Moz down under part 1: Australia deep dive

Welcome to Beyond the Benchmark, the EFG podcast with Moz Afzal.

Moz Afzal:
Hi, everyone. So I am actually in Sydney, Australia today, and I have the pleasure of having Martin Crabb, who's the CIO for Shaw and Partners here in Australia. Martin, welcome.

Martin Crabb:
Thanks very much. It's great to be back. I can't believe it's four years since we were last talking on this podcast.

Moz Afzal:
Is that right? Four years ago. Oh my gosh, we've certainly got to change that.

Martin Crabb:
Time flies.

Moz Afzal:
Time flies. I know, that's very true. That's very true. So let's go straight to it. Obviously, as we record, we're right in the middle of the Middle Eastern crisis and oil price is over $100, Brent is over $100. Lots of fear about inflation, rates have all moved up together in unison, pretty much across the world. Worries about recession. Maybe for that specific point, how do you feel that Australia's positioned in this position? Because I've been lucky enough to be pretty much visiting the whole country over the last five days, but the views are quite extreme, I would say.

Martin Crabb:
Yeah, yeah. We're probably both a crisis and an opportunity for Australia. I think it's a crisis from the perspective of we have very low levels of reserves of automotive fuel, of diesel, of aeronautical fuel that's measured in weeks, not months. And we are reliant very much on imports of those products. And yet it's an opportunity from two perspectives. One, the size of the energy sector and the commodity sector on the Australian share market is quite significant. So it's relatively easy for investors to get exposure to energy within their portfolios. And secondly, about 3.5% of our GDP is actually energy export. So we're a net energy exporter, but-

Moz Afzal:
I would not have thought that given the-

Martin Crabb:
We're the largest exporter of LNG in the world. We're bigger than Qatar, but we import all the fuel, all the diesel, all the aeronautic fuels, all imported.

Moz Afzal:
Oh, so it's specific to LNG rather than diesel-

Martin Crabb:
Exactly. And big coal exporter as well, big thermal coal exporter. So we're actually a net beneficiary of higher energy prices, but there are people queuing up outside petrol stations at the moment trying to fill their tanks up because they're worried about us running out of that.

Moz Afzal:
So how come Australia's got yourself in this kind of mess? It seems to be strategic reserves in many Asia-Pac countries, of course, other than Thailand, Indonesia. But certainly if I think about Japan and Korea, China, you would've thought they would've had more.

Martin Crabb:
Yeah. Well, being a reliance on crude imports is a relatively new phenomenon for this country. As recently as 2000, we had 98% of our needs produced locally, but we've run down our oil reserves and we've massively increased our LNG capability, but most of that's been for the export markets. Most of the LNG terminals are in the Northwest Shelf in WA or they're in Gladstone and Queensland, and those are shipped straight to Korea and Japan and places like that. So we've run the big oil fields such as Bastrait and so forth, they've depleted. So we've sort of run down our oil, which we're using, and we had a number of refineries here turning that into fuel and so forth. We've now only got two refineries and they're mostly import terminals. So it's been sort of a strategic and somewhat misguided, if you like, policy that now we're very, very reliant on imports despite being a net exporter.

So yeah, I think that's a real challenge for the government to work out what to do going forward because I don't think they really want to be held hostage to what's going on in the Middle East, and that exactly is how we feel at the moment.

Moz Afzal:
Yeah. Well, it certainly seemed to be like that for many countries. They just can't find why they're in this mess. And it just shows you how shortsighted governments have been because it wasn't long ago we had Russia-Ukraine with the same challenges, and we seem to be just replaying exactly the same issue again.

Martin Crabb:
Yeah. And it's just, I think, belief in the global world order and the rule of law and the rule-based system and the World Trade Organisation and all that sort of stuff, which that was a multi-decade march forward. And I think a lot of people just assume that would continue forever. And obviously with the rebuilding of global geopolitics that we've seen in the last half a decade, that's changing everyone's view on that. So will you see governments rebuilding their strategic petroleum reserves and strategic fuel reserves and probably accelerating the move away from fossil fuel? I think if we're all driving Teslas, we're probably not worried about the price of petrol too much. So I think this will probably accelerate that quite ironically.

Moz Afzal:
And actually just wandering around, and I've been to five cities pretty much from west to east and noticing there are actually not that many electric cars around other people, I guess it's the distances, right? People are still worried about the fact that-

Martin Crabb:
Yeah, they call it range anxiety. So there's still people that ... So it's making up about three or 4% of cars on the road. So obviously that's from zero a few years ago, but there's more BYDs now all the time, but still we haven't adopted them the same way some European countries have, but we're still a bit behind.

Moz Afzal:
Clearly we've had a bit of a hit with these oil price spike and inflation worries, roughly 75 basis points across the curve or so the short end of the curve in Australia. What's your view on rates? Where do you think it's going to go? And I guess we think as well that maybe just overdone the short term, what's your thoughts on

Martin Crabb:
Interest? Yeah, I think the problem for the reserve bank here is that inflationary pressures were building in the economy even before the fuel price hikes that we've seen. So there was probably a change of view back in October last year when we had a much hotter CPI than expected and the reserve bank pretty much went from being in cutting mode to holding and now hiking, and they're very hawkish now. So they were talking even prior to the Iran situation, 4.2% inflation in this quarter, and that was up from probably the two, 3% ban they've been aiming at. So they're in hiking mode anyway, and this is just part of the pun put fuel on the fire in that this will add another 1% to inflation in Australia if petrol prices stay where they are. So we're looking at inflation with a five handle. Now you can probably read through the fuel and food part, that volatile items part, but we've still got underlying inflation going in the wrong direction.

So they've already hiked twice. They'll probably hike another two times. So we probably see 4.1% cash rates in Australia, which is definitely in restrictive territory. Now, when we look back on that in two years ago, they overdid it because they responded to a transitory moment in the economy, but they're very concerned that the productive capacity of the economy's not that great. It doesn't have a high speed limit. It's not like America where there's very high labour productivity. It's actually negative in Australia, which makes the speed limit lower. So I think they're just concerned the economy actually can't grow too fast without causing inflationary pressure. So when you get a pickup in demand, and we've got public demand growing at 8% here as well, so government spending's kind of out of control, that's putting a lot of upward pressure on inflation and they're just having to hike rates to control it.

Moz Afzal:
Does it look a bit like the UK going forward? Obviously, UK's also had the same issues, low productivity, big government spending, and the economy is just spluttering along rather ... Do you see that? So similar because Australia has always had a pretty high growth rate relative to Europe.

Martin Crabb:
Yeah. And we've had traditionally one and a half to 2% of labour productivity. It's just in the last decade or so that it's really fallen away. Now there are some idiosyncratic reasons around that, but we've also had a lot of growth coming from population growth. So we've had a big immigration policy. We had over a million people a year coming into the country. There's only 25 million people living here, so that's 4% growth in population. So we've had some of the inflation caused by that, because obviously we're not building enough houses for those people, so that's pushing up house prices. Again, I see similar things in the UK as well. And so the government's responding by limiting an immigration student numbers. So it's trying to pull back on that demand, but I still think without that labour productivity piece, it is pretty hard to grow your economy without having inflation. So the parallels are definitely there.

Moz Afzal:
And in terms of the housing in particular, given that population growth, have they deregulated in any way to allow home building and easier? I was in Brisbane yesterday, presumably less because of the Olympics more than anything else, but have they eased up a bit to allow that or is policy actually reasonably good from that perspective?

Martin Crabb:
Yeah, so I think there's been a lot of effort by government at all levels to release more land, to reduce red tape, to make planning easier and height limits and building on top of station, retro station things. So there's been a lot of that. I think the issue's been, there's been massive inflation in building costs as well. So it's not just a whole bunch of people have come to the country, there's nowhere for them to live, so they're crowding into the market and pushing prices up. It's not just that. During Covid in particular, building costs went through the roof. So in 2019, it cost about a dollar a brick to lay a brick. It's now $1.42. So even in a couple of years, we've had 40, 50% inflation just in something as simple as laying a brick. So that's caused a lot of the problem as well. It's actually really expensive to build houses. So even if you make it easier from a planning perspective, which they've done, they've also made it easier first home buyers so that the government's guaranteeing your deposits and you now only have to put 5% deposit down instead of 10. So they've definitely eased up the demand to make affordability easier, but it hasn't really changed the fundamentals. It's very, very expensive to build a house, and that's keeping up with pressure on existing property prices as well.

Moz Afzal:
So moving then on to that rate expectations, your sense that where does the terminal rate at the top end? Have you got any thoughts around that?

Martin Crabb:
Yeah, it feels like 4.1 where the market's oscillating around when we've had ... And again, what happens in the Middle East seems to move the futures curve on interest rates around by 25 points a day because it's troops on the ground, it's higher, it's a ceasefire, it's lower, it's almost like binary. The neutral rate, there's always debate about where that is, that's probably closer to three. So that would be up to 1% restrictive, which is probably about as far as they want to go. And they'd want to then see domestic demand really start to fall, and then they can take the brakes off. I think if you go out more than 18 months, it does seem to be some tapering off of that futures curve, suggesting that they hike and then maybe they cut. So they hike, they get the result they want, the economy slows, and then they can move back down towards three, three and a half again.

Moz Afzal:
Yeah. Well, absolutely makes a lot of sense. What does the currency do in that scenario?

Martin Crabb:
Yeah, well, obviously we're looking at this compared to something, so the US dollar. So the US obviously printing cash like there's no tomorrow and potentially the Fed easing, although again, the narrative on that has changed. We've traditionally had higher rates than global markets to attract capital because we've been running big current account and capital account deficits. We don't do that anymore. We've probably got current account surpluses because of all the exporting to Asia and China of fuel and materials. So we probably don't need to have that high an interest rate, but at the moment we're looking to having cash rates in Australia, probably one to 1.5% above the US, for example. That should push the Aussie dollar up all other things being equal because obviously there's a risk on risk off characteristics to these. But assuming some normalisation of the Middle East, for example, we expect that interest rate differential will attract more capital to the Aussie and you'll see it push higher. So we are advocating for Aussie-based clients to hedge their global exposure because we can see that whatever returns they make on their global equities will be eroded by the higher currency.

Moz Afzal:
So moving then on to the stock market, ASX has obviously been great over the last 12, 18 months, obviously had a bit of a correction now. What's your thought process around it?

Martin Crabb:
Yeah, the Aussie market's a little bit different to other markets around the world. It's really three groups. You've got the banks, the domestic banks, they make up about 25% of the market. You've then got the mining sector, which makes up another 25%, which again is very cyclical, but that's enjoyed some pretty strong commodity prices. Gold in particular, to a lesser extent, copper and iron ore have been pretty good. And then everything else, which is a grab bag of some domestic and international businesses. And the outlook for those three is probably all completely different. The domestic banks, most expensive banks in the world, I can't really see them performing from here, to be honest. The miners are mostly iron ore, and that's linked to China, which is slowing. So again, it's difficult to see a lot of growth there.

I think copper will be good, gold will be good, but that's really not going to turn the dial. And then you're looking at everything else and that really becomes a bit of a stock pickers market. There are some really good businesses in there. Like everyone else in the world, our software sector's been really hammered, our healthcare sector's been really hammered, so there's some really good opportunities there, but because half the market's probably got limited growth, the other half has to do quite a lot of heavy lifting. So what we advocate is you use the Aussie market for income and then looking elsewhere for growth. So we'll partner with groups such as yourselves, Moz, to find strategies to deliver that growth because there's really not a lot in the Aussie market.

Moz Afzal:
We touched upon it a little bit in terms of software and AI. What is the state of AI in Australia?

Martin Crabb:
It's interesting. The government's obviously very keen to encourage it and they've set aside, I think, four to 500 million in grants, mostly for upskilling. I think one of the concerns a lot of governments have is that if people get dislocated, if they're in an industry that gets impacted by AI, what do those people do? So everyone's talking about coders. You come out and you know how to code. Well, sorry, there's not a lot of future for you. It's like being a crofter back in the or a weaver. So how do we reskill? So a lot of the money the government set aside is for that. There is a very active build out of data centres. I think there's something like four to five gigawatts of data centres being built at the moment. And I think that the US is like 15, so it's a big number.

There's a very big build out, and there's a couple of companies that are on the ASX that have done particularly well in that space. So I think there's definitely, I think there doesn't seem to be in Australia, more of a coordinated national like there is in China or like they're in the US where the government's championing things and they're trying to encourage big scale CapEx. That's not happening. The government's sort of sitting there in the background saying, "Look, we'll support you, but we want to let industry take the lead rather than spending a lot of money to make it happen."

Moz Afzal:
So Australia has been one of those countries that's limited, for example, social media. Has that had any blowback? Has there been any concern about that? Obviously, probably decent for society, and certainly outside of Australia, there's been a lot of noise about it as a bit of a place to watch.

Martin Crabb:
So I'm very surprised how well it's been adopted and how little pushback there is. Maybe 13, 14-year-old kids are furious, but I don't see them marching in the streets, you know what I mean? So I think it's been relatively well-adopted. And I think as you point out, other countries are looking at it going, "Was a bit of a social experiment here. Is it having an impact?" Now, I don't know how you measure it. Hopefully there is a lot less bullying going on. There's less of that. Nefarious activity that happens when everyone's on their phone. So I haven't seen ... But yeah, from a man on the street perspective, it seems to be really well taken and most people are supportive of it.

Moz Afzal:
Yeah. Well, certainly it's been cases recently before Meta and Google who've been hit by lawsuits and actually have lost more recently and that certainly had took a chunk out of those stocks over the last few days. There's certainly something that I think is actually well worth watching, not just from an Australia perspective, Australia having an influence everywhere else and what that means to those habits and how those companies are going to deal with it. So it certainly is a particularly interesting case study. In terms of then wrapping up in terms of the Australia outlook, on a say five-year, 10-year view, what are you telling your clients about Australia? What are you talking about in terms of the best investment opportunities rather than just a one-year to two-year, but five or 10 years?

Martin Crabb:
Yeah, I mean, it's still a fantastic outlook. It is a country where a lot of people want to come and live, so it always has this capacity to dial up its immigration if it wants to. So it's never really going to slow down. In fact, infamously, or famously, it's never had a recession since the 1990s, even including the GFC where everyone else got, because it's got that capacity just to got to that one to 2% population growth. Productivity has been a problem more recently, but over a longer period of time, that's been pretty solid. And then you've got a bit of inflation. So you're looking at 5% nominal growth forever, which is great. And the country is very underdeveloped from an infrastructure perspective. There is a big Australia policy that looks at 50, 60, 70 million people living here. So you run the numbers on that and there's a massive runway for infrastructure, whether that's rail systems or road systems or schools, hospitals. So there's a big longer term urban thematic about taking some of the spaces in this country. You've just flown around it. It's like six hours in a plane from one side of the country to another. Absolutely. It's like going across Europe. So there's a lot of space. And so you go longer term, we're on the footstep of the fastest growing region in the world, which is Southeast Asia.

There's very strong linkages because a lot of people come here and study and then go back. So half of the cabinet in Colombo, for example, went to university in Sydney and Melbourne. So there's all these great linkages. So I think net positive, we are endowed with incredible natural resources and that's a little bit of the living off the sheep's back and all that sort of stuff. But we feed a lot of people in the world. We heat a lot of people in the world because we've got these great natural resources and obviously iron ore and things like that. So it's sort of got that side to things, but it's also developing more of a knowledge economy. So the education sector here is really coming along, the healthcare. We have some great world-class companies, so we're developing more creativity. So you mix all that together, great place to visit, great tourist destination, beautiful country, fresh air or good rule of law, et cetera.

So it's got a whole lot of little things going for it. So I think the outlook medium to longer term is very positive. And I'm biassed because I live here, but you travel here enough to know that what I state is true. So I think it's difficult to point to an industry and go, well, Australia does that really, really well. They're going to dominate the world. It's just a whole lot of little things, but I think collectively they paint a pretty positive picture on the outlook.

Moz Afzal:
And also something that doesn't get enough attention is actually if you've got the super funds, hugely endowed providers of capital to fund it. So I think that's also the thing that sometimes people forget from a long-term planning perspective.

Martin Crabb:
Yeah. So there's 12% of the national wage or 12.5% of the national wage gets paid into long-term savings account, which you can't access now. Now the retirement release age is 67 and that's being increased to 70. That's at four and a half trillion dollars at the moment, and that's growing at sort of five to 10% a year. Even with 11% of national income is actually money coming out of those super funds now being paid in pensions. That's a massive number for 26 million people. So we're a very wealthy nation on that basis and a lot of it's housing, but a lot of it's also that superannuation. So you're right, we're exporting financial services through that superannuation pool as well.

Moz Afzal:
Yeah. Well, Martin, on that very upbeat note, thank you very much for joining the podcast. It was great to be here. Well, that wraps us up for today. Thank you for listening to Beyond the Benchmark, and we'll speak to you again next time.

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