As a developed market economy, Australia isn’t alone in facing near-term headwinds.

Externally, the nation’s three largest trading partners—China, the United States and Europe—are challenged by slowing economic growth and/or political disruption.

Domestically, consumption has been grinding lower as high household debt, a near-zero savings ratio and low wage growth have constrained spending. It had become hard to identify catalysts that could drive a turnaround in the short term.

That was until the Liberal-National coalition government confounded expectations by beating the Labor Party in parliamentary elections this May. At the least it removed a number of negatives that had been stifling investor sentiment.

It’s not what the coalition plans to do as much as what it doesn’t. Labor was seeking to limit negative gearing, remove tax refunds on franking credits and halve the discount on capital gains tax.

These policies would have prevented investors from deducting losses against income tax, and would have eaten into retirement savings and disposable incomes. It would have lumped a negative wealth effect onto an already stressed consumer and weakening economy.

But following its surprise victory, the coalition can press ahead with tax cuts and infrastructure spending—which should give consumption and business confidence a boost. Already we are seeing a pick-up in business activity and new orders.

We have also seen both the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia loosen borrowing conditions. This should further support consumption and underpins the country’s improved economic outlook.

While rate cuts aren’t great for banks’ net interest margins, APRA has issued guidelines to cut the minimum lending requirement as a means to stimulate credit growth. This promises to be positive for banks over time.

The retention of negative gearing and capital gains tax add to reasons why we are more optimistic about banks’ medium-term prospects.

China’s Growth



While the election result has blown some domestic headwinds away, the U.S.-China trade war continues to generate uncertainty. It forms part of a shaky macro-economic backdrop, which is a concern given that a number of stocks we own derive a chunk of their earnings offshore.

Australia’s vulnerabilities stem largely from its reliance on China as a trading partner and on commodity prices. China’s GDP growth continues to slow and U.S. trade tariffs have added to the pressure on Chinese company earnings.

However, Beijing is striving to mitigate the slowdown by boosting consumption. It has cut taxes, introduced measures to spur demand for cars and electronics and increased infrastructure spending. All this is designed to stimulate its economy and preserve growth.

In the face of trade tensions China has also accelerated steel production. This—together with the tragic collapse of Vale’s tailings dam this year and supply disruptions—has driven up iron ore prices. This has enabled Australian miners to generate strong free cash flows, reinforcing balance sheets and enabling them to put capital spending plans in place years in advance.

We could see more earnings upgrades given prolonged elevated prices. We expect further capital management from the miners—which can drive growth in earnings per share. We favor diversified miners with strong balance sheets and cash flows and improving return profiles.

Ultimately we expect China and the United States to reach a compromise on trade given how much is at stake. In the meantime, U.S. aggression will likely speed progress in Chinese self-sufficiency—which could be a fundamental driver for domestic hardware and semiconductor firms.

Over the long term we retain confidence in China’s consumption-led growth. As incomes rise, we expect its growing middle class to pursue a better quality of life—premium products, more frequent travel and additional insurance and health-care services. We will look to invest in companies well placed to benefit from this structural trend.

Finding Value

Buoyed by the coalition’s election win, the ASX200 Index has rallied to the point of touching historic highs. It is trading in line with the S&P500 Index, with a 12-month forward price-earnings ratio of 15.5x.

This has led to a dichotomy in valuations. Sectors such as financials look reasonable value relative to their historic trading multiples, while others such as health care are trading at all-time highs.

Looser monetary and fiscal conditions will likely boost sentiment and valuations in the near term. Nonetheless, investors can still find value in the Australian market.

Health care is an area where we see structural tailwinds and sustainable earnings growth. We are prepared to pay high multiples to access companies with strong balance sheets and stable, recurring income.

We also anticipate strong returns for leading companies with strong offshore earnings growth.

In the energy sector we favor firms well placed to ramp up large liquefied natural gas projects to exploit a tightening market into the mid-2020s.

Michelle Lopez is head of Australian equities and manager of the Aberdeen Australia Equity Fund.