Aussie equities have little to fear from rising rates
A booming local economy and a share market packed with miners and banks should offset any damage from higher rates.
Inflation has surged to its highest level since the Howard era, but forecasters remain cautiously optimistic about the outlook for Australian equities, saying steadily rising rates are unlikely to dent a buoyant economy and a share market riding the commodity boom.
Speaking with Morningstar, Anthony Doyle, head of investment strategy at Firetrail Investments, says Australia’s all-important banks and miners could alternately benefit from the rising rates and soaring raw material prices that have sent global markets into double-digit tailspins this year.
“The outlook for Australian equities is pretty strong,” he says. “There’s the strength of the consumer, low unemployment and the structure of the market here relative to say an S&P 500, which is overweight those quality growth companies that have been hammered by rising interest rates.”
Wednesday’s record inflation reading has analysts betting the Reserve Bank will launch its campaign against higher prices when it meets next Tuesday. It would be the first election campaign hike since 2007. AMP Capital expects a jump to 0.5% while ANZ and UBS expect an increase to 0.25%.
Kerry Craig, global market strategist at JP Morgan, is positive about the local equity market thanks to rising commodity prices and a strong economy bolstered by wealthy households and rising wages. While he sees rates increasing steadily this year, he expects them to stop at the “neutral” rate, a point where they neither add stimulus nor contract economic activity.
“The gradual pace of tightening should not be disruptive to consumers or corporates and the continued economic expansion,” he says. “Meanwhile, the support for commodity prices globally continues to benefit Australia.”
Optimistic forecasts would extend months of outperformance that have made Australian equities the envy of the developed world. The benchmark S&P/ASX 200 is down 1.2% year-to-date, mostly sidestepping a 12% fall for the S&P 500 and a 9% decline for Europe’s STOXX 600. The technology-heavy Nasdaq Composite is down 20% into bear territory amid a broad sell-off in growth stocks.
In its April World Economic Outlook, the International Monetary Fund bumped up estimates for Australian growth in 2022 thanks to higher commodity prices. At the same time, the international watchdog cut its forecasts for global growth, citing how Russia’s invasion of Ukraine is stoking commodity prices and inflation as central banks move to raise rates.
History suggests rising interest rates are compatible with positive equity market performance, says Shane Oliver, chief economist at AMP Capital.
During the 2002 and 2008 tightening cycle, local equity markets gained steadily against the backdrop of the original mining boom. Oliver believes investors could see a “mini-version” of that cycle this time around.
“The easy gains are behind us and it’s a tougher slog going forward,” he says. “However, as long as the economy holds up, shares should continue to trend higher.”
Australian consumer prices rose 5.1% in the March quarter compared to a year before, the highest rate since the Goods and Services Tax was introduced in 2000. The Reserve Bank’s preferred measure, trimmed mean inflation, hit 3.9% annually, punching through the bank’s target range of 2%-3%.
Watch China
But’s it not all rosy outlooks. Stephen Miller, an adviser at GSFM Funds Management says Australia’s outsized exposure to China is a potential source of weakness.
As China extends draconian lockdowns in its battle against the latest covid outbreak, slowing growth in the world's largest commodity importer could spill over to Australia, he says.
“The big question for Australia is how pervasive China's slowdown will be," he says.
"Commodity prices might support our market, but China could offset that. In either scenario we're in a challenging market and equities face multiple headwinds.”
Hundreds of ships lie anchored outside major Chinese east coast ports as the city-wide lockdown in Shanghai extends into its second month, stoking fears that supply chain disruptions could ripple out to major trading partners like Australia.
The outlook for commodity prices is more mixed once the possibility of slower growth in China is added to uncertainty over how long the conflict in Ukraine, says David Bassanese, chief economist at BetaShares.
“I don’t think it’s clear skies ahead to be long commodities,” he says.