Investor Update - July 2022
“A peak in inflation is one the typical drivers of a bear market trough, a perception that the rate of deterioration in economic growth has peaked is also important as is cheap valuations and it seems premature to expect this as yet.”
Chief Equity Strategist
A swashbuckling recovery in July saw the ASX 200 rise 5.8%, with Banks, Technology and Real Estate sectors benefiting from lower bond yields. On the other hand, concerns over China’s economy weighed on commodity prices with Materials the only detractor for the month.
Nevertheless, equity markets proved remarkably resilient in the face of deteriorating economic data with rising inflation and the United States GDP declining for a second consecutive quarter suggesting that the economy is showing the febrile signs of ‘stagflation’. Offsetting this pessimism was a better-than-expected second quarter results season for the S&P 500 where earnings are on track to deliver ~9% year-on—year growth and the expectation that US rate rises are closer to peaking.
However, we believe it is still too early to remove the guardrails as the fundamental imbalances impacting the global economy remain prevalent. With this mind, we further tilted the portfolios toward defensively exposed companies.
The speed and magnitude by central banks, including the RBA, to tighten monetary policy has had a deleterious effect on cooling the housing market. National house prices fell 1.4% in July, registering the third consecutive month of declines. Over the past decade there has been a strong correlation between bank share prices and the direction of Australian housing values. We have reduced our weighting to the banks as we expect housing credit growth to moderate as house prices decline and auction clearance rates fall.
We prefer the outlook for telecommunications as rising interest rates slow the economy and inflation. An improved industry structure in Australia has seen Telstra and Optus announce matching price rises of ~5% during July, with Telstra indexing prices to inflation amid continuing strong demand for mobile data services. Moreover, the announced monetisation of both Telstra’s and Spark NZ’s mobile tower assets provides the optionality for capital management initiatives.
As we commence the FY22 reporting season we will be monitoring several key data points, namely:
Is there evidence of demand slowing and are underlying earnings moderating?
How are companies managing with higher cost inflation, are they still able to pass-through higher costs to the end consumer? Margin performance compared to 1H22.
Changes in working capital ratios, inventory levels, & cash conversion.
Are banks benefiting from an improvement in NIM from higher rates vs slowdown in mortgage lending?
Commodity stocks challenges on production and costs, view on capital expenditure & capital management.
Outlook & guidance statements – visibility of earnings and confidence to provide guidance.