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  • Writer's pictureMarcus Bogdan

Investor Update - July 2023

The ASX 200 rose by 2.9% in July, supported by the belief that central banks are now close to the end of the interest rate tightening cycle thus avoiding a hard landing for the global economy.

With interest rates at a two-decade high there was warranted concern that a broad- based contraction was inevitable. We believed that the cumulative effect of multiple rate rises would have had a deleterious impact on the economy and equity market valuations.

Our proposition was that in an environment where interest rates moved from virtually zero to be up over 400 basis points in 14 months, corporate balance sheets and earnings would be strained.

As such we prepared the portfolio to have more defensive characteristics, to be overweight in Consumer Staples, Healthcare, and the Telecommunication sectors.

Instead, what has transpired has been a more benign outcome where the economy has remained resilient, supported by strong employment and high migration levels. At the same time inflation has peaked and now is in an orderly decline, suggesting that monetary policy could achieve a goldilocks (soft) landing for the economy.

Under this backdrop, cyclical Industrials and Information Technology companies have been strong outperformers relative to Quality and Defensive companies. Moreover, the July bounce in the ASX 200 has now pushed valuations above average, with the price earnings ratio trading on >15 times for the 12 months to December 2023.

Nevertheless, we remain cautious heading into the upcoming FY23 earnings season. Recent company announcements and an increase in negative earnings revisions suggests Australian companies have begun to experience a slowdown, as higher interest rates and cost of living pressures weigh on the consumer.

We expect a moderate downturn in corporate profits, with bottom-up expectations for the ASX 200 EPS forecasting a low single digit contraction for the 12 months to December 2023.

At a portfolio level, Industrials, Banks, and Energy sectors led by Cleanaway Waste Management, National Australia Bank, and Woodside Energy were strong performing stocks. Notably, the major banks (+6.6%) outperformed the broader equity market (+2.9%) following the RBA’s decision to hold the cash rate steady. Whereas CSL, Woolworths, and Northern Star weighed negatively on performance. Overall, the Healthcare sector was the weakest sector for the second month in a row, weighed down by CSL (-3.2%) where the pace of recovery post-COVID is slower than expected. While the Healthcare sector has lagged materially over the last 6 months, we do expect a strong recovery in earnings over FY24-25.

In an environment where corporate profits are expected to slow, we remain defensively positioned in the key sectors of defensive industrials (consumer staples, telecommunications) and Healthcare, which should offer greater earnings resilience.


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