The Reserve Bank of Australia (RBA) has once again raised interest rates, increasing the official cash rate by 50 basis points to 1.85%, which was fully anticipated by the market. Despite the significant uncertainty that Nancy Pelosi has brought to the global markets, the Australian stock market, as measured by the ASX 200 index, quickly recovered from a decline of about 0.4% following the announcement of the rate hike, and at one point climbed directly above 7,000 points.
After the turbulence in the first half of the year, the ASX 200 index has been relatively strong since the start of the new fiscal year, showing a noticeable rebound. On the last trading day of July, the ASX 200 rose by 0.8% to 6,945.2, closing at a seven-week high, up about 7% from the low point in June. The technology sector, which was heavily sold off in the first half of the year, has also seen a strong rebound, increasing by more than 22% in just over a month.
However, the newly appointed Treasurer, Jim Chalmers, last week downgraded Australia's economic expectations. The Gross Domestic Product (GDP) for the fiscal year 2022 was reduced from the previous government's 4.25% before the May election to 3.75%; for the fiscal year 2023, it was lowered from 3.5% to 3%.
Moreover, the Treasury's highest inflation rate forecast is 7.5%, which is higher than the RBA's previous forecast of 7.0%.
At the same time, the latest data shows that Australian house prices are falling at the fastest rate since the 2008 financial crisis. Sydney house prices have fallen by 5.3% from their peak in less than four months; Melbourne has also seen a decline of 3.4%.
Interest rate hikes continue, economic expectations are downgraded, the real estate market is cooling rapidly, yet the stock market is experiencing a significant rebound. Why has this uncommon situation arisen?
Against this economic backdrop, a new earnings season has begun. This is the first earnings season of the current interest rate hike cycle, and it will obviously be quite different from last year's earnings season in terms of what to watch for.Which sectors and individual stocks are worth paying attention to? From the financial reports of ASX 200 companies, what trends can be observed to make a judgment about the overall macroeconomic trend from the small to the large?
Externally: The United States experiences a "technical recession"
In fact, the stock market rebound in July was led by the U.S. stock market. The main reasons behind this are, on one hand, not much significant macroeconomic events have occurred, and on the other hand, the Federal Reserve's stance after raising interest rates last week has made the market "emotionally optimistic."
Despite the fact that the Federal Reserve raised interest rates by another 75 basis points last week. Powell also declared in the statement that although there are signs of softening in the U.S. economy, the Federal Reserve is still committed to controlling inflation. However, he also revealed that "slowing the pace of interest rate hikes later this year may be appropriate."
As soon as the news came out, the U.S. stock market rebounded quickly. The S&P 500 index soared by 2.6%, and the Nasdaq index soared by 4.1%, setting the largest single-day increase in more than two years.
In fact, since mid-June, the S&P 500 index has risen by nearly 10%, and it is clear that investors are betting that as the U.S. economy softens, the Federal Reserve is getting closer to cutting interest rates by raising interest rates in advance.
Subsequently, the United States announced GDP data, with the second quarter GDP decreasing by 0.9% quarter-on-quarter, shrinking for two consecutive quarters, and the economy falling into a "technical recession." This has led more people in the market to believe that the Federal Reserve will slow down the pace of interest rate hikes.
Internally: The economic fundamentals reduce expectations for interest rate hikes
BMY Chief Investment Officer Wei Ruihao said that both the global economy and the Australian economy are now in a special period that has not been seen for decades. The pandemic and geopolitical conflicts have driven up inflation, leading to rapid interest rate hikes by central banks.The impact of previous interest rate hikes on the Australian economy has gradually become apparent. Since the Reserve Bank of Australia (RBA) started the rate-hiking cycle in May, Sydney's housing prices have fallen by 4.7%, and Melbourne's by 3.2%.
Considering that during the 2008 financial crisis, the median value of Australian real estate fell by 8.5% over 11 months, it can be said that the current rate is almost catching up to that of the financial crisis period.
However, Australia's economic fundamentals are clearly better than those of the United States. The recently announced second-quarter inflation rate (CPI) increased by 6.1% year-on-year, which, although the highest level since June 2001, is lower than the market's widely predicted range of 6.2-6.3%. Moreover, the second-quarter CPI increased by 1.8% quarter-on-quarter, lower than the first quarter's 2.1%, which also took the market by surprise.
Although the Treasurer's inflation expectations are higher than the RBA's, he also believes that global inflation will decrease next year due to the decline in gasoline and other commodity prices, as well as the alleviation of supply chain pressures, and that Australia's inflation may return to low levels by the end of the year.
In comments made on the day of the inflation release, Wei Ruihao pointed out that Australia's economic growth in the second quarter is likely to slow down. If GDP decreases as expected, it will inevitably slow down the RBA's rate-hiking pace.
Today (August 2), the RBA raised interest rates by 50 basis points, not 75, which is in line with this expectation. In fact, the market's expectation for the peak official interest rate has already dropped from 4.5% two months ago to 3%.
Some economists have also lowered their forecasts. HSBC believes that the cash rate may be raised to 2.6% by December; CBA has the same expected value but has pushed the timetable to the second half of 2023.
Westpac and ANZ both believe that the interest rate will eventually reach a peak of 3% in mid-2024. Westpac also stated that if the interest rate rises above 3%, Australia's GDP growth will slow down to around 1% next year.
Australian stock market performance in the 2022 fiscal year: only three sectors rose
The impact of interest rate hikes is also reflected in the Australian stock market, with the S&P/ASX 200 index falling by 10.2% over the 2022 fiscal year.In the 11 sector indices, apart from the public utilities, energy, and industrial sectors that achieved positive returns in the last fiscal year, the returns of the other sectors were all negative. The financial, basic materials, real estate, consumer discretionary, and technology sectors performed worse than the overall market. The technology sector, which was hit the hardest by interest rate hikes, saw a decline as high as 38.50%, far exceeding other industries.
Due to the high weight of the financial and materials sectors in the Australian stock market, accounting for nearly half of the total market capitalization, the fluctuations of these two sectors essentially determine the trend of the overall market. In the fiscal year of 2022, these two sectors fell by 10.43% and 10.53% respectively, which can be described as "hard times for both."
Although the outbreak of the Russia-Ukraine war led to an increase in commodity prices, which drove the overall upward movement of the materials sector, the expectation of a global economic slowdown in the last two months of the fiscal year of 2022 also dealt a heavy blow to this sector.
Driven by surging electricity and energy prices, the public utilities sector saw the largest increase, reaching 31.27%; the energy industry came in second, with an increase of over 20%.
Six Key Themes to Watch During the Earnings Season
However, in less than two months, the performance of the sectors has undergone significant changes. With the arrival of the earnings season and given the uncertainty of the economic outlook, as well as the differences among various sectors and companies, Wei Ruihao believes that investors should pay attention to the earnings season from both the macroeconomic and micro-enterprise levels.
Macroeconomic Level: Focus on the impact of inflation and interest rate hikes on different industries
Focus Point 1: Consumer Goods Industry
Many consumers have already felt the pressure of rising prices, with food prices increasing by more than 5% and energy prices reaching double-digit increases. Many people are also facing the situation where fixed housing loans will mature in the next 6 to 12 months and switch to higher interest rates.
The high level of consumer spending over the past two years is difficult to sustain. As international borders open and the service and entertainment industries return to normal, consumers have other outlets for their money, no longer just buying a TV or a sofa, especially as housing prices continue to fall rapidly.Despite the pandemic, companies such as JB Hi-Fi (ASX: JBH) and Harvey Norman (ASX: HVN) have maintained strong financial performance, but weakening consumer spending will inevitably put pressure on the future growth of these companies. In the essential consumer goods sector, the performance of giants like Coles (ASX: COL) and Woolworths (ASX: WOW) will also demonstrate the impact of price increases on consumption. There is no denying that potential opportunities may be found among them.
Focus Point 2: Energy Industry
In the first half of this year, the fluctuation of commodity prices has been a focal point in the market. Particularly, changes in energy prices have affected various industries. Energy is also one of the few sectors in the Australian stock market that saw significant gains in the 2022 fiscal year.
However, with the decline in international oil prices in July, it has added uncertainty to the outlook of the energy industry in the new fiscal year. Coupled with the Australian government's intention to limit natural gas exports to alleviate the country's energy crisis, the financial reports of companies such as Woodside (ASX: WDS) and Santos (ASX: STO) are very much worth paying attention to.
Focus Point 3: Companies Related to New Energy
Wei Ruihao pointed out that the recent energy crisis has sparked new thinking about new energy. In this field, the Australian market is mostly upstream raw material companies, such as lithium mines, rare earths, and copper mining enterprises. The stock prices of these companies have also fluctuated greatly in the past year, and their future trends will also reflect changes in global new energy demand and even expectations for economic growth.
Micro Enterprise Aspect: Looking for Companies with "Strong" Fundamentals
Focus Point 4: Oversold Technology Stocks
In the fourth quarter of the 2022 fiscal year, due to systemic risks, a large number of companies' stock prices were severely oversold, including many technology stocks that had soared in the past two years.
However, among them, there are no shortage of high-quality companies with good long-term cash flow and even positive profits for many years. After being over-sold and oversold, there may be opportunities to "bottom fish."Focus Point 5: Share Buybacks, Mergers and Acquisitions, and Special Dividends
In terms of balance sheet strength, Australian companies are in excellent condition, with many companies almost debt-free. According to the Australian Financial Review, there is an expectation of an increase in special dividends and share buyback activities in this financial reporting season. Diversified mining companies such as BHP (ASX: BHP), large banks such as Commonwealth Bank (ASX: CBA), and energy companies such as Whitehaven (ASX: WHC) are all potential candidates.
Investors can also pay attention to the possibility of mergers and acquisitions. As growth prospects slow down, many companies will face cost pressures and revenue slowdowns, and seeking acquisitions for growth will become an option for some businesses. This financial reporting season may also provide clues as to which companies have already begun the acquisition process.
Focus Point 6: Robust Blue Chips
Macroeconomic uncertainty will mean that companies will remain cautious about earnings growth. However, some blue-chip stocks that are less affected by economic cycles, with long-standing solid performance and strong fundamentals, such as CSL, Australia's largest healthcare stock, may be able to maintain better earnings expectations.
In Conclusion: Cutting Through the "Noise" to Find Opportunities
Whether it is the global economy or the Australian economy, we are currently at a very special point in time. There are indeed many uncertainties at the macro level, creating significant "noise" for investors. But it is precisely at such moments that a clear voice is needed to clarify the risks and opportunities in the current market.
If investors can cut through the noise, they will have a great opportunity to build a high-quality investment portfolio, thereby obtaining better long-term value.
- 7 October'24
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