We expect earnings risk to remain on the downside in the short to medium term as economic activity softens. Beyond the short-term uncertainty, we believe five reasons reveal the Australian market offers opportunities for investors looking for steady dividend yields and long-term growth potential.

1. Stake in China's recovery and potential

Where there's China, there's Australia. Despite past political skirmishes between the two, Australia remains closely hitched to its largest trading partner. Its rich natural resources, including minerals like iron ore, coal, gold, and various metals, will continue to be in demand as China strives towards greater economic heights. Notably, China's current recovery has been slower than expected amid domestic challenges like an ailing property sector, which has weakened demand for commodities. But the recent Politburo meeting signaled a pro-growth shift in policy tone to boost domestic demand. The government has also pledged to improve the business environment for private enterprises and the platform economy, boost capital markets, and increase investor confidence.

How this will be done over the coming months remains to be seen. Any ensuing support for the Chinese economy could lift consumer sentiment and release huge pent-up savings, which will convert into a renewed demand cycle (see Chart 1).

Source: Haver, Morgan Stanley Research, as of June 2023. Figures calculated as of three months moving average.

When that happens, demand for commodities will rise, creating multiplier effects through the entire supply chain. This, in turn, will benefit the mining and energy companies in Australia and the broader economy, providing some buffer against the weak macro backdrop.

Longer term, China is also a vast consumer market with a growing and increasing affluent middle class (see Chart 2). The premiumization of China's consumption will also play well for Australian sectors such as agriculture and healthcare. China also dominates the clean tech ecosystem – producing 90% of global solar production capacity and 75% of battery capacity.

Source: Haver, abrdn, as of August 2023.

And more than half of the electric cars on roads worldwide are now in China and the country has already exceeded its 2025 target for new energy vehicle sales.¹

2. Opportunity in the green transition

The Australian government has termed this decade as a defining moment in terms of how the resource-rich economy manages a smooth switch to cleaner, cheaper, and more reliable energy and positions itself as one of the leading players in the green transition.

Source: OpenNEM, August 2023.

The stakes are high. If the economy reaches net-zero emissions by 2050, GDP could increase by A$890 billion over the next 50 years, according to Deloitte Access Economics modelling for the Business Council of Australia, which would result from higher productivity levels and 195,000 additional jobs.² At the same time, the capital expenditure (CapEx) burden is heavy, too. The country would need around A$625 billion to decarbonize its industry and energy system by 2050, comprising A$400 billion of investment and a further estimated A$225 billion of transition CapEx.³

The government has already made a head-start with various green initiatives in the 2023-2024 Federal Budget in May. It is allocating A$2 billion to ramp up large-scale renewable hydrogen projects. Another A$1.3 billion has been set aside to improve household energy efficiency through areas such as double glazing and battery-ready solar systems, with a similar amount targeted at reducing industrial emissions.⁴

Source: IEA, Macquarie Research, May 2023.

3. Well-regulated and capitalized financial pillars

Australia's banking sector is well regulated and well capitalized, with strong capital positions, solid liquidity levels, and diversified funding mixes. This position of strength has enabled the banks to absorb some COVID shocks during the pandemic, with the regulator allowing them to draw on their buffers. The current times present a different challenge of more expensive and constrained funding in a rising rate environment.

4. Industry leaders with growth runways

Although the domestic market is weighted heavily towards financials and materials, such as banks and miners, it is also home to companies with strong market positions in other sectors that are well placed to capitalize on the structural growth trends of the global economy.

• The healthcare sector is a potential opportunity for compounding returns, given ageing populations and increasing demand for medical services.
• The technology sector has been growing fast, supported by contributions from both start-ups and established companies, and with increased adoption of cloud-based solutions, is now transforming itself into a global software leader through rapid overseas expansion.
• Australia has also seen strong domestic plays in telecommunications and retailers, particularly supermarket grocers.

5. Strong dividend yield potential

Investors on the hunt for income have always looked to Australia, where the stock market has historically offered attractive dividends. In an environment of rising consumer price pressures, looking for companies that grow dividends is also a good way to stay ahead of inflation. Many Australian companies have a good track record of payouts, with dividend payments from ASX-listed companies high by international standards.⁵ This is partly due to a system of dividend imputation (franking credits) that began in July 1987. Previously, earnings were taxed at the company rate and personal tax rate for shareholders. Dividend imputation means company profits paid to shareholders are taxed only once.

Source: S&P Dow Jones Indices LLC, as of December 2022. Dividends are calculated before imputation.

Final thoughts

Australian equities offer a combination of both potential growth and income, given the country's abundant resources that ride on China's structural growth and the green transition. And while the backdrop remains volatile over the short term, we believe there is a strong regulatory environment underpinning the financial system. The domestic market is home to quality companies with strong market positions in other sectors that are well placed to capitalize on the structural growth trends of the global economy.

¹ Global EV Outlook 2023, Catching up with climate ambitions, April 2023, International Energy Agency
² Energy transition absolutely central to growth: Chalmers, 24 March 2023, Australian Financial Review.
³ ClimateWorkds, Ibid.
⁴ Australia & NZ Research, 10 May 2023, Macquarie Research.
⁵ Analysing Higi Dividend Yield Strategies in Australia, 10 Feb 2023, S&P Dow Jones Indices.

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