End of Quarter Review – December 2022

Investors experienced the worst year in world financial markets since the 2008 global financial crisis (GFC) as rising inflation forced central banks around the world to raise interest rates aggressively, putting an end to almost a decade of cheap borrowing for investors. Global stocks are estimated to have lost about a fifth of their value during the 2022 calendar year, as the ‘all asset bubble’ that inflated during the COVID-19 pandemic burst, sending technology shares and crypto assets tumbling in the second half of calendar 2022.

Inflation climbed as many economies re-opened from the pandemic lockdowns and Russia triggered an energy crisis in Europe by curbing gas supplies and using it as an economic weapon. Elsewhere, China’s economy endured another turbulent 12 months in 2022 as the impact of the coronavirus and Beijing’s zero-COVID policy took a toll on its economy while the impact of the war in Ukraine and rising tensions between China and Taiwan continued to cause geopolitical challenges .

World equity markets fell sharply as inflation soared, dampening hopes that price rises would be transitory. US consumer price inflation reached a four-decade high of 9.1% in June 2022, while proving to be harder to tame than first expected. As food and gasoline prices climbed, it prompted the US Federal Reserve into its most aggressive interest rate hikes since the 1990s. Technology stocks were particularly hit hard as the Nasdaq Composite lost almost a third of its value in calendar 2022.

On reflection, 2022 will be remembered as the sudden end of an era for ‘ultra-cheap easy money’ and the start of a new era of sustained tighter monetary policy from the U.S. Federal Reserve and other major central banks. This new paradigm of interest rate hikes is likely to continue for as long as it takes to get inflation back towards the 2.0% global threshold for most central banks.

The MSCI All Country World Index fell 19.8% to 605 points for the calendar year 2022, the S&P 500 Index declined 19.4% to 3,840 points and China’s Shanghai Composite dropped 15.1% to 3,089 points.

Domestically, the Australian S&P/ASX 200 Index outperformed its global peers comparatively, declining only 5.5% to 7,039 points, benefitting in part from its skew towards the big miners and the banks and its relatively smaller exposure to technology companies. More notably, the Energy and the Utilities sectors were the standouts— rallying 39.7% and 24.2% respectively while the Materials sector also gained 4.8% for the calendar year 2022.  By contrast, the Information Technology sector was the weakest—down 34.3% and not surprisingly, the Real Estate sector fell 23.9% as rising interest rates took its toll.

On the commodities front, gold finished the year almost unchanged at US$1,824/ounce, and iron ore retreated 2.4% to US$118/ tonne in part due to lower demand and COVID-related lockdowns in China. Brent oil jumped 19.2% to US$86/barrel—impacted mainly by the Russian-Ukraine war and a surging U.S. dollar.

Following a 0.9% expansion in the June 2022 quarter, the Australian economy expanded 0.6% in the September 2022 quarter supported by strong household discretionary spending. On an annualised basis, GDP was up 5.9% in the 12 months to September 2022.

The most recent underlying inflation rate increased to 1.8% in the September 2022 quarter─ accelerating sharply to 6.1% on a year-on-year basis (the highest since 1990). This sharp increase was primarily caused by higher dwelling construction costs and rising food, energy, and automotive fuel prices. In order to combat the steep rise in inflation, the Reserve Bank of Australia (RBA) raised its official cash rate numerous times from May 2022 onwards, taking the official cash rate from 0.10% to a 10-year high of 3.10% by end of December 2022. In this regard, underlying inflation is still expected to remain well-above the RBA’s 2%-3% target band throughout 2023, and as such, our cash rate target of  3.35% for February 2023 remains unchanged.

The Australian dollar fell 6.2% to finish the year at the current ~US68.2 cents largely because of the strength of the US dollar against all the major currencies.

The Australian labour market remains extremely tight and resilient as evidenced in the latest unemployment rate of 3.4% in November 2022, a large 64,000 increase in jobs, and a rise in the labour force participation rate to 66.8%. While the near-term wage growth outlook remains strong, we expect unemployment rate to rise to 4.4% by end of calendar 2023.

Against the backdrop of a global energy crisis, cost-of-living pressures and high interest rates, we feel a sharp economic slowdown (if not a recession) is inevitable in 2023. We therefore expect the world economy to expand by only 1.9% in CY23 and then 2.7% in CY24. As regards the Australian economy, we forecast growth of 1.4% in CY23 and then a slightly higher 1.8% in CY24.

Looking ahead, we acknowledge continued challenges from the pandemic, the Russia-Ukraine war, high inflation, and resulting headwinds from the central bank rate hikes. Reflecting these factors, the global economy is likely to endure “rolling” country level recessions specifically in the Euro area and the UK, and perhaps in the U.S. as well as Australia. Furthermore, inflation is likely to remain painfully persistent and central banks are likely to keep interest rates high and tighten further as needed. All up, we therefore expect heightened market volatility to dominate the first half of 2023.

Nevertheless, the key question shaping the global economic outlook and equity markets centres around the path of inflation versus economic growth over the next twelve months or so. We see global economic conditions as poised to be on an improving trajectory towards later part of calendar 2023, as the projected global slowdown is likely to ease labour market tightness, calm wage pressures, soften commodity prices, and moderate consumer demand ─thereby moderating inflation and hence allowing central banks to begin easing monetary policy with economic growth bouncing back. For these reasons, we believe there is a reasonable expectation that the trajectory of inflation should trend lower, though not in a straight line.

Against this background, the Australian share market is currently valued on a forward consensus price earnings ratio of 14.1x, which is 8% below the long term average of 15.4x. The forward consensus dividend yield for the Australian share market is 4.6% (80% franked). We also forecast further gains in the market and our current S&P/ ASX 200 index target is 7,400 at the end of calendar 2023. This is 5.1% above the 30th December 2022 close of 7,039 (excluding dividends).

We would like to reiterate ten stocks from our recent investor report ‘Analysts’ Buy-Rated Stocks’ which we particularly like over the next 12 months or so for private clients. These are:  Aristocrat Leisure, Brambles, CSL, Goodman Group, GPT Group, South32, Suncorp Group, Woodside Energy Group, Woolworths Group, and Worley.

For those investors looking to gain exposure in the global share markets, we have also recently produced an international investor report titled, ‘Our Buy Rated Global Stocks’ that identifies our preferred ten international stocks for private clients. These are: ASML Holding NV, Beiersdorf AG, Compass Group PLC, Johnson & Johnson, MercardoLibre, Novo Nordisk, Pernod Ricard, Rentokil Initial, Visa Inc, and Vulcan Materials Company─ all are buy rated by the analysts.