Key Takeaways
- • Australia's unemployment rate rose to 4.7% in September, according to the Australian Bureau of Statistics, continuing a trend up from the low-4% range earlier in the year toward the 5% level the RBA is targeting.
- • Small caps have underperformed large caps significantly year to date, with Morningstar's Joel Grosvenor attributing the weakness to consumer-exposed segments struggling under cost-of-living pressures and higher interest rates.
- • Structural headwinds compound the cyclical slowdown: active small- and mid-cap managers are underperforming the index, several high-profile active funds have closed or closed to new products, and super funds are shifting toward passive and systematic strategies.
- • Private equity is stepping in to acquire small and mid-cap companies at valuations Grosvenor describes as attractive, with limited competing buyers willing to take those positions.
Summary
Australia's labour market is softening. The Australian Bureau of Statistics reported that the unemployment rate climbed to 4.7% in September, according to Morningstar's Joel Grosvenor, who said the rate has trended upward since the start of the year from the low fours toward the 5% the Reserve Bank of Australia is seeking. Interest rates remain elevated, and cost-of-living pressures and higher mortgage payments are weighing on household spending.
Grosvenor said the slowdown in economic growth is hitting consumer-exposed segments of the market hardest. Small caps have underperformed large caps significantly over the calendar year to date as a result, he said. He added that structural factors are also at work beyond the cyclical pressure.
Among those structural factors, Grosvenor pointed to persistent underperformance by active equity managers relative to the index. Small and mid-cap strategies have traditionally been where active managers seek to outperform the cap-weighted benchmark, but over the past year or two several high-profile names have closed products or shut down entirely, narrowing the set of managers able to participate in those segments. He also noted that superannuation funds have increasingly moved toward passive implementations or systematic active strategies, redirecting capital away from small and mid-cap exposure.
Grosvenor linked recent merger and acquisition activity to valuation dislocations. He said there is considerable discrepancy in the valuations applied to small and mid-cap stocks and that many look attractive. The issue, in his view, is who has the capital to act on those valuations. He said private equity is currently stepping in to take many of these companies private while few other buyers are willing to step up.
Grosvenor said the slowdown in economic growth is hitting consumer-exposed segments of the market hardest. Small caps have underperformed large caps significantly over the calendar year to date as a result, he said. He added that structural factors are also at work beyond the cyclical pressure.
Among those structural factors, Grosvenor pointed to persistent underperformance by active equity managers relative to the index. Small and mid-cap strategies have traditionally been where active managers seek to outperform the cap-weighted benchmark, but over the past year or two several high-profile names have closed products or shut down entirely, narrowing the set of managers able to participate in those segments. He also noted that superannuation funds have increasingly moved toward passive implementations or systematic active strategies, redirecting capital away from small and mid-cap exposure.
Grosvenor linked recent merger and acquisition activity to valuation dislocations. He said there is considerable discrepancy in the valuations applied to small and mid-cap stocks and that many look attractive. The issue, in his view, is who has the capital to act on those valuations. He said private equity is currently stepping in to take many of these companies private while few other buyers are willing to step up.
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