Australian investing: Six considerations amid triple Rs: rising rates, record inflation and likely recession
Summary: Australian investing: Six considerations for the ASX amid triple Rs: rising rates, record inflation and likely recession.
Australia’s national export income and stock market will likely be jolted higher in Q2 and for the rest of the year, with the luckily commodity-rich country tipped to come out on top while the world braces for the big three Rs: record inflation, rising interest rates and a possible recession.
Australia’s stock market outperformed global equities in Q1 as its coal, LNG, iron ore, gold and agricultural equities flew off to the races. We think momentum will continue in Q2 with mining and agricultural stocks primed to strengthen amid higher prices and accommodative China policy. As the Australian Federal Election campaigns ramp up, the coin jar for commodity and green energy spending will also be jingling. Here are 6 considerations for the quarter.
Consideration 1 – at a national level, foreign investors will increasingly be compelled to invest in Australia
This supports the Australian dollar. Australia boasts one of the highest trade surpluses (exports minus imports) in the G20 countries—meaning it earns more money. It’s also likely to have one of the strongest economic growth rates in the G20 (4.3 percent GDP) and one of the best employment rates (just 4 percent unemployment this year and 3.9 percent next year). This is all thanks to Australia being the king/queen of exports. It is:
- the world’s largest iron ore mining country;
- the second-biggest LNG exporter;
- the third-biggest uranium producer;
- the fourth-biggest coal nation;
- the fifth-biggest copper and lithium producer;
- the sixth-biggest wheat and other grains exporter.
Australia is benefiting from commodity prices surging. The iron ore price is up 28 percent so far this year, oil is also up 36 percent and wheat is up 41 percent (as at March 29). Australia’s exports surged to AUD 49.3 billion in January (the most recent reading), so you can bet that Australian exports will climb further in March. On top of this, prices are poised to rise over the longer term, amid anaemic supply and roaring demand, further benefiting Australia; this will attract more foreign money.
Consideration 2 - higher commodity prices to benefit the ASX, but specifically the commodity sector, which makes up 30 percent of the Australian share market
BHP (BHP), the world’s biggest miner, is an AUD 171 billion company—it’s the biggest company on the ASX. Rio Tinto (RIO), the world’s second-biggest miner, is an AUD 120 billion company—the third-biggest stock on the ASX. Fortescue Metals (FMG) is also in the mix. These stocks are poised to pay the highest dividend yields in the world; BHP with 10.5 percent yield, RIO 10 percent and Fortescue 16.4 percent. Their above-market dividend yields attract large institutional investors and retirees seeking income stability in a very noisy and volatile market. Additionally, shareholders also stand to benefit from share price growth as the iron ore price rallies. Remember earnings and cashflow growth drives share price growth.
The iron ore price is about AUD 150 at the time of writing. It’s likely to move north this quarter for three reasons: China has relaxed its carbon emissions targets for five years, meaning it can produce more steel; China dropped its official interest rates three times, encouraging property firms to borrow money and buy iron ore for steel; and China wants to ramp up economic activity to achieve its growth target of 5.5 percent in 2022. So you could expect higher highs for BHP, RIO and FMG shares as earnings growth slowly improves. However, there are risks to be considered, the biggest being if China ceases or reduces Australian trade; based on our discussions with BHP, we don’t think this is likely. Considering that these three companies generate a combined AUD 96 billion in total revenue from China, Australia wouldn’t want to fray that tie. Note: In 2021 BHP made 66 percent of its revenue from China; that figure was 57 percent for RIO and 89 percent for FMG. When China’s economy grows and it boosts infrastructure spending these companies grow too and—given their sheer size of the market—the ASX gets a boost.
Consideration 3 – Australia’s federal election is in May
More fiscal commodity sector spending will likely be announced so that Australia can achieve carbon neutrality by 2050, so watch commodity stocks and ETFs. Australia has some of the largest rare earth reserves in the world, and wants to compete with China in supplying the 17 rare earth elements to the high-tech manufacturing sector. China supplies 70 to 80 percent of global rare earth industry needs. In March, the Australian prime minster pledged AUD 243 million to four Australian rare earth projects, including a new nickel manganese cobalt battery material refinery hub and a vanadium refinery project led by Australian Vanadium. In September 2021, Australia’s government announced a AUD 2 billion loan facility to help secure Australian critical minerals projects. The announcements supported rare earth stocks and ETFs higher; given global undersupply and rising high tech demands, support is likely to continue. The ASX’s biggest rare earth company, Lynas Rare Earths (LYC) is a great example—the market thinks it could see 102 percent revenue growth this year with earnings growing by 71 percent; that could be worth a look. Alternatively, consider looking at an ETF in rare earths, like the VanEck Vectors Rare Earth/Strategic Metals ETF that invests in 22 rare earth and strategic metal stocks across the globe.
Consideration 4 – remember a company is valued on future cashflows and earnings
The biggest earnings, cashflow and sales growth are tipped to come from the energy sector this year, with over 60 percent earnings per share growth likely—it’s hard to walk past. I like to pick companies that are growing their market share and earnings in the industry. Whitehaven Coal (WHC) and Woodside (WPL) are great examples, with both being leaders in their fields and tipped to see rising demand, benefitting from higher long-term underlying commodities prices which support their share growing. Both companies’ shares are up 50 percent in Q1 and they operate on low price-to-earnings ratios, meaning they are ‘cheaper’ to buy in comparison to the ‘earnings’ they generate. These are just examples.
Consideration 5 - consider selling out of listed property and consumer discretionary spending stocks
It’s not just the cost of chicken, beef, oil and bread that are rising—so too is lumber. It’s flowing to builders, squeezing their profits, while higher house and construction prices are being passed to consumers; this has started to cause cracks in the property market. This has big knock-on effects, and this is before interest rate rises have even begun. In Q1, ASX-listed property stocks have collectively fallen 8 percent and ASX consumer discretionary spending stocks are down 12 percent (at the time of writing). More losses are expected in Q2 and Q3. Why? Australia’s debt-to-income ratio climbed to 185 percent. After an expected rate rise in May, mortgage repayments will rise and cost of living will go up, resulting in decreased consumption and a slowdown in property demand.
Consideration 6 - consider softer agricultural commodities too
Consider not only have having a bigger chunk of your portfolio in hard commodities such as metals and energy, which will benefit from higher prices this quarter, but also in softer agricultural commodities—they are also poised to benefit from the supply glut and continued rise in demand. Meat, grain and fertiliser business Elders (ELD) is a great for example of a company to look at. They’re able to benefit from higher prices and higher profits this year. Australian grain giant GrainCorp (GNC) is another example; they are also tipped to reap higher earnings and profit growth. And don’t forget that commodities need to be shipped all around the world, so consider looking at global freight and logistics companies—great examples are Qube (QUB) and WiseTech (WTC).
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.