Global equity markets had a strong start to the year, with the ASX 200 rallying 6.23% in January, its best start in over 3 decades. The strength in the ASX 200 was broad-based with all sectors (except Utilities) contributing to a positive performance. The cyclical sectors of Consumer Discretionary, Materials and Real Estate led the ASX 200 higher.
At a portfolio level, BHP, Macquarie Group, and Northern Star were notable strong performing stocks. Whereas the defensive stocks of Spark NZ, Amcor, and Brambles weighed negatively on performance, ironically some of the best performing stocks in the portfolio in 2022.
The start of 2023 has been markedly different to 2022 where risk assets were progressively priced lower by the weight of inflation, the unprecedented rise in interest rates and a Chinese economy closed by Covid.
The pick-up in risk appetite has been particularly expeditious driven by an improvement in global macroeconomic data that has eased financial conditions with expectations of peak inflation, and a slower pace of interest rate rises. Moreover, the dramatic change in the mood of the markets has been further supported by a surprising Covid U-turn by Chinese policy makers to reopen their economy to the world, a pivotal driver for higher commodity prices. Significantly, the resilience in consumer and employment data combined with China’s reopening suggests that the Australian economy will continue to grow this year, providing the foundation for corporate earnings to also expand (albeit at more moderate levels).
Nonetheless, the rapid rise in risk assets at the start of 2023 has largely priced in a goldilocks scenario (not too hot, not too cold) whereby central banks successfully navigate a ‘soft’ landing for the global economy avoiding a serious global recession.
As such much of the good news, reflecting a more stable and benign outlook, is largely priced into equity market valuations. In fact, valuations now sit comfortably above their long- term historical average. The ASX 200 Index is trading on a 12 month forward Price Earnings Ratio (PE) of ~15.5 times, well above its recent low point of ~12 times in June 2022, and above its 30-year average of ~14 times. This is at a time when the cost of capital (higher interest rates) is still rising and corporate earnings revisions are negative, highlighting further pressure on the outlook for corporate earnings. We expect that in 2023 that the absolute level of interest rates will progressively weigh on equity market valuations.