Analysts are becoming a little more war of equities, but they do see some good plays. Morgans, for example, is sounding a slightly more cautious note:
“The path for further gains in equities looks to have narrowed after a strong run, but we reaffirm our pro-risk stance, supported by a broadening global restart and ongoing negative real interest rates. However, rising bond yields and elevated valuations will limit the probability of strong capital returns in equities in 2022, with the near-term outlook now also blurred by Omicron.
The path through the pandemic was always going to be non-linear, and a strong 2021 coupled with incredibly low volatility did leave markets vulnerable to an event like Omicron. We think portfolios can continue to position for an eventual arrival at full de-escalation of the pandemic and we continue to see risk assets outperforming defensive positions over the balance of 2022.”
Morgans argues to look for “best-of-breed companies” capable of thriving regardless of the economic backdrop. A Morgans report points to Materials, Energy and Financials as having benefitted from the bounce back in economic activity, although a potential further tightening in financial conditions may limit the upside for key sectors.
“Household balance sheets are in great shape, which should continue to support the recovery in consumption. We also see upside risks to dividends as uncertainty from the virus clears through 2022, keeping payout ratios elevated.”
Here is their sectoral breakdown, starting with banks:
“We continue to see the key reasons for being invested in the major banks sector to be the strength of balance sheets and robust dividend yields. Dividend yields remain attractive relative to the yield curve, and we expect this to remain the case if the RBA keeps the official cash rate on hold for the next couple of years. Once the RBA commences raising interest rates, we expect bank earnings to benefit from this through net interest margins. That is, we expect a rising rate environment – in the absence of material asset quality deterioration – to generally be supportive of bank earnings.
“While some investors are concerned about the threat to major bank market shares from emerging fintechs, we are not too concerned about this factor; reason being that the major banks have large balance sheets with the capacity to acquire fintechs which have attractive prospects.”
Next come diversified financials:
“We continue to see value in the sector overall as it lags the post-pandemic recovery. Having said that, the domestic focused general insurers (IAG and SUN) continue to face a frustrating environment, with a recent run of unfavourable weather events remaining a headwind for stock share prices. On a more positive note, several stocks (MQG and CPU), are beneficiaries of the current robust global M&A and ECM environment, which is expected to continue in the near term given large levels of global liquidity.
“The Health Insurers are facing a favourable operating environment, with concerns around the Omicron variant likely to help supress private health insurance surgeries near term to the benefit of claims costs.
“The Insurance and Diversified Financials sector remains favourably exposed to increasing global inflation, which would likely be accompanied by the rising interest rates, thereby supporting sector earnings. Overall, we recommend an overweight exposure to the sector.”
Industrials are next:
“The operating environment remains volatile, but the good news is that many companies are dealing with these issues reasonably well. Almost all are increasing prices to offset the impact of cost inflation and, importantly, this has not had an impact on demand. To mitigate shipping delays, businesses are ordering much earlier than previously. Raw materials availability remains low but should improve as additional capacity is added. While labour remains tight, this should also ease as international borders reopen and migration caps are lifted.”
The healthcare sector has outperformed the broader market over the last five months, but still gets a strong rating:
“It's clear that continued high volumes of pathology testing, remote monitoring of various health conditions and consultations through tele-medicine settings are structural changes that will be with us for a long time to come. As a result of these long-term trends, earnings growth for many healthcare companies (medical devices, pharmaceutical, diagnostic services) is underpinned.”
Consumer stapes have had a volatile time, with panic buying and pantry loading, but that is easing:
“ As vaccination rates increase and economies emerge from lockdown, we are seeing some redirection of spending away from supermarkets to food service providers such as restaurants, pubs and cafes. While this will cause a moderation in sector sales growth, we don’t necessarily expect sales to fall off a cliff. Looking to the year ahead, we see modest potential upside for the sector due to relatively full valuations, but as always, will depend on how COVID plays out from here.”
Consumer discretionary is in come back mode:
“At least for now, the stores are open once more and many retailers are reporting a surge in sales as pent-up demand is released. Any reopening euphoria is likely to be short-lived, however. Sentiment is likely to remain subdued as the new COVID variants emerge and the threat of lockdowns lingers.
“The availability of labour will also become an increasingly pertinent issue for many retailers. Inbound labour migration has effectively stopped, creating shortages for employers utilising casual and semi-skilled labour.”
Telcos are considered an easy call:
“The telco sector has the positive attributes of earnings defensiveness, growth and in some cases yield. Incumbents have more yield and less growth due to their relative defensiveness while challengers and digital infrastructure provides have ample growth. Overall the sector is set for growth as macro trends remain constructive.”
Resources and energy is seen as a more of a matter of seeing opportunities to buy on weakness:
“Our positive medium-term view on commodities recognises: 1) pent-up demand being unlocked by the global economic re-start; 2) constrained supply due to both short (pandemic) and longer-term factors (underinvestment); 3) ongoing growth in global money supply; and 4) US dollar headwinds. These forces also complement commodities strength during periods of rising inflation.
“We recommend core holdings in the diversified miners and large-cap energy stocks for Balanced Portfolios. More Assertive/Growth oriented investors should consider tactical exposure to our favoured energy, copper, nickel, and specialty metals (lithium et al) stocks exposed to growth in battery markets.
“Tactical exposure to gold is worth considering as an additional inflation hedge while it poses macro-economic risk. Gold is also a hedge against the risk that (we think inevitably) equity market volatility breaks above abnormal calm seen through most of 2021. The favoured ASX gold majors (NCM, EVN) offer both the defensive attributes of gold, and increasing cyclical exposure to copper.”
Agriculture is booming:
“ABARES’ most recent Australian Crop Report is forecasting winter crop production in 2021–22 to reach a new national record following favourable growing conditions over the spring. Furthermore, the Bureau of Meteorology’s three-month rainfall outlook suggests that rainfall is likely to be above average for Eastern Australia, given La Nina was recently declared. This coupled with already high subsoil moisture levels and with plenty of water in the dams and storages, Australia looks to be on track to benefit from the largest summer cropping season in recent years, with high plantings of cotton, rice, and sorghum.”
Travel stocks have plummeted, but may now be looking at a recovery:
“We have always advocated a strategy of buying your favourite travel companies when they are trading at a material discount to valuation and this strategy remains. Recent history has shown that their share prices can recover quickly when confidence returns.”
Online, media and technology are seen to be fully priced and the offering for infrastructure has been reduced by mergers and acquisitions:
“In a normal environment, the core infrastructure sector boasts a mix of defensive qualities, structural growth drivers, and appealing distribution yields. This translates into sector returns that historically have been less volatile than the broader market. Within the sector itself, the market risk of patronage-driven assets (toll roads, airports) is typically higher than regulated and/or long-term contracted businesses because they have greater linkage to economic conditions. Given economic uncertainties, we recommend investors balance their infrastructure exposures between these two asset classes.
During periods of rising interest rates, concerns usually surface about the performance of the infrastructure space. We think the asset companies have a number of mitigants to this risk, including inflation-linked revenues and debt that is largely fixed rate and long rated debt.”
Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.