ASX Market Update 23rd December 2022

Global Market Commentary

It’s been a long time between drinks, but that is bound to happen when you have a newborn in the house, but I do apologise for the lack of ASX updates. Ironically the story hasn’t really changed when it comes to what is driving markets. I’m not going to dwell too much on what has happened in 2022 as it’s been well covered, and I am sure you are all keen on what I think the year ahead could bring us.

*Chart- S&P500 as at 21/12/2022

As you can guess central banks, inflation, rates & yields still dominate market moves. The rhetoric has slightly changed in the last two months with a more dovish tone spilling from central banker mouths. What we see now is a clear indication that the rate cycle is close to peaking, with a long pause on the cards. In fact, the RBA could be done for this cycle and we will probably see rates higher for longer. I would expect at worst rates to be paused by end of Q1 2023.

This saw a large rally in equity markets globally up until the Fed meeting last week. At its worst the S&P500 was down 25% and its now off around 19%. This compared to the XJO which is only down 4% and was about 15% at its worst. If you include dividends, we are practically flat in terms of returns for the year. Below shows a simple comparison on how we have compared against the major US indexes in 2022 to date.

- S&P500 -18.63%

- DowJones -19.38%

- Nasdaq100 -31.15%

- S&P/ASX 200 -3.94%

Our somewhat insulated economy, shielded from a lot of the trouble plaguing other economies around the world, plus a more upbeat earnings outlook for 2023 has really helped our market outperform. Also, the RBA has been more conservative when it comes to rate hikes, mainly as they have a more direct impact on household budgets and demand when compared to the US. I wouldn’t expect this outperformance to roll into 2023 just because the US is working off a much lower base than us.

Its clear inflation has peaked both in the US and locally. Two months in a row now inflation has surprised to the downside, and I called this deflationary environment the global economy was entering into as early as June. For instance, container prices from Shanghai to LA now cost less than they did pre-pandemic. Real world prices were nose diving it just takes some time for that to hit the street and for it to show in data. My only concern is food prices, which have been heavily affected by weather events in the northern hemisphere, the Ukraine situation + supply chain disruptions. However, food works in very short cycles from planting crops to hitting supermarket shelves. It’s easy for supply to catch up. I would expect food prices to see some major downside in 2023.

Finally, the China situation has probably hit a trough as the markets see it. It’s very much a case of markets bottoming, before the bad news peaks. Economic data coming from China continues to be extremely soft, and I doubt we have seen it at its worst. However, the market is looking through that and what will China bring in 2023 and the picture looks much brighter. The Hang Seng Index is down 16.5% for the year and their tech index is down 27.1%. Remarkably the Hang Seng is still down 37.1% from their highs in 2021.

In summary 2022 has been an extremely tough year for equity markets globally. The major factors that drove us lower for me are:

- High inflation that we hadn’t seen in 40+ years

- The first tightening cycle by central banks in a decade

- Runaway bond yields

- Move from Quantitative easing to tightening by central banks

- A slowing global economy

- The high base that an extremely strong 2021 created in data on a comparative basis

- China covid zero policy, lockdowns & a slowing economy

- General, uncertainty when it comes to the global economy.

Thankfully this is all in the rearview mirror now and whilst some of these factors may still linger into 2023 the picture is a much more positive back drop moving forward. We will discuss this next!

My 2023 Outlook

A ’goldilocks’ year?

I do think 2023 has the potential to be a ‘goldilocks’ year, but what do I mean by that? Well, it means everything will be ‘just right’ for equities. The one factor that equities hate more than anything is uncertainty. They will be sold off and questions and reassessment can be done later. 2022 was rife with this mainly due to inflation and the rate hiking cycle. Questions of how high would inflation/rates go? When will they stop? These were questions that we didn’t have answers to until recently. Now we live with more certainty that inflation has peaked, and rates will likely peak in Q1 2023. If anything, rates may have gone too far to the upside and need trimming in 2023. This has provided the market with much more certainty from which proper evaluation can be done. Certainty breeds confidence which means markets can start moving to the upside again.

Now even though I think markets will resume their upward trajectory next year I don’t think we will see exponential returns. I believe the standard 8-10% can be expected on the XJO and maybe slightly higher abroad. However, I think we can all agree that its far better than what we all experienced this year.

The VIX index, a measure of market expected volatility, has been much higher this year. With uncertainty comes volatility, that’s just how its works. For most of the year its has traded between 20 & 35, but in 2023 I believe that settles down a bit and we see a lot more sub 20 readings than we have in the last 12 months bringing much more stability to our markets.

Thus, to summarise the ‘Goldilocks’ year 2023 could be we will see much more certainty, market upside & less volatility to make the year ‘Just Right’ for equity investors.

Earnings

Most of the time price is dictated by earnings, but obviously we have seen an uncertainty and fear drive a lot of price action in 2022. Uncertainty of a possible US/EU recession how deep would that be & how hard would earnings be hit as a result. Thus, a hefty sell-off ensued. Often during these times, the market will over correct to the downside which I think we saw this year. The market was factoring in how earnings would behave in 2023 as markets are always forward looking. The S&P500 currently has a forecast of +4% for 2023, but we know that analyst often overestimate earnings by 7% on average for a 12 month forward looking basis. This would mean we may see earnings fall by 3% or more in 2023. If we extrapolate that out that gives us a 17.2x forward PE on the SPX, bang on the 10-year average. If earnings fall 10% then the SPX is trading at 18.5x, around the 5-year average. So, at the moment you would have to say the US markets are currently at a fair price. Not expensive nor cheap, but fair. Now I also believe we could see some downside in the US in Q1 next year as another over correction ensues due to the nervousness about a recovery. However, I believe this will be a buying opportunity as the market turns to a 2024 outlook soon thereafter.

Locally we are currently trading around 14x forward earnings with a 7%+ earnings outlook for 2023. I feel this is a little enthusiastic given the current economic back drop and a 3-5% earnings growth in more appropriate. This lifts our PE slightly but nothing to write home about it. Yields are roughly 4.5% forward looking which again is right on average. Again, it looks as if the XJO is fairly priced. Not cheap nor expensive.

I think we will find as 2023 moves on, especially past Q1, we will see it look towards 2024. At this point earnings are expected to be flat but feel it’s too far out to speak with any certainty. It’s my belief we will keep on our trajectory of mid-single digit growth in 2024 as the XJO avoids recession and household budgets remain solid.

Hence 2023 will be more about 2024 and why I feel most of these earnings downgrades are factored in and the picture looks far better in the coming years.

China

The Chinese economy and its zero covid policy shook markets to their very core this year. It saw most commodity prices fall by up to 50% on soft demand. I did mention some time ago after the NPC meeting in October things would start to open with restrictions to soften. This has played out perfectly and even though they haven’t officially declared it China is opening again. Most analysts expect it to be fully open in Q2 2023, but we will start to see the benefits well before then. Manufacturing & Services should begin to recover in Q1 with its property sector seeing huge amounts of investment moving forward. We have already seen mass amounts of debt issued to help prop it up with much more in the pipeline. Also, China’s much talked about credit impulse index has bottomed and has started to turn back up again. GDP & the credit impulse index are heavily correlated as obviously debt helps drive growth.

I would expect to see a strong China in 2023, especially in the back half. They will want to make up for lost time spent in lockdown and continue their path to be the world’s largest economy sometime in the next decade or two. Obviously, commodities are the big winner here and so is the XJO. China’s stranglehold on their tech sector will also ease and we could see some very large listings on the Hang Seng in 2023. Having exposure to China in some form next year (CNEW & ASIA?) I think will provide some alpha in portfolios.

Global Economy

This is a tough one to call. The consensus is that the US will enter a recession sometime in the next 12 months. However, GDP data that released last night suggested its economy is still strong as at the third quarter. If they do enter a recession, I feel it will be mild and brisk. Some companies have started letting people go but the numbers are timid at this point. Most companies are electing to implement a hiring freeze instead and see how things play out. US households are still in a solid position and consumption remains fair.

I feel the EU does enter a recession though. All indicators are things are pretty soft over there and measures to help avert an energy crisis will also contribute to a slow down.

As stated above China rebounds strongly and probably keeps the globe from entering a recession. I think we see a return of 5-6% growth and they have all engines firing by the end of the year. They also have a low base for comparison from this year.

At home I feel we avoid a recession, but a decent slowdown ensues. I am talking about 1.5-2% annual growth, which isn’t a terrible place to be at all. The jobs market remains strong and whilst we have started to see some slowdown in spending household budgets are also strong. We could see the unemployment rate tick up purely on the back on more people looking for work as we ramp up immigration. Wages are much stronger than the WPI indicates as it doesn’t include bonuses, overtime, and incentives. We also have a lag period as workplace agreements take time to bring themselves in line with CPI. I feel wages is the only thing that could keep the RBA hiking as it will fuel demand. However, I don’t feel this will be a problem because as we have seen for the last decade high immigration puts a cap on wage growth. I feel Q1 could be ugly here with some real soft data, which may cause a sell off on the XJO. People will adjust their budgets after Christmas and the New Year and reign it in for a period.

Investment Themes for 2023

*Chart- S&P/ASX 200 as at 23/12/2022

Resources- An easy one to start with as it lines up very well with the China re-open theme. I really like industrial metals like copper, nickel, zinc etc. Avoid bulk metals exposure to begin with as stockpiles are strong, but I feel BHP & RIO will give us an entry opportunity in Q1. A company like South 32 (S32) and Independence Group (IGO), gives us decent exposure here.

Rare Earths- I believe rare earths could have a year like what lithium had in 2022. It seems to be building momentum as more micro-caps acquire prospects and larger companies, such as Hancock Prospecting, start to make major investments into the space. The world needs more rare earths, and it wants to diversify away from Chinese supply. The obvious choice here is the largest producer outside of China in Lynas (LYC). From here we are limited to micro-caps to invest in so the very high-risk end of town and from those I have known in the past ARR, ASM, AR3, IXR, ENR & REE are all worth keeping on the radar.

Financials- As I expect rates to remain higher for longer then the NIMs of the financial sector should continue to widen. Also, with immigration starting to kick in again I would expect house prices to bottom in 2023 and to see demand rise again. My favourite in the sector is Macquarie Group (MQG) but also would have Commonwealth Bank (CBA) right behind it. For a broader stroke you can invest in the Vaneck Banks ETF (MVB).

Biotech- Its been a lean year for biotechs, like most sectors, but they have been hit harder than most. Unfortunately, its pretty thin on the ASX when it comes to this space so we look to the US for exposure. Most biotechs in the US are trading at or below cash value which historically has been a entry signal. Luckily on the ASX we have an ETF under the ticker CURE called the Global X S&P Biotech ETF. This will give us the exact exposure to what we need. I will continue to browse through the names on the ASX that may be suitable but for now CURE is our best option.

AVOID- Lithium & Coal- Two of the hottest sectors in 2022 are set to underperform in 2023. I feel spot prices for both underlying metals can easily fall by half, and this will drag the sector down with it. For lithium EV sales in China have cooled, subsidies may not be renewed for 2023 and battery makers are well stocked. Prices will remain historically high, but the sentiment and momentum will drag it down. I can see some real nice opportunities in the sector later in the year. Coal is a similar story with the EU expected to have a milder winter and an abundance of gas on hand. China is also ramping up their own domestic production. Again, prices will remain historically high in comparison but well below current spot and again negative sentiment will drive prices down. I can see prices of some stocks falling 50%+ from their recent highs. Lots of profits to be taken off the table here.

AVOID- Discretionary Retail- This is a shorter-term play as I think most of the damage is already done here. We all know spending on goods will slow dramatically in 2023 as households tighten up but the sector has already anticipated this and fallen 20-30% from their highs on most names. A lot of the bigger names like JB Hi-Fi are only trading 11x forward earnings so much of it is factored in. However, in Q1 I think we get some really soft retail figures and updates, and we see a capitulation sell off in the sector. This will provide opportunity for some quality names.

Now I have only mentioned a handful of names as suggested exposure above, but there are many more and will be more to come. It will also come down to the individuals own risk tolerance and needs & wants.

I will wrap it up for the year here. Now as you may have picked up earlier, we had our beautiful daughter arrive on the 3rd November. Olivia Jade Moss has brought such joy to our family and is a very healthy and happy little baby. Mum is doing very well also and is such a brave and inspirational person. Getting used to 3am feeds again is a challenge, but it doesn’t last forever and is all worth it in the end. The boys have finished reception and Kindy with the youngest starting school next year. Again, very bittersweet as we are so very proud of them both and they make being parents such a joy but also sad seeing them grow so fast. You never get enough time with them when they are this age.

In closing I would like to wish you all a very Merry Christmas & a Safe and Happy New Year. Please look after yourselves during the festive period. I can’t wait to speak with you all next year where I hope we can look forward to much better conditions than in 2022. Go Crows!

Important Notice

Any advice in this article should be considered General Advice only and does not consider your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.