MEDIA RELEASE: While the impact of rising interest rates and inflation is still to be fully felt in the market, there are still pockets of opportunity for stockpickers within certain sectors, according to portfolio managers at Fidelity International.
Paul Taylor, head of investments at Fidelity International, says Australia will most likely avoid a recession, although it’s not entirely off the table.
“While we think many developed markets will head into recession later this year, our view is that Australia is in a good position to avoid the worst.
“If we do head into a recession, it will be fairly shallow. Australia is in a stronger position than other developed markets because of our links to better performing Asian countries as well as higher population growth from immigration. Nonetheless, the best-case scenario is that we see a slowdown in Australia.
“Central banks around the world have moved quickly to get on top of inflation and avoid the pervasive inflation experienced during the 1970s. They are now taking a pause to see how economies react and what the next steps will be.
“In Australia, there are indications we are getting close to the peak for both interest rates and inflation. The real test for whether we go into a recession or not, is consumers and how they adjust. Consumer behaviour is lagging behind the interest rate cycle and there is still some pain yet to be felt.
“While there are a number of risks in the market, this also creates a great opportunity to buy the market at a much better risk-adjusted price, which will likely deliver much better longer-term returns,” Mr Taylor says.
Maroun Younes, co-portfolio manager of the Fidelity Global Future Leaders Fund, agrees that a number of sectors stand out.
“The tech sector has been delivering strong earnings and has an optimistic outlook. It is benefiting from ongoing structural growth in areas such as data centres and the cloud, networks and connectivity enablers, software to create productivity or critical information management, artificial intelligence, and content platforms.
“Looking ahead, earnings will be a significant driver of share prices during the next 12 months. The drivers of sustainability of earnings will also be important considerations – for example, pricing power and market structures, as well as the discretionary nature of consumer spending. Businesses that can withstand any softness in the economic environment will also likely be well sought after.
“As the risk of recession or economic slowdown flows through the economy, these considerations will determine valuations, meaning that stock picking will be critical,” Mr Younes said.
Casey McLean, portfolio manager for the Fidelity Australian Opportunities Fund, also sees opportunities in a number of sectors in the Australian market.
“Commodities and building materials – in particular consumption-related commodities – are looking attractive at the moment. Consumption-related commodities are those that are exposed to structural growth elements such as decarbonisation; for example lithium, copper or rare earths, and are not running into a headwind of weak Chinese property demand.
“We also think the insurance sector is one of the beneficiaries of the current inflationary environment as inflation means insurers are able to increase their premiums. We are also experiencing a high level of natural disasters, both in Australia and in markets like the US, which pushes up claims inflation, reinsurance rates and ultimately insurance premiums. Further, a higher interest rate environment means insurers are able to earn good returns on the investment of premiums. Overall, the outlook for their earnings looks pretty strong over the medium term.
“Another area that is somewhat overlooked is small cap equities. They have underperformed over the past two years but as the cycle turns, conditions will be substantially more favourable for them and many will be in a strong position,” Mr McLean says.
Zara Lyons, portfolio manager for Fidelity’s Australian Equities Fund, says that the bank sector is well prepared to weather a downturn, but the market will likely focus on asset quality in upcoming results.
“Since the RBA paused hiking rates in July, market expectations for two 25 basis point increases in the cash rate have eased slightly to one 25 basis point increase, following a weaker monthly inflation figure. This, combined with a slight softening in competitive dynamics across both mortgages and deposits, has led to a share price rally in banks, which have outperformed the broader market over the last few months.
“However, we think this rally may be short lived if the economy deteriorates further from here. The yield curve continues to be inverted implying that the market expects slowing economic growth in the future and potential easing in policy rates,” says Ms Lyons.
Mr Taylor adds that against the macro-economic background, equity markets now present a much more interesting opportunity.
“History teaches us that when significant risks are priced into equity markets, they’re more likely to provide better longer-term investment returns. There’s plenty to worry about, but that also creates better opportunities for the future,” he says.
