Tracey McNaughton
Australia’s biggest long-term economic challenge may not be inflation, but productivity. While recent debate has focused on AI, housing, superannuation, infrastructure and tax, each issue ultimately comes back to the same question: where will capital be invested, and will it make Australia more productive?
AI is expensive, but not necessarily a bubble
When we think about bubbles, we tend to think about periods like the dot-com boom or Japanese equities in the late 1980s, where prices became completely detached from economic reality. At the peak the Nikkei was trading at 60 times earnings. That’s not where we are today. The US equity market is trading on 25 times earnings.
This is a technology revolution that spills over into many industries. It has many layers to it. What is good about it is the centre of gravity keeps shifting.
Two years ago the market was almost entirely focused on the AI model builders and the hyperscalers. Then it moved to semiconductors. More recently we’ve seen leadership broaden into memory, networking, power infrastructure, electrical equipment, data centres and even utilities.
As each part of the AI value chain becomes fully valued, the market has tended to rotate towards the next bottleneck rather than simply pushing the same group of stocks ever higher. In that sense, it’s almost been self-correcting. Leadership broadens rather than simply becoming more expensive.
Consider what happened to tech stocks in the second quarter. Relatively unknown memory stocks like SK Hynix in Korea surged over 200% in the quarter while Microsoft rose just 1% in the quarter. This rotation is keeping valuations in check. The forward price-to-earnings multiple for Microsoft is around 25 times. Even Nvidia, the poster child for AI, is trading on 23 times earnings. That’s certainly not cheap, but it’s also a long way from the valuation excesses we saw during the dot-com era.
So, I don’t think we’re in a classic valuation bubble. I think we’re in a market with very high expectations – and that’s a different risk altogether.
Does this reflect a market maturity issue?
Growth is no longer the binding constraint. Inflation is, and because inflation determines what central banks do, it increasingly determines what value investors place on future earnings.
The higher interest rates are, the less value is placed on future earnings. So even though we are likely to see some pretty extraordinary earnings from may US companies this reporting season, we may see a more muted response to them by the market.
How it’s shaping the battle for capital
The Prime Minister made an important observation when he said Australia shouldn’t simply become a data warehouse for somebody else’s AI.
It’s not enough to attract investment. The investment also needs to leave Australia better off. That’s why the Government is proposing that large AI data centres contribute to the electricity system they rely on, create lasting employment opportunities and ensure Australian copyright holders share in the value created by AI.
Conceptually, I think that’s exactly the right objective. It is aligning who pays, who benefits and who bears the costs. But there is a balancing act. Every additional requirement also changes the economics of investing in Australia. Private capital is incredibly mobile.
Ultimately, that capital will flow towards the jurisdictions offering the best return for the risk. So, I think the challenge for governments is becoming increasingly clear. How do you make sure Australians share in the benefits of AI without making Australia a less attractive place to invest?
Super as a national asset to fund Australia’s future
Superannuation doesn’t belong to governments. It belongs to members. Trustees have one overriding obligation – to invest in the best interests of those members. I don’t think those two positions are incompatible. In fact, the ideal outcome is where they’re perfectly aligned.
If investing in Australian infrastructure, energy, AI or housing delivers the best long-term risk-adjusted returns for members, then everybody wins. Members receive better retirement outcomes. Australia builds the infrastructure it needs. Governments achieve their policy objectives. That’s alignment.
The challenge is making sure governments create investment opportunities attractive enough that super funds choose Australia because the economics stack up – not because they’re asked to.
The influence of taxation
One of the things economists often say is that every tax system creates incentives. And whenever incentives change, capital follows.
For almost thirty years, Australia’s tax system has strongly rewarded capital growth, shaping behaviour across investment property, shares, venture capital and private equity. The Budget changes that equation.
I don’t think growth investing suddenly becomes unattractive – great businesses will always create wealth. But I do think the relative attractiveness of different types of investments changes. Superannuation becomes relatively more attractive for example.
The question around housing
If the after-tax return becomes less attractive, some investors may simply decide not to buy the next property. Who replaces them? Owner-occupiers don’t necessarily value investment properties in the same way investors do.
It’s the marginal buyer who ultimately determines price. Prices may need to adjust down until a new marginal buyer emerges – until the market clears. So prices fall.
What does this mean for productivity?
If Australia wants more investment in housing, AI, infrastructure and innovative businesses, then our policy settings need to encourage that investment.
Ultimately, productivity isn’t just determined by technology, It’s determined by where a nation’s savings are invested. Perhaps that’s the question we should ask of every major policy reform:
Does it encourage more productive investment into Australia… or less? Because in the end, that’s what will determine not just the returns investors earn, but the kind of economy Australia builds over the next decade.
If Australia can get productivity working for it and create the right incentives for private capital to invest in productivity-enhancing projects, then perhaps the narrative shifts again.
Instead of asking whether inflation will keep interest rates higher for longer, investors can start asking where the next phase of sustainable growth will come from.
By Tracey McNaughton, CIO
