The information in this article is current as at 2 January 2022.
Overview
The S&P/ASX 200 Total Return Index returned 3.8% over the six months and 17.2% over the twelve months to 31 December 2021.
Outlook
Recommendation: Downgrade to neutral.
The Australian sharemarket continues to trade near record highs and many companies screen as fully-valued when compared to longer term valuation metrics. Most of the tailwinds, however, that have propelled domestic shares since the depths plunged at the onset of the pandemic appear likely to continue over 2022. First, money is expected to remain cheap. In December, the RBA Governor Dr. Philip Lowe, restated that “the (RBA) board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”. This should allow businesses to refinance debts, upgrade plant and equipment, and ensure sufficient working capital is available to help meet demand. Households can continue to take advantage of low interest rates and their strong cash positions to buy assets such as property and shares, or more generally, increase spending levels in the economy.
Second, the OECD (Organisation for Economic Co-operation and Development) expects strong global economic growth of 4.5% in 2022, notwithstanding their warning of growing imbalances and risks1. Australia’s growth rate is forecast to be 4.1% in 2022. The strong outlook, both globally and domestically, is likely to boost corporate earnings. Third, supply-chain bottlenecks should gradually ease during the year as restrictions continue to be lifted. Fourth, Australian companies have benefitted from fiscal stimulus measures and generally improved their balance sheets. Finally, shares remain attractive relative to low-yielding fixed interest returns. Nevertheless the outlook is tempered by concerns surrounding lofty valuations, the severity of the slowdown in China, and renewed restrictions as the Omicron variant sweeps the world. Accordingly, we move from a modest overweight to neutral position.
Sector View
Our outlook for some of the major sectors of the S&P/ASX 200 is as follows:
Banks
Recommendation: Retain neutral.
The banking sector’s share price performance plateaued during the last quarter of 2021. Three of the banking majors reported financial year results during the period. The highlights of these FY21 results were strong demand for business and home loans as the financial health of corporate and household Australia continues to increase, the announcements of share buybacks and the writing back of loan provisions taken in the previous financial year, culminating in solid increases in declared dividends.
The economic recovery in Australia and New Zealand will continue to support earnings and asset quality at Australia’s four major banks in 2022, despite longer-term headwinds such as the low interest rate environment, strong competition and elevated investment costs. These headwinds will continue to pressure Net Interest Margins (NIMs). However, over the medium-term, NIMs are expected to recover as the interest rate tightening cycle begins in earnest, though competition will limit any expansion in NIMs.
The banking sector continues to be well capitalised, with Common Equity Tier 1 (CET1) ratios remaining substantially above APRA’s “unquestionably strong” benchmark of 10.5%. This has allowed banks to increase dividends closer to pre-pandemic levels, as well as engage in share buybacks.
Resources
Recommendation: Maintain neutral.
Commodity prices have been a beneficiary over the past year of massive global fiscal stimulus packages, burgeoning infrastructure spending and supply-side constraints. Prices are expected to remain solid as the reflation of the global economy continues and inventories remain at historically low levels across most commodities. The International Monetary Fund (IMF) projects that the world economy will grow by 4.9% in 2022, a view which is conducive to strong commodity prices over that timeframe. Whilst the deployment of stimulus measures and the setting of accommodative interest rates by Central Banks, along with massive infrastructure packages announced by governments, have been the drivers of the strong uplift in commodity prices, it stands to reason that the tapering of stimulus programmes will impact commodity price strength over the medium term. To this effect, the recent announcement by the Federal Reserve that it will cut back on its stimulus programme more quickly than planned, as it ratchets up its response to rising inflation, is likely to put downward pressure on prices in 2022.
Another potential reason for a more protracted decline in commodity prices remains the growth outlook of China. This was evidenced during the second half of 2021 as most commodity prices sold-off. The resources sector (notably iron ore) has since stabilised as fears of a worsening demand outlook predicated on the potential of a protracted economic slowdown in China have quelled, as well as continued supply side restraints lifting prices (notably with oil and base metals). Whether this improvement is sustained may depend on further policy stimulus from China, which remains unclear. Finally, over the longer term, demand for commodities such as steel and copper as a result of rising urbanisation rates across the world is expected to remain solid. Overall, we believe that the risks are evenly balanced and therefore recommend a neutral weighting.
Retail
Recommendation: Retain neutral.
The Australian retail sector continues to benefit from the lifting of many lockdown restrictions. Vaccination rates of 90% have enabled the economy to re-open, unleashing a wave of pent-up spending in the process. Notwithstanding the strong rise in retail sales, the household savings rate continues to be very high. This augurs well for an expectation of an expansion in consumption patterns over the next year.
Notwithstanding strong headline growth in retail sales, many retailers continue to struggle through an uncertain economic environment. This is because COVID-19 has accelerated many consumer trends. For example, there has been marked shift in spending levels at suburban malls, at the expense of CBD retailers. While the lifting of restrictions will see spending levels in and around CBD’s regain some lost ground, many consumer spending patterns have been permanently altered as a result of the pandemic. Another example of the permanent shift in consumer behaviour revolves around e-commerce, with strong momentum through this channel accelerating strongly over the past 18 months, as consumers take advantage of extra time at home to browse and purchase online.
Accommodative interest rates, high savings rates and increased consumer confidence levels continue to be tailwinds for retail sales. These drivers appear likely to support strong retail sales readings well into the next year. However, as most companies in the sector are cycling very strong earnings over the past 12 months and as consumers accelerate spending on services, we temper our otherwise bullish outlook and reaffirm our neutral outlook.
Australian Real Estate Investment Trusts (AREITs)
Recommendation: Retain neutral.
AREITs continued to perform strongly in the last quarter of 2021. The AREIT Total Return Index is around 26% higher over the past year and has risen around 10% during the past quarter.
The retail sector continues to benefit from the easing of many restrictions. Lockdowns were punitive, most notably for the services sector as well as for those retailers without online offerings. The lifting of these lockdowns as vaccination rates rose to 90% have coincided with the festive season and have unleashed a torrent of spending as a result of pent-up demand and a war-chest accumulated during the lockdowns. Notwithstanding the strong rise in retail sales over recent months, the household savings rate continues to be very high. In combination with low interest rates and strong consumer confidence levels, this augurs well for a continuation of strong discretionary spending patterns over 2022.
The office sub-sector is finally seeing green shoots after the battering it received during the initial phase of the pandemic when city centres (CBDs) were turned into ghost towns amid lockdown measures. Many workers in and around these capital cities have returned in recent months and occupancy levels have since stabilised. With more certainty in the underlying health of the economy and the risk of further lockdowns declining significantly, office property is likely to continue its recovery. A headwind for the sector remains the renegotiation of leases as they expire, as these are likely to be renewed on less favourable terms and involve a smaller footprint – in line with a more flexible working environment for many companies.
The residential sub-sector has been strong in 2022, with house prices increasing more than 20%. Prices have benefitted from the historically low interest rate environment, government incentives and income support measures, as well as pent-up demand driven by strong increases in household wealth. These tailwinds have led to worsening affordability. The outlook for 2022 for residential property is for far more constrained growth outcomes as supply continues to rise. Further, interest rate rises could be brought forward from the currently-slated timeframe and continued macro-prudential tightening may occur, constraining borrowing levels. The re-opening of borders could see immigration levels begin to return to pre-pandemic levels, which would limit potential price falls.
The industrial sub-sector continues to excel. Strong investor demand has driven down capitalisation rates, significantly boosting asset values. The vacancy rate across industrial property is at a historically low 1.3%2 with the Sydney market boasting an even lower vacancy rate of 0.4%. This has driven a wave of capital into industrial real estate, with investors unfazed at the low yields on offer but rather attracted by the solid market dynamics.
In conclusion we remain confident that the short-term dynamics remain favourable for the sector but recognise that risks are rising as valuations are far from cheap and bond yields are starting to rise.
1 OECD Economic Outlook December 2021 https://www.oecd.org/newsroom/oecd-economic-outlook-sees-recovery-continuing-but-warns-of-growing-imbalances-and-risks.htm
2 More rent rises tipped as industrial vacancy rates hit record lows, Australian Financial Review, 1 December 2021: https://www.afr.com/property/commercial/more-rent-rises-tipped-as-industrial-vacancy-rates-hit-record-lows-20211201-p59duq
Liability limited by a scheme approved under Professional Standards Legislation. Any advice included in this article is general only and has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisors at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFS number 336950.
