While share markets globally have largely shaken off higher interest rates, companies are showing relative immunity to higher credit costs, Zenith Investment Partners has said.
However, this could change if the world falls into a recession, according to Zenith head of portfolio solutions Steven Tang.
“So far, interest rate rises have had little impact on the economy and share markets, though they have impacted the bond market,” Mr Tang noted.
“Earnings and economies have been resilient, and we attribute this to a reduction in interest rate exposure across companies and households following the easy monetary policy we had for so long, which allowed many companies and households to lock in low rates on their debt.”
Higher interest rates, he warned, could eventually start to bite.
Namely, signs of stress are beginning to emerge via highly leveraged households and slowing Australian economic growth.
As such, Mr Tang projected: “We expect that winners and losers will emerge as share market volatility increases, creating opportunities for active stock selection.”
“We have therefore increased our exposure to quality focused equity fund managers,” he said, adding, “as a consequence, our portfolios are well-equipped to perform in a broad range of markets.”
Should the country enter a recessionary environment, Zenith expects higher quality companies to outperform.
While projecting a soft economic landing, Mr Tang conceded that a more pronounced recession is still a possibility, with Australian companies being more vulnerable than their US counterparts given higher inflation and a greater exposure to interest rates.
“Australia is more vulnerable to a recession, given the household sector is more leveraged and it has a higher exposure to variable interest rates. The central bank too has taken a more dovish approach to setting interest rates than in the US, where inflation has moderated more materially.”
With recent market weakness, Mr Tang further observed that some asset classes, which have previously been expensive, are now looking cheap. Global small caps were used as an example, which are priced for a more pessimistic outlook.
This, he said, is not in Zenith’s base case, noting that global small caps also look cheap relative to large caps.
“Similarly, valuations in some emerging markets are also looking more attractive as are interest rate sensitive sectors such as infrastructure.”
Ultimately, Mr Tang assured that there is ample opportunity to generate attractive returns above cash and other low-risk investments when adopting a diversified approach to equity investing.
“While corporate profits can be a casualty of higher interest rates, high-quality equities remain a must for diversification and as a hedge against inflation. We favour high-quality companies in a strong financial position where their debt is either longer dated or at comfortable levels.”
