“Having badly misjudged the strength of inflation over the past year, central banks are now anxious to convey the message that they are determined not to repeat the mistakes of the 1970’s.”
John Plender Financial Times September 2022
In the shadow of a dramatic rise in government bond yields, the ASX 200 fell 6.20% in September. An aversion by investors to higher yields had a significant impact on Real Estate (-13.6%) and Technology (-10.6%), whereas Materials (-2.3%) and Energy (-3.8%) recorded the smallest falls in September. Within stocks BHP, Northern Star, and Oz Minerals positively contributed while Ramsay Health Care, Goodman Group, and Macquarie were the key detractors.
It is self-evident that the optimism in stocks which manifested itself as earnings recovered strongly from the depths of the pandemic, has now been deflated. Equity markets are facing into five main macro headwinds, notably rising rates, slowing growth, elevated geo-political risks, stubbornly high inflation, and a strong US dollar. This has created a vicious cycle for equity valuations with the ASX 200 12 month-forward PE compressing from over 18 times to ~13 times this calendar year.
At a company level, the KKR-led Consortium bid for Ramsay Health Care collapsed in September following the announcement that the Consortium was not able to improve the terms of an Alternative proposal ($88 cash for first 5000 shares then $78.20 cash + 0.22 Ramsay Sante shares). Notwithstanding this, the ~20% fall in Ramsay’s share price now offers medium-term valuation support. Critically, the latest Medicare Data and industry feedback suggests that the delayed recovery in healthcare procedures is now showing tangible signs of recovery. Faced with an unprecedented backlog in elective surgery lists healthcare providers are well placed for a sequential recovery in earnings.
In the immediate future we believe that the financial pressure of tighter financial conditions will continue to weigh on equity market valuations. Yet despite a myriad of economic headwinds, it is noteworthy that the recent earnings reporting period conspicuously highlighted that underlying demand remains strong, supported by a robust labour market and well capitalised corporate balance sheets. We expect the upcoming AGM season should provide insight into whether there are signs that recent rate hikes are beginning to moderate economic activity.
From a portfolio perspective, we can continue to favour companies that offer stable growth in the consumer and industrial sectors, in healthcare as earnings recover from pandemic disruption, and in the energy and resources sector where structural shortages in supply should support higher prices as the global economy decarbonises.
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