A dual-speed economy

• Struggling real estate and industrials may dent sectors sensitive to labour markets in the coming months.
• Sustained levels of inflation will continue to prop resources and energy company budgets.
• The separation in conditions between certain sectors of the economy may continue to widen into 2023.

A dual-speed economy

The economic outlook for the next 12 months will be centred around what investments can be made in an elevated interest rate environment and with sticky service sector inflation.

Some sectors like energy and materials will have already factored additional expansion plans into their budget and will provide an added draw on Australia’s already tight labour market with planning for the next 12 months of investment having factored in high prices for a basket of commodities.

Others, including real estate, construction, and industrials, may find their markets somewhat depleted by changes in the labour market pushing conservative corporate and government budgets. We may enter an economic cycle of austerity after several years of heavy spending and billowed money supply.

Real estate and industrials

Higher prices for resources and labour combined with an elevated and ratcheting higher interest rates environment, if eventuating, will weigh heavily on real estate and industrials.

Construction, as some of the largest employers in Australia, may potentially provide the push to a softer labour market that policymakers have long expected with their monetary policy actions.

Real estate continues to struggle under the double-edged sword of higher rates and COVID-19-induced shifts away from office leasing. S&P/ASX 200 Real Estate XRE:ASX (^AXRE) 1-year return is -21%.

Financials

Lower employment levels may start to weigh on the financials that have until now been supported by higher interest rate margins and low unemployment shielding their credit portfolios.

The S&P/ASX 200 Financials XFJ:ASX (^AXFJ) has trodden water for the last 12 months, down 3.9% on the year; softening in the labour markets and a moderated cadence in the rate-hike path will pressure financial stocks.

Consumer spending

Weakness in the largest components of the labour market will make it difficult for consumer discretionary to find a footing. Staples may fare slightly better, but under difficult circumstances.

Energy and materials

Energy and materials have kept the lights on in the Australian economy for the last 12 months. In the short term, the energy and materials sector will enjoy elevated levels of capital expenditure and expanded hiring.

Higher prices have provided multi-year runways to capital reinvestment, and record stockholder returns. A Federal Reserve, burdened by an enormous balance sheet and engorged money supply, is presented with limited options lest completely kneecapping a broad basket of asset valuations.

The result is more likely to be a gentler rate-hike path and an acceptance of higher inflation in the economy, providing a broader and longer tunnel for capital to pass to resource extractors and traders.

Others

Though never likely to blow the windows out regarding returns, healthcare and utilities may find inflows as traditional safe havens in regressive economic environments.

Technology stocks have suffered greatly over the last 12 months as the super-charged shift to digital, remote, and the associated marketing dollar dwindled post-pandemic. Increased costs of capital leave their nascent businesses less desirable relative to their risk profiles, further stifling stock valuations.

With artificial intelligence and machine learning advancements greatly accelerating, technology R&D will likely increase as companies are forced to adapt or die to this new paradigm, irrespective of economic conditions. A more stable interest rate environment would also favour growth sector valuations. For these reasons, technology may join the resource sectors as one of the big winners for 2023.