Australian inflation has peaked and is declining. Unless there is a big wage breakout that should continue. Interest rates are also at or very close to their peak. Retail sales data shows the Australian economy is beginning to slow.
How much will it slow? Some commentators suggest there will be a recession. Will that cut into company profits and cause share prices to fall?
When inflation was extremely high in the 1970’s and 1980’s, up to 15 per cent per annum, there were severe recessions. So now central banks are being very careful not to raise rates too far and cause recessions.
Fund manager Mercer points out that past recessions following unexpected shocks such as the 9/11 terrorist attacks (2001) and Covid (2020) were short and mild. They expect a mild, shallow economic contraction in Australia.
This will affect companies in some industries more than others. Consumer staples suppliers like Woolworths and Coles would be little affected. Consumer discretionary companies such as Myer and JB HiFi could suffer more as shoppers cut out non-essentials.
Big government spending on infrastructure should see companies such as CSR, NRW and Downer EDI continue to do well. Home builders might see slower demand due to high mortgage costs but the shortage of housing should minimise that.
Mining companies are shipping big volumes at very high prices, making outstanding profits. If there are serious economic slowdowns overseas demand for commodities will drop and prices weaken. However, for now, the world seems to want raw materials.
We have iron ore, copper, alumina, zinc, coal, gas and all the traditional needs. We can supply lithium, nickel and cobalt needed for the renewable energy conversion. We are the largest source of rare earths needed in high-tech equipment, outside China. I’m glad we live in Australia.
When interest rates and inflation are low, growing companies with expansion potential do well. When inflation and interest rates are high, like now, shares paying healthy dividends usually perform best.
Materials companies BHP, Rio Tinto, Fortescue and Incitec Pivot are paying 7 to 9 per cent dividend. ANZ, Westpac and Bank of Qld pay 6 to 7 per cent. CSR and Nine Entertainment pay about 7 per cent. Woodside Energy and Cromwell Property offer over 10 per cent income.
Most of these companies are trading at very reasonable prices relative to the profits they are making. Their borrowings are low so the high interest rates shouldn’t affect profits much. Some, particularly commercial property owners, will see their profits increase with inflation. Shares should hold up.