Hold onto your hats in FY25, says Emanuel Datt

There’s a good chance Australia will slip into recession at some point in the next financial year. That’s the broad macro perspective shared by Datt Capital’s Principal and Portfolio Manager Emanuel Datt in a recent investor webinar.

His sobering outlook also includes declining household sentiment, as cost of living pressures driven by elevated inflation place continued pressure on expenditure.

“Inflation is remaining stubbornly above the RBA’s target range…at just over 3.5% annualised,” Datt said.

“I don’t expect to see any material changes in interest rates over the next six months. I believe rates will hold steady in the short term, with the ultimate view that inflation appears to be trending down.”

He emphasises his view the Reserve Bank of Australia will maintain its “safety first” approach in neither lifting rates further nor rushing to cut them.

A couple of the anomalies Datt called out within this environment are the high taxation rates across the local economy and the persistently high levels of immigration.

"Taxation revenues have risen about 50% over the past four years, driven by increases in overall taxation at all levels of government," Datt says.

"This is a real surprise to me. We often like to joke amongst ourselves that the government likes to take a lot of tax out of people's pockets. But this is really an example of that."

“Immigration is currently holding up the Australian economy…whilst it is easing labour shortages, it’s definitely increasing cost of living and inflationary pressures overall, given this represents half a million people that require the very essentials of life – roof over their heads, food to eat and jobs,” Datt said.

At the same time, he refers to “an incredible state of affairs” with our low unemployment rate persisting since late 2021.

“We’ve been through a long period of full employment that has really led to significant labour shortages. Going back to that immigration point, immigration is required to support higher labour availability over time.”

He believes this is something that will benefit the economy over the medium term.

Household savings depleted

But coming back to his earlier point about households, Datt notes the household savings ratio is currently “plumbing new depths” hitting lows not seen since March 2008. This occurred in a macro environment that is a stark contrast to the current one, where unemployment then hovered around 6%.

“To see the average household is running such a tight savings ratio, despite full employment and very strong asset values mostly across the board, is very unusual,” Datt said.

“I believe it’s quite likely, in the upcoming financial year, that Australia will experience a recession and a weaker economic environment.”

“I think the government has to tread a fine line between being too overzealous and being responsible and prudent in their expectations.”

What does this mean for investors?

In fixed income, Datt sees the next financial year as a period of “elevated risk where perhaps the risk of an asset valuation coming in significantly lower, which may put the security of certain fixed income assets at risk for the next financial year.”

Looking across real assets, Datt’s views are:

Office: “I believe is likely to remain very soft. There’s a huge ample supply of office stock and a lack of demand,” Datt said. He points to the example of Melbourne’s CBD, where the A-grade commercial office sector remains “very tenant-friendly”

Industrial – “Very popular for last 4 years, driven by the shift toward online businesses, requiring industrial space and warehouses, which has compressed cap rates lower than we’ve traditionally seen. I think industrial properties will be flat…we believe there will be slower economic conditions in the financial year ahead.”

Residential – While he believes the residential sector will remain “firm,” in large part because of immigration, he notes the large disparity between individual markets and types of residential makes it difficult to make a broad call.

Higher payouts ahead

In Australian equities, Datt believes the large-cap market segment will deliver flatter returns in the coming 12 months than we saw in the prior period. “But I expect certain stocks may have stronger income return profiles,” he says. Datt explains this view is because the normalisation of interest rates will reduce the incentive for companies to invest capital in growing their businesses, which will, in many cases, opt to return capital to shareholders instead. “I expect to see that become more prevalent in the new financial year,” Datt said.

Datt believes small-cap companies will be relatively more resilient, with a lot of the growth here to be driven by M&A and consolidation activity.

“This is driven by the value differential between small cap public equities and privately backed companies in similar verticals. I believe this will continue into FY25 and that the small cap universe is intriguing and full of great stories where alpha could be captured in the year ahead,” Datt said.

At a sector level, he anticipates softer returns from the so-called “bond proxies” of listed real estate, infrastructure and bulk commodities – including iron ore and coal

His preferences for share price growth are among companies in the Technology and Financials sectors, alongside what he terms “niche commodities.”

Datt concluded by saying, “We believe the economic and market outlook for the 2025 financial year is highly uncertain”

“Traditional safe-haven assets are unlikely to provide the level of certainty of the past,” he said, while seeing “strong return potential from small-caps…and the ability to grow in idiosyncratic manner.”