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‘Interest rates could be raised quickly’: Looking at the Australian share market in 2022 - Part 3

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As the road to COVID recovery for Australia appeared rocky on the back of rolling Delta variant lockdowns, and some commentators predict the post-2020 earnings rebound has reached its peak, what does 2022 hold in store for the Australian share market?

We spoke to some of the top portfolio managers, economists and chief officers in Australia to get their take on what’s in store for the next 12 months: the outlook, the challenges, and most importantly, the opportunities.

Simon Brown, portfolio manager, Tribeca Investment Partners

In your opinion, what does the Australian share market look like in 2022?

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In terms of framing the outlook, it is important to consider where we’ve come from. Markets have emerged strongly from the COVID-19 induced shock, with the assistance of extreme monetary and fiscal policy. As economies around the world reopen, consumer balance sheets are as healthy as they’ve been for some time, while financing remains very accommodative. We think this will be supportive for consumption, a key driver of economic growth. However, through 2022, we will have to cycle over a period of extreme government stimulus and central bank liquidity and, as such, growth and share market gains are likely to be more muted than they’ve been recently. I should add, the smaller cap part of the market is quite dynamic, with new industries and business models always evolving. Historically this has provided opportunities for strong gains even in mediocre markets.

What are the main volatility risks on the horizon? 

Nobody thinks interest rates are going up ever again so should they do so (or at least more than the market expects), this could impact growth. Policies seeking to address climate change have the potential to be very inflationary, while supply chain shocks from the pandemic may also add additional and more permanent costs. Nobody really knows the level of tolerance for inflation at central banks. Additional strains of the virus should not be completely discounted, should new vaccines not be able to respond in time. Also, China’s property woes have been garnering recent attention, however the central authority has a habit of letting these situations ride to the brink before stepping in.

What sectors and companies will do well in the next 12 months and why?

We have seen new energy advocates for several years now and while recent strong gains have brought the sector into the spotlight, we think the opportunity is so big it will endure for a while yet. We think Independence Group and emerging copper player Aeris Resources represent good value. As seen in other markets that have reopened abroad, the shift in consumer spend towards services has been powerful, just as we saw with durables consumption during the lockdowns. In this space, we like Tyro and oOh!media. As always in small caps, there are companies forging their own path and leveraging their IP to grow revenue into new areas. We think that Life360 and PWR Holdings will continue to do well.

What are the biggest opportunities for companies in the next 12 months?  

We think that the re-emergence from the pandemic is one of the biggest opportunities over the next 12 months. Human nature suggests demand for experiences will re-emerge with a vengeance, while Australia’s enviable COVID record should ensure it’s at the front of the queue when borders open and vacation, international student and migration-led demand returns. We anticipate capital investment to be another theme over the next year, as supply chains are modified to become more agile and capacity improvements are made after years of underinvestment.

Max Cappetta, CEO and portfolio manager, Redpoint Investment Managements

In your opinion, what does the Australian share market look like in 2022?

Trading at a multiple of 18x Forward Earnings estimates the ASX 200 is priced at similar multiples to where it was at the end of 2019 (pre-COVID). Earnings estimates for 2022 are slightly higher than at the end of 2019 and share prices are also slightly higher  after a tumultuous two years.

The rise in earnings estimates in 2021 has come disproportionately from the mining sector. Notwithstanding the current retracement in the iron ore price, it is likely that 2022 will still see higher earnings from this sector relative to what they delivered in 2019.

Policy settings are set to remain favourable for the equity market. The RBA overnight cash rate remains at 0.1 per cent and this is likely to persist into 2022. Amazingly, the last time the cash rate was at 2 per cent was back in April 2016. The return of dividend payments in the recent reporting season will also attract income-hungry investors who remain devoid of income options from traditional sources such as cash and term deposits.

What are the main volatility risks on the horizon? 

While interest rates are lower today than in 2019, the focus in 2022 will be about the path to re-normalisation of policy settings. Reductions in monetary and fiscal stimuli will depend on the strength of the domestic and global recovery and whether inflationary pressures are transient or more permanent. Central banks (including Australia’s RBA) are currently indicating that they will retain a supportive low interest rate setting for longer to ensure that the economic recovery is well entrenched. Changes in monetary policy are expected to be well managed thanks to the independence of the RBA. Changes in fiscal policy may be more uncertain due to the fact that they are impacted by the political process. The US government’s debt ceiling problems are a key example of this at present.

Another risk is the rise of a vaccine resistant COVID strain causing renewed global lockdowns. 

Investors should be aware to expect some consolidation as prices have rallied strongly since March 2020, but the overall environment remains positive for equities. The average price to earnings multiple over the past decade has been approximately 15x which implies a 16 per cent possible retracement from the current level of 18x. A recent increase in market volatility may be an indicator of growing investor uncertainty which could lead to a further fall in prices. Notwithstanding the chance for this to occur, the environment remains positive for equities in the medium term.

What sectors and companies will do well in the next 12 months and why?

Higher interest rates (or expectations thereof) will favour “shorter duration” stocks. Low and falling interest rates have enabled less profitable companies to access capital for projects which are not expected to be profitable for many years. Companies able to grow existing earnings in the near term will be highly regarded  this is the “inflation hedge” that investors will value most if inflation is less transitory than expected. 

The search for income will favour stocks which can share profits via dividends while maintaining a growth trajectory at least in line with inflation  high cash yield with no growth will become a new “dividend trap” and should either be avoided or seen as short-term investments from an income capture perspective. Mining stocks will likely provide another solid earnings and dividend year in 2022 but investors need to be wary of their price volatility like we have seen over the past few months. This leads us to believe that an active approach is best suited to capturing a share of company profits paid as dividends.

Characteristics such as balance sheet strength and profitability are well placed to reassert themselves if the path to re-normalising policy settings becomes less certain or other risks emerge which reduce the risk appetite of investors.

What are the biggest opportunities for companies in the next 12 months?  

Ongoing acceleration in climate transition initiatives spurred by the COP26 summit. 

This summit will shine a light on a range of opportunities and investment requirements. Electrification of the grid including battery storage and electricity infrastructure and a ramp up in renewables to support the increased demand for electricity will be the first areas of focus. Frameworks to support investment, policy and technology in upcoming carbon solutions will also be critical. These include hydrogen and carbon capture.

Building economies of scale which enable profit growth remains attractive while capital (debt) remains cheap and freely available. This will be good for shareholders in those companies being taken over. As always investors should be wary of acquirers overpaying and being unable to secure sufficient cost synergies to warrant their investment.

Dougal Maple-Brown, head of Australian Equities, Maple-Brown Abbott

In your opinion, what does the Australian share market look like in 2022? 

The Australian share market had a phenomenal year in FY21 with very strong returns. By contrast, we expect the next 12 months to be challenging and returns to be modest. We view the market as fully priced, trading on around 20x earnings and an eye-watering more than 30x for industrials (excluding financials). Tech and healthcare names are trading at 40x or 50x. With the economy recovering from the pandemic, there is more uncertainty around those earnings, which are currently forecast to be 15 per cent higher than FY21. Also, the market will need to navigate a likely slow-down in China, QE tapering and the machinations surrounding the US debt ceiling.

What are the main volatility risks on the horizon? 

The greatest risks to equity markets have historically been a growth scare or an inflation scare, which are heightened when valuations are full. We are more worried about inflation. It can be transitory: take the strong increase in second-hand car prices, with supply constraints limiting new vehicle production. However, not all inflation appears transitory. Hard commodity prices have risen sharply and are trading above our long-term assumptions. Many companies we spoke to over the recent reporting season are concerned about a labour shortage. Such concerns often lead to wage growth. In addition, the world’s central banks (including the RBA) have said they won’t raise rates until inflation is within the desired range (as opposed to a forecast). In our view, this guarantees they will be behind the curve and interest rates could be raised quickly when the time comes.

What sectors and companies will do well in the next 12 months and why?

We like two sectors for the coming 12 months, namely banks and insurers. Both will benefit as interest rates rise. General insurers are in the enviable position of having revenue (premiums) growing while costs (claims) are falling in some major lines due to the east coast lockdowns (for example, less driving means less motor claims).

 

‘Interest rates could be raised quickly’: Looking at the Australian share market in 2022 - Part 3

As the road to COVID recovery for Australia appeared rocky on the back of rolling Delta variant lockdowns, and some commentators predict the post-2020 earnings rebound has reached its peak, what does 2022 hold in store for the Australian share market?

We spoke to some of the top portfolio managers, economists and chief officers in Australia to get their take on what’s in store for the next 12 months: the outlook, the challenges, and most importantly, the opportunities.

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Neil Griffiths

Neil Griffiths

Neil is the Deputy Editor of the wealth titles, including ifa and InvestorDaily. 

Neil is also the host of the ifa show podcast.

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