, November 2023: https://business.nab.com.au/wpcontent/uploads/2023/11/Financial-Hardship-Report-Q3-2023.pdf 6

Migration Strategy, Department of Home Affairs, 11 December 2023: https://immi.homeaffairs.gov.au/what-we-do/migration-strategy

7

Foreign investors to be slugged with huge fee, penalty increases, Australian Property Investor, 10 December 2023: https://www.apimagazine.com.au/news/article/foreign-investors-to-be-slugged-with-huge-fee-penalty-increases 3 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

The Government’s biggest contribution to the fight against inflation, however, has been its fiscal restraint. In the December mid-year economic and fiscal8 outlook, the Treasurer Jim Chalmers, significantly revised down estimates for the budget deficit this financial year from $13.9 billion to just over $1 billion. While the incumbent Government cannot take credit for higher tax revenues from strong mining sector profits and higher employment, it has resisted the temptation to spend this windfall revenue gain, which would have only added to aggregate demand and increased inflationary pressures.

As a consequence of the RBA rate hikes and government fiscal restraint, further evidence of inflation subsiding has continued to emerge in recent months. Indeed, inflation has decreased from a peak of 8.4% in December 2022 to 4.9% at the end of October. In recognition of this trend, the RBA paused in December but has been careful to avoid language that might suggest rates have peaked, in case that helps de-anchor expectations and reignites demand. Yet with global goods inflation largely back to pre-pandemic levels, and the domestic economy continuing to slow, the case for the RBA hiking again is now weak. Further, a forecast rise in unemployment in 2024 is likely to contain wage price pressures and moderate services inflation.

8%

200

7%

180 160

6%

140

5%

120

4%

100

3%

80 60

2%

Job Ads s.a. ('000)

Unemployment rate s.a.

Australian Unemployment Rate v ANZ-Indeed Job Ads

40

1%

20

0%

0

Unemployment Rate (LHS)

Job Ads inverted (RHS)

Sources: ANZ, Indeed, ABS

The Cash Rates Futures chart below supports the view that market participants believe that rates have peaked. The futures market is expecting the first 25 basis point rate cut in July, with another to follow by the end of 2024.

RBA cash rate forecast (Jan-24 to Jun-25) 5.0% 4.5% 4.0%

Cash Rate

3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jan-24

Mar-24

May-24

Jul-24

Cash rate forecast

Sep-24

Nov-24

Jan-25

Current cash rate target

Source: Bloomberg 8

Mid-Year Economic and Financial Outlook 2023-24, Australian Treasury, 13 December 2023: https://budget.gov.au/content/myefo/download/myefo2023%E2%80%9324.pdf

4 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Mar-25

May-25

Conclusion The Australian economy is expected to continue to slow in 2024 as savings are eroded and high interest rates continue to crimp household spending. The effects are likely to become more pronounced as job losses in discretionary retail and financial services start to rise. The economy however is likely to avoid a recession due to high net migration and employment levels that still remain high by historical standards. In summary, Treasury expect the economy to grow by 1.75% 9 over this financial year (FY24) and by 2.25% in FY25.

Unemployment is expected to rise modestly to 4.25% and 4.5% 10 over the same periods.

Part 2: Key economic indicators Economic snapshot

Last reported result

Date

Growth (GDP)

2.10%

Sep-23

Inflation

5.40%

Sep-23

Interest rates

4.35%

Dec-23

Unemployment rate

3.90%

Nov-23

Composite PMI

46.9

Dec-23

Economic snapshot

2024e

2025e

Growth (GDP)

1.4%

2.2%

Inflation

3.5%

2.9%

Interest rates

4.1%

3.3%

Unemployment rate

4.3%

4.6%

US Dollars per 1 Australian Dollar ($)

0.70

0.71

Source: Bloomberg

By Martin Fowler, Partner | CIO – Pitcher Partners Sydney Wealth Management p. +61 2 8236 7776 e. martin.fowler@pitcher.com.au

9

As above

10

As above 5 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

International economy United States In the US, growth has been resilient in the face of material interest rate hikes. The Federal Reserve has hiked interest rates by 1% in 2023 following 4.25% of hikes in 2022. This has raised financing costs substantially but has seen limited impact outside of certain interest-rate sectors, such as commercial real estate. The bulk of American households have been insulated due to taking on fixed rate mortgages when interest rates were materially lower.

In addition, the US government was extremely proactive in its fiscal support programs during the coronavirus pandemic. This has seen US households retain strong levels of excess savings across all income groups, which remain about 20% above the pre-pandemic levels11. The median US worker continues to see reasonably high levels of wage growth with the Atlanta Fed wage tracker showing growth of 5.2% for the year to November.

Median household savings by income category (Jan-19 to Nov-23)

Source: Bank of America

A strong household sector has supported consumer spending and overall economic growth as a result with some level of excess savings offering a buffer in the year ahead. In addition, the business sector has weathered higher financing costs surprisingly well. Partly, this has been thanks to prudent capital management when rates were at lower levels by locking in fixed rate debt. Another important factor has been ongoing demand from consumers, as well as support from the US government. Initiatives such as the Inflation Reduction Act have been a powerful “carrot” to incentivise business investment. Construction activity for US manufacturing is up 71.6% for the year to October or some US $86bn12, a material surge that dwarfs typical “late cycle” behaviour by the private sector.

11

Consumer Checkpoint: Happy Holidays, Bank of America Institute, December 2023: https://institute.bankofamerica.com/content/dam/bank-of-america-institute/economic-insights/consumer-checkpoint-december-2023.pdf 12

Construction Spending October 2023, United States Census Bureau, October 2023: https://www.census.gov/construction/c30/pdf/release.pdf 6 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Annual growth in US construction spending (Oct-03 to Oct-23) 100%

Annual growths.a.

80% 60% 40% 20% 0% -20% -40%

Source: FRED

Manufacturing

Total

After a decade of underinvestment in housing, we are seeing emerging signs of a recovery that should provide a tailwind over the medium term as well.

Leading indicators, such as the Conference Board Leading Economic Index (LEI), appear to have failed as a recession barometer. Typically, when the LEI has remained at strongly negative levels for over a year, we see recessionary conditions ensue. This has not happened. One major contributor is the over-indexing on manufacturing sector performance. Usually this sector is the “canary in the coal mine” with performance peaking just as a recession is commencing. However, the pandemic brought forward a surge in demand with locked down households focused on goods consumption. As restrictions eased, we saw household spending shifted to services and “experiences” (e.g. going out) and retailers pulled back on new orders when expected demand for goods was ultimately unsustainable. As a result, “this time” may indeed be different from past late-cycle periods and a recession will not be forthcoming. This is increasingly our view on the US. The labour market has shown a similar dynamic of over-ordering more expensive temporary labour before subsequently correcting to pre-pandemic levels. Ultimately though it is also showing a marked resilience and any weakness is more consistent with a growth slowdown than a major recession.

Finally on the inflation front, it would appear the Federal Reserve considers its job largely complete. The latest headline inflation print of 3.1% for the year to November is a marked deceleration from the 9.1% peak inflation seen in June 2022. The Fed is now forecasting three rate cuts in 2024 and a further four in 2025.

Taken together the extreme risk of a major recession now appears off the table. The worst case may still be a mild recession but this would be materially less disruptive from a global context. While there is scope for the US to see growth slowdown in 2024 as household excess savings are finally exhausted, we believe the offset of a supportive Fed will be an important tailwind. Overall, we are firming up in our support for the US and see it continuing to be a growth leader amongst developed economies.

Eurozone The situation in Europe has showed limited signs of improvement. Growth in the September quarter was slightly negative (down 0.1%) and flat for the year to September. Elevated energy costs and high interest rates have had a larger impact on the Eurozone with its households more subject to variable rates that makes rate hikes more effective than is the case in the US where 30-year fixed rate mortgages are the norm.

Subdued global demand for manufactured goods has impacted the region hard, particularly its largest economy, Germany. The HCOB Manufacturing PMI from S&P Global has languished in contractionary territory (readings below 0) for over a year now in a testament to the region’s malaise. Even the services sector has been impacted with the HCOB Services PMI shifting to a contractionary phase in the past four months.

7 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Eurozone PMI surveys (Dec-20 to Dec-23)

PMI diffusion index (readings above 0 are expansionary)

15

10

5

0

-5

-10

Source: Bloomberg

Manufacturing PMI

Services PMI

There are signs that the worst on the inflation front might be over with consensus forecasts anticipating a deceleration of inflation to sub-3% levels going forward. This may offer scope for near-term relief by the European Central Bank on the interest rate front.

A more potent source of support would be sustained fiscal spending on the part of Eurozone governments, However outside of certain, regional solidarity efforts such as the Green Deal13, more targeted support for both businesses and households appear less than forthcoming in sharp contrast to the UK, for example, where its own unique challenges, as well as weaker regional demand, has seen a more forceful government response than its peers in mainland Europe.

Taken together we would expect current subdued economic conditions to persist for the Eurozone in the near term. Eventually as conditions rebase, we would expect to see an uptick in growth with consensus arguably anticipating this already as the current recessionary conditions are not expected to deepen.

China China has seen a mixed year in 2023. On the one hand there has been a notable bounce back in household spending with retail sales up 10.1% for the year to November as activity normalises from a lockdown-afflicted 2022. The industrial sector has also held up reasonably well with 6.6% growth to November, well ahead of developed markets with a 0.4% decline in the US by contrast, as well as negative growth in the Eurozone.

While growth is certainly more subdued than prior years, it has still shown marked resilience with 4.9% growth for the year to September. This was admittedly flattered by comparisons to a pandemic-challenged 2022 but is still a strong result in a global context.

On an underlying level however, China’s economy faces some notable challenges.

The property sector, a material contributor to growth in recent decades, has struggled markedly with residential property sales for the year to November declining 4.3% and property investment spending down 9.4% over the same period.

Further, official price data shows that with both consumer inflation and producer inflation declined 0.5% and 3% for the year to November respectively. This is not the backdrop of a “healthy economy” per se. It is suggestive of subdued underlying demand amongst consumers and an inability for companies to pass through costs to preserve profitability. On that last note, industrial profits for the year to October declined 7.8% suggesting limited pricing power in the current environment.

13

The European Green Deal, The European Commission: https://commission.europa.eu/strategy-and-policy/priorities-20192024/european-green-deal_en 8 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Business survey data also offered a level of confirmation with the manufacturing sectors flirting between expansionary and contractionary states for the bulk of 2023. Meanwhile the services sector has seen a protracted slowdown since it initially surged on the lifting of pandemic restrictions in the March quarter.

The inability to meaningfully break out with stronger underlying growth is perhaps unsurprising. China was unwilling to exercise the same degree of household or business support as was the case in Western countries. This meant one lever of excess savings has not been evident as a support for economic growth.

Signs have begun emerging that authorities are acknowledging the potential scale of underlying weakness.

There is heightened expectation that the central government will enlarge its deficit target to at least 3.8% of GDP, mirroring its efforts in 2023 where the deficit target was lifted from 3% to 3.8% in order to support increased investment spending and provide a measure of natural disaster relief.

China lending growth by sector (Mar-20 to Oct-23)

Source: People’s Bank of China | Reuters, Nov. 8, 2023 | By Kripa Jayaram and Kevin Yao

Finally, the credit environment has become more supportive particularly as authorities look to divert credit creation towards sectors more aligned to the CCP’s long term goals, predominantly in manufacturing as the aim is to create a stronger technology sector in areas, including semiconductors and electric vehicle production. We can see this illustrated below by the sizeable acceleration in manufacturing lending growth relative to overall lending and the anaemic conditions for the property sector.

On balance, we do not expect further deterioration in the Chinese economy. The diversion of resources including credit to other sectors will be a net support to economic activity while the potential enlargement of the national fiscal deficit should act similarly. In net terms, we would still anticipate China being a major source of resource demand in the near term to fund its expansionary manufacturing sector notwithstanding underlying weakness in domestic consumption.

Conclusion Our outlook for global growth suggests rebasing at current levels before gradually accelerating towards the end of 2024. The key driver of a shift in our view has been the resilience of the US private sector, spurred on by strong government support beyond the pandemic emergency spending. A more proactive fiscal response out of China is also giving us scope for optimism. While we acknowledge the malaise higher interest rates are having on the European economy, we believe there is sufficient positive evidence to suggest an inflection point in global growth into 2024 with central banks increasingly likely to shift to a more supportive stance as the supply shock of the pandemic fades into memory with inflation, it appears, being brought to heel successfully.

9 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Part 2: Key economic indicators United States Economic snapshot

Last reported result

Date

2024e

2025e

Growth (GDP)

2.90%

Sep-23

1.3%

1.7%

Inflation

3.10%

Nov-23

2.6%

2.3%

Interest rates

5.37%

Dec-23

4.3%

3.3%

Unemployment rate

3.70%

Nov-23

4.2%

4.3%

51

Dec-23

Last reported result

Date

2024e

2025e

Growth (GDP)

0.00%

Sep-23

0.5%

1.4%

Inflation

2.40%

Nov-23

2.5%

2.1%

Interest rates

4.00%

Dec-23

3.7%

2.9%

Unemployment rate

6.50%

Oct-23

6.8%

6.7%

47

Dec-23

Last reported result

Date

2024e

2025e

Growth (GDP)

4.90%

Sep-23

4.5%

4.3%

Inflation

-0.50%

Nov-23

1.4%

1.8%

Interest rates

1.91%

Dec-23

2.3%

2.3%

Unemployment rate

5.00%

Nov-23

5.0%

5.1%

Composite PMI

51.6

Nov-23

Last reported result

Date

2024e

2025e

Growth (GDP)

1.50%

Sep-23

0.8%

1.0%

Inflation

2.80%

Nov-23

2.3%

1.7%

Interest rates

-0.10%

Dec-23

0.1%

0.2%

Unemployment rate

2.67%

Sep-23

2.5%

2.4%

Composite PMI

50.4

Dec-23

Composite PMI Eurozone Economic snapshot

Composite PMI China Economic snapshot

Japan Economic snapshot

Source: Bloomberg

By Cameron Curko, Head of Macroeconomics & Strategy | Pitcher Partners Sydney Wealth Management p. +61 2 9228 2415 e. cameron.curko@pitcher.com.au

10 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Australian equities Overview The S&P/ASX 200 Total Return Index returned 8.4% over the three months and 12.4% over the year to 31 December 2023.

S&P/ASX 200 Accumulation Index cumulative return (Dec-22 to Dec-23)

Cumulative return (31 December 2022 = 0)

14% 12% 10% 8% 6% 4% 2% 0% -2% -4% Dec-22

Mar-23

Jun-23

Sep-23

Dec-23

Source: S&P Global, Bloomberg

Outlook Recommendation: Maintain underweight.

The Australian economy continues to slow with the September quarter marking another period of below trend growth and GDP per capita declining for the past 6 months, highlighting the challenges facing Australian households. We expect discretionary spending to continue being pressured in 2024 with higher unemployment also likely. This backdrop will weigh on both the banking sector and retailers with the former remaining pressured by heightened competition as well. Despite weakness in global industrial production, demand in the mining and resources sector is holding up better than expected and continued support from Chinese policymakers suggests that a positive outlook is warranted. The prospect of monetary easing in mid2024 is likely to provide material support for interest rate sensitive sectors, including commercial real estate and infrastructure. Indeed, A-REITs have been the strongest performer in recent months justifying our neutral positioning on the sector. The December quarter rally, however, has reduced the attractiveness of valuations for the broader market and several sectors are now trading above our estimate of fair value.

On balance, while we see some causes for optimism in certain market niches, we believe that earnings downgrades are likely to increase in the upcoming reporting season, which is likely to weigh on market sentiment and challenge valuation assumptions. A gradual easing in monetary policy in 2024 though is likely to help limit downside risks. We maintain a modest underweight positioning as a result.

11 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Table 1: S&P/ASX 200 valuation metrics as at 31 December 2023 Metric

Latest

15-year average

1-year Forward P/E ratio

16.2x

14.2x

Price move to revert to long-term average -12.4%

Average 2 and 3-year forward P/E ratio 1-year Forward Dividend Yield 1-year Forward Price to Cashflow ratio Price to Book ratio

15.2x

13.1x

-13.5%

3.9%

4.6%

-15.1%

10.9x

9.8x

-9.8%

2.2x

2.1x

-2.0%

Source: Bloomberg

NB: Dividend Yield price move calculated after converting yield into Price to Dividend ratios.

Sector view Pricing at a sector level remains mixed. Some sectors, such as banks and retail, would need prices to fall over 15% or more to get valuations back to their long-term average. Resources are a notable exception, although this is highly dependent on outcomes in China particularly for iron ore pricing given the importance of the commodity as a source of overall profitability for the sector.

Table 2: S&P/ASX 200 Sector Forward Price-Earnings Ratios as at 31 December 2023 Sector

Forward PE Ratio

15-year average

Banks

15.2x

12.4x

Price move to revert to long-term average -18.6%

Resources

13.3x

12.6x

-5.0%

Retail

22.0x

16.5x

-25.2%

A-REITs

16.5x

14.3x

-12.9%

Source: Bloomberg

Our outlook for some of the major sectors of the S&P/ASX 200 is as follows: Banks Recommendation: Maintain underweight.

The banking sector outlook remains problematic. Valuations are tracking reasonably above longer-term averages suggesting scope for price corrections before the sector is attractive on a longer-term perspective.

On the growth front, there are some positive signs. Elevated population growth has supported new mortgage growth after being dominated by refinancing activity. These factors should be supportive of revenue growth due to higher overall volumes of mortgages being written.

12 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

New mortgage volume growth vs 1-year total return for major banks (Dec-03 to Dec-23) 100%

Annual total return/growth

80% 60% 40% 20% 0% -20% -40% -60%

Rolling 1-year return of Major Banks Rolling annual growth of housing credit (excluding refinancing) Source: Bloomberg

Intense competition however is impacting profitability due to net interest margins, the spread between interest income on a bank’s loans and the cost to finance these assets. These margins are expected to decline and remain lower in 2024 and beyond.

Consensus net interest margin forecasts for major banks (2023 to 2027) 2.2%

Net interest margin forecast

2.1% 2.0% 1.9% 1.8% 1.7% 1.6% 1.5% 2023

2024

Commonwealth Bank of Australia

2025 National Australia Bank

2026 ANZ Bank

2027 Westpac

Source: Bloomberg

Finally in terms of operating costs, these are anticipated to be higher in FY24 before gradually declining, although remaining elevated relative to 2023 levels. This is another net negative to bank earnings growth.

13 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Consensus cost to income ratios for major banks (2023 to 2027) 54%

Forecast efficiency ratio

52%

50%

48%

46%

44%

42%

40% 2023

2024

Commonwealth Bank of Australia

2025 National Australia Bank

2026 ANZ Bank

2027 Westpac

Source: Bloomberg

A final positive is the extent to which banks are overcapitalised, driven by a combination of factors. On the one hand, loan defaults have been much lower than expected given the pace of RBA rate hikes. This reduces the need for money to be set aside against potential loan impairments. These funds could potentially be deployed into share buybacks or increased dividend payouts with Commonwealth Bank illustrating this in announcing a $3bn buyback as part of its FY23 results In summary, we have some net positives in the form of excess capital and positive mortgage growth in aggregate. These remain outweighed, however, by clear negatives in the form of expensive valuations and weakening profitability, which should see difficult conditions for earnings growth and ultimately for higher dividends. Accordingly, we continue to maintain our underweight positioning for the sector.

Resources Recommendation: Upgrade to neutral.

The resource sector has had a troubled 2023 with limited exceptions. Most commodities outside iron ore and precious metals have seen prices correct materially with drawdowns in double digit territory. Iron ore has been supported by a shift in Chinese investment spending towards manufacturing and infrastructure projects.

Even though property investment is still down year-to-date, falling 9.3%, other sectors have offered a level of support with credit conditions also inflecting higher as shown below (in orange). A positive credit impulse tends to lead to strong conditions for industrial metals such as copper.

14 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

China credit impulse versus Industrial Metal price growth (May-14 to May-24) 80%

35%

40%

30%

20%

0%

25%

China Credit Impulse, advanced 6 months

Industrial Metals annual change

60%

-20%

-40% 2014

2015

2016

Industrial Metals YoY

2017

2018

2019

2020

2021

2022

2023

20% 2024

China Credit Impulse (% of GDP), Advanced 6 months (RHS)

Source: Bloomberg

In addition, there is heightened speculation that Chinese government authorities will continue to be supportive of resource-intensive sectors into 2024. The Politburo has flagged a moderate uptick in fiscal stimulus with spending on infrastructure at a local government level being brought forward, funded by an enlargement of the central government’s modest fiscal deficit from 3% of GDP to 3.8%. A continuation of this policy stance into 2024 will be supportive of additional metals consumption including iron ore. Finally, Chinese steel mills were not, unlike prior years, subject to production caps in 2023, which has allowed for more steel exports that has also seen iron ore consumption remain sustained.

Slowing global growth in 2024 is a concern however for resource demand. Typically, in slower economic conditions, we see reduced investment spending and a corresponding decline in consumption for commodities, such as copper and iron ore. That must be balanced however against demand for “New Economy” initiatives. The US has been a notable driver of this in the developed world with the Inflation Reduction Act spurring a surge in construction activity and “re-shoring” (bringing business operations from overseas back to the US) behaviour from major US multinationals. In addition, national resolutions such as discontinuing fossil fuel reliance 14, an agreement out of the COP 28 Summit, are seen as supportive of increased commodity consumption over the medium term given the vast amount of resources necessary to move away from reliance on hydrocarbons, such as oil and coal, as an energy source.

We are concerned for the potential decline in resource consumption that a global economic slowdown would entail. We have already seen elements of that in certain resources, but not, importantly, for the entire commodity complex. It is telling in our view that key sources of demand, such as China, and secular drivers, such as decarbonisation, are already having a material impact on global demand. Increased support from Chinese authorities even if ultimately modest compared to past efforts are also a tailwind. Consequently, we upgrade our stance to neutral.

COP28 Agreement Signals “Beginning of the End” of the Fossil Fuel Era, United Nations Climate Change, 13 December 2023: https://unfccc.int/news/cop28-agreement-signals-beginning-of-the-end-of-the-fossil-fuel-era 14

15 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Retail Recommendation: Maintain underweight.

The household sector is showing clear signs of weakness. The savings rate is at its lowest level since 2008 with excess savings being run down. Discretionary spending in nominal terms is now negative for the year to October as shown in the chart below. If we strip out inflation, underlying volume growth has been negative for three of the past four quarters.

Household spending growth in nominal terms – Discretionary vs Essentials (Jan-20 to Oct-23) 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40%

Discretionary

Essentials

Total

Source: ABS

There have been green shoots in car purchases, for example, as suppliers gradually clear backlogs from the pandemic period. The hospitality space, “experiences”, more generally such as eating out has also held up with positive volume growth. Elevated population growth of 2.4% for the year to September is also a support in aggregate terms. Nevertheless, it is impossible to ignore the headwinds posed by the marked decline in household disposable incomes. Household confidence is tracking near multi-year lows suggesting limited willingness to support continued spending growth. Household incomes are instead being channelled towards essentials, such as shelter (rent and/or mortgage repayments), insurance, education and healthcare.

Given this backdrop, we believe the outlook for the retail sector remains challenging. Offsets do exist in the form of elevated population growth, which should put a floor on overall growth in revenues as more people equates to more spending on goods and services. Certain retailers may also offset a weaker consumer by taking more market share. In aggregate, however, we believe the headwinds will continue to outweigh these potential positives and believe the sector remains at elevated risk for earnings downgrades and subsequent price corrections as a result.

Australian Real Estate Investment Trusts (AREITs) Recommendation: Maintain neutral.

The AREIT sector continued to see a degree of portfolio positioning with several trusts looking to sell noncore positions and reduce gearing in the face of higher interest rates. The sector was the best performer in the December quarter as investors retraced rate hike expectations both domestically and overseas. A lower rate environment (if those cuts transpire) will be supportive both for property valuations and net income due to lower financing costs.

In the office sector, material transactions have seen capitalisation rates (net income as a percentage of property value) climb sharply as shown below. This is beginning to close the gap between discounts implied by current market pricing versus actual transactions in the commercial real estate market.

16 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Commercial real estate cap rates by sector (May-10 to Oct-23)

Capitalisation rate (net operating income divided by land value)

10% 9% 8%

7% 6% 5% 4% 3% 2% 1% 0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Office

Industrial

Retail

Source: Bloomberg

Occupancy continues to track favourably for higher quality properties with Dexus, for example, seeing its predominantly A-grade portfolio tracking at above 94% occupancy versus the decline experienced by the broader office market, especially lower quality sites.

Dexus occupancy vs broader office market

Source: Dexus Nov-23 Annual General Meeting materials15

15

Dexus 2023 AGM Chair and CEO Address, 25 October 2023: https://cdn-api.markitdigital.com/apiman-gateway/ASX/asxresearch/1.0/file/2924-02729957-2A1482971 17 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Overall, the office outlook has not changed materially since our last update. We are still seeing challenges in leasing for lower quality sites relative to premium-grade. In addition, office sales are better reflecting the lower valuations implied by market pricing of listed REITs. Importantly though, the depth of discounts in listed REIT pricing appears to be overly pessimistic relative to recent transactions suggesting that we should continue retaining exposure at the current share price.

In the retail space, consumer demand continues to be resilient in the face of macroeconomic headwinds, such as weaker growth and higher interest rates. Westfield mall operator Scentre Group highlighted this facet with customer visitations of 410 million for the year to September, up 7.4% versus the same period in 2022. This has also coincided with an ability to reprice tenant agreements higher as average leasing spreads (the difference between old and new rental agreements) rose 2.9% over the same period. Strong population growth (2.4% to the September quarter16) has also been a support for the sector as it drives increased foot traffic. However, given the challenges to the retail sector from reduced household savings, reduced disposable income and higher interest rates, we expect the current trend to potentially soften in the quarters ahead.

Finally on the industrial sector, a lack of supply in key markets, such as Sydney and Melbourne, will continue to keep occupancy rates elevated and support spending. Sector heavyweight, Goodman Group, continues to be a showcase for this phenomenon with occupancy running at 99% and strong like-for-like rental growth of 4.9% for the year to September 17. While cap rates for the sector have begun moving upwards in line with higher rates, we would expect the strong demand and limited supply to continue supporting sector valuations in the near term. Importantly, even if valuations soften somewhat, ongoing demand for new locations could continue to be a strong support for earnings growth by building out its development pipeline and adding new sites to the portfolio.

Taking stock of AREITs as a whole, occupancy has held up well particularly in the leading properties and even more so in the industrial sector thanks to strong demand from both businesses and consumers. This is flowing through to rental growth, albeit somewhat offset by higher financing costs. The latter may see some relief in 2024 if the RBA follows market expectations. Finally, whilst valuations are softening, there still appears to be material support for book values, which suggests upside to current share prices. As a result, we maintain our neutral weighting to the sector.

By Cameron Curko, Head of Macroeconomics & Strategy | Pitcher Partners Sydney Wealth Management p. +61 2 9228 2415 e. cameron.curko@pitcher.com.au

16

Australian National Accounts: National Income, Expenditure and Product September 2023, ABS, 6 December 2023: https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-national-income-expenditure-andproduct/latest-release 17

Q1 FY24 Operational Update, Goodman Group, 6 November 2023: https://dataapi.marketindex.com.au/api/v1/announcements/XASX:GMG:2A1485708/pdf/inline/q1-fy24-operationalupdate?_gl=1*12vcp8g*_ga*MTIwNjc1ODk1Ni4xNzAyNzczOTM2*_ga_R504V9JPBH*MTcwMjc4MTc1MS40LjEuMTcwMjc4MTc2My40O C4wLjA. 18 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

International equities Overview The MSCI World (excluding Australia) Net Total Return Index (AUD) returned 5.3% over the past three months and 23.2% over the year to 31 December 2023. A notable contributor to this return was the decline in the Australian dollar with the MSCI World (excluding Australia) Net Total Return Index (hedged to AUD) returning 21.7% for the year to December, a differential of 1.5%.

MSCI World excluding Australia Net Total Return Index (Dec-22 to Dec-23)

Cumulative return (31 December 2022 = 0)

30%

25%

20%

15%

10%

5%

0%

-5% Jan-23

Mar-23

Jun-23

Sep-23

Dec-23

Source: MSCI, Bloomberg

Outlook Global equities have finished 2023 strongly, led by interest rate sensitive sectors, such as utilities and real estate, where leverage is widely employed. The increased optimism for rate cuts by central banks, has seen investor optimism improve markedly.

This exuberance has been matched by a substantial rerating in equity valuations with the leading US index, the S&P 500, moving from a forward earnings multiple of 16.8x to 19.4x, a 15.7% price return.

The US market is also benefitting from stronger economic fortunes relative to other economies. Households and businesses have been sheltered from the impact of rate hikes in aggregate due to fixing interest rates for long durations at the pandemic lows. Household spending continues to be supported by sizeable excess savings, at least 20% above pre-pandemic levels. Finally, the US government is maintaining an elevated budget deficit of 6.3% of GDP as of November. Although government spending of this magnitude is unsustainable, it is providing enormous support to the US economy. Taken together, these factors suggest limited recessionary prospects for the US in the near term and consequently earnings should not suffer materially as the underlying economy will continue to expand, supporting business revenue growth and profitability.

Elsewhere, the outlook for markets is considerably less attractive as economic conditions generally remain subdued. Nevertheless, markets are forward looking and the prospect of significant interest rate cuts in 2024 could signal sizeable relief for households and a tailwind to overall earnings growth for these regions.

19 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Valuations In the US, operating earnings for S&P 500 companies are currently expected to now rise by 0.6% in 2023 (compared to 1.5% growth last quarter), and then increase by 10.3% and 10.8% in 2024 and 2025, respectively (up again from 10% average growth expectations last quarter).

Assuming conventional long-term multiples, we estimate that the US sharemarket (as measured by the S&P 500 Index) is overvalued by almost 24.9% in the near-term and by a slightly lower 8.1% in the medium-term.

2023 calendar year forecast

EPS earnings estimates (US$)

S&P 500 fair value estimate

Upside/(downside) S&P 500 = 4769.83

Consensus

221.0

3536.2

-25.9%

if 10% below

198.9

3182.5

-33.3%

If 10% above

243.1

3889.8

-18.5%

EPS earnings estimates (US$)

S&P 500 fair value estimate

Upside/(downside) S&P 500 = 4769.83

Consensus

243.2

3891.2

-18.4%

if 10% below

218.9

3502.1

-26.6%

If 10% above

267.5

4280.3

-10.3%

EPS earnings estimates (US$)

S&P 500 fair value estimate

Upside/(downside) S&P 500 = 4769.83

Consensus

270.0

4320.6

-9.4%

if 10% below

243.0

3888.6

-18.5%

If 10% above

297.0

4752.7

-0.4%

2024 calendar year forecast

2025 calendar year forecast

Source: Bloomberg consensus estimates for 2023, 2024 and 2025 as of 31 December 2023

Forward PE

15-year Average Forward PE

Potential upside/downside

All Country World (ex-US)

13.1x

12.6x

-4.1%

Australia

16.2x

14.2x

-12.3%

Europe

13.1x

12.7x

-3.7%

Emerging markets

11.8x

11.2x

-5.7%

Japan

14.8x

14.6x

-1.4%

UK

11.0x

11.8x

+7.2%

China

9.1x

11.1x

+22.5%

Region

Source: Bloomberg. Data as at 31 December 2023.

Conclusion Recommendation: Upgrade to neutral.

In summary, the valuation backdrop continues to see material divergence between the US and other major equity markets. US equities are pricing in a period of above-average earnings growth led by technology names and more supportive conditions for interest-rate sensitive sectors, such as real estate. Monetary policy relief has been increasingly priced in with inflation decelerating to target levels, prompting a change in central bank guidance to an easing bias. Outside the US, valuations are less demanding and the prospect of significant interest rate cuts could prove to be supportive of markets, even in an environment where earnings growth remains subdued. Overall, we upgrade our recommendation to neutral.

By Cameron Curko, Head of Macroeconomics & Strategy | Pitcher Partners Sydney Wealth Management p. +61 2 9228 2415 e. cameron.curko@pitcher.com.au 20 Current as at 1 January 2024. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

Making business personal Authors Jordan Kennedy

Martin Fowler

Partner | Pitcher Partners Sydney Wealth Management +61 2 9228 2423 jordan.kennedy@pitcher.com.au

Partner | CIO – Pitcher Partners Sydney Wealth Management +61 2 8236 7776 martin.fowler@pitcher.com.au

Charlie Viola

Cameron Curko

Partner | Managing Director – Pitcher Partners Sydney Wealth Management +61 2 8236 7798 charlie.viola@pitcher.com.au

Head of Macroeconomics & Strategy | Pitcher Partners Sydney Wealth Management +61 2 9228 9173 cameron.curko@pitcher.com.au

Andrew Wilson Principal | Pitcher Partners Sydney Wealth Management +61 2 9228 2455 a.wilson@pitcher.com.au

Adelaide Brisbane Melbourne Newcastle Perth Sydney Copyright © 2024. Any advice included in this newsletter is general only and has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisers at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFSL number 336950.

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