The ASX 200 fell -3.21% in December, as central banks remained determined to further tighten financial conditions by pushing official interest rates higher.
The path of higher interest rates has had a deleterious impact on equity valuations throughout 2022 and was common theme for global equity markets over the year. The combined impact of persistently high inflation and the rise in bond yields provided a major headwind for price–earnings ratios (PE) and the decline was most prominently felt in the cyclical and technology stocks that are acutely sensitive to rising rates.
At a portfolio level, Spark NZ, BHP (Concentrated Fund), Northern Star (Blended & Income Funds), and Integral Diagnostics were notable strong performing stocks. Whereas Macquarie Group, Cleanaway Waste Management, Commonwealth Bank (Income Fund), and CSL (Blended & Income Fund) weighed negatively on performance.
With the prospect that interest rates will continue push higher in 2023 and at a time when earnings growth is set to moderate, we have reduced the portfolio’s exposure to higher PE stocks that offer only modest dividend yields. In December, we divested our position in Coles (Income Fund) and Wesfarmers (Blended Fund) both of which trade on a 12- month forward PE ratio of >20 times and a dividend yield below the market average. We used the proceeds of the Coles & Wesfarmers divestments to initiate a position in Metcash (MTS), a leading wholesale distribution company with operations across food, liquor, and hardware. Metcash’s most recent 1HFY23 was encouraging with sales growth of 8% and EBIT growth of 10%. Metcash’s growth relative to the market combined with its PE ratio of ~13.5x and dividend yield of ~5.3% provided an attractive entry point.
We are cognisant that tighter financial conditions (a higher cost of capital) for Australian corporates will place a burden on earnings momentum and margins in 2023. With this in mind, valuations and balance sheet strength will remain in focus. Our portfolios are balanced across defensive industrials, value sectors, and companies providing dividend yields above the market average.
