Get ready for the sharemarket switch
This week’s ASX correction signals a major change where inflation will dictate the winners and losers on the sharemarket.
Guess what? While you were at the beach the investment markets just did a U-turn. We’ve had a sharemarket correction on the ASX, a breakout of inflation and more importantly a major shift in how money will be made this year.
But it hardly came out of the blue. The ASX correction – a loss of more than 10 per cent from top to bottom – has taken more than five months. So far, it’s a half-baked sell-off mainly because the underlying fundamentals still look too strong to justify a dramatic reversal.
In fact, the ASX had barely registered that accumulated 10 per cent drop before the big investment banks were calling it a buying opportunity. In other words, this correction is first a sign of things to come rather than a heart-stopping sell-off.
Shares are widely expected to return more than 10 per cent again this year, but it will be much more volatile. Keep in mind we have barely had a setback since the Covid crash of mid-2020.
Instead, we might see the correction as the ringing of a bell: we are heading into a major long-term direction change on the markets. Rising rates and inflation means the days of easy money are over.
Investors are changing their approach not because we will soon get a rate rise, it’s because we are soon to enter a rate rise cycle.
Money markets are now signalling Australia’s first rate rise could be in May, while in the US it could be March.
In reality, the Reserve Bank will aim to hold out for longer, although the number of economists who believe it can delay a rate rise until the end of the year is dwindling by the day.
Inflation, on the other hand, is here, there and everywhere. It is running at 3.5 per cent annualised in Australia. In the US it is at its highest level for 40 years. In New Zealand this week, the latest inflation reading was the highest in 30 years at nearly 6 per cent.
Looking back over recent months, the writing has been on the wall – senior executives have been noting inflation for 12 months. In October last year, construction group James Hardie became the first major company to call out inflation in its sector. Four months later, executives at iron ore major Fortescue were reporting a 20 per cent increase in quarterly costs.
As the inflation forces edged into our market, the “growth at all costs” trade has been fading fast. There is no better example than our profitless buy now, pay later sensation, Afterpay.
On the day Jack Dorsey’s Square announced its takeover, Afterpay stock was worth $126.21 – now it is trading around $66.50.
In a similar vein, a swath of speculative hard-to-believe-the-story stocks have been dumped by investors, culminating in the halving in value of bitcoin, the ultimate speculative investment.
Looking wider, we can also see the big switch had started in earnest on Wall Street in November. As Russel Chesler at VanEck noted this week, “we have seen a rotation away from growth stocks into value – value stocks have outperformed growth stocks by a massive 17 per cent since mid-November.”
Financial adviser Doug Turek puts it this way: “The change came months ago. Investors need to understand what’s going on – inflation is here, in every market. It demands a change of approach.”
Turek says inflation and rising rates redraw the lines across the entire portfolio of investments – bonds will struggle, while hard assets such as gold or even residential property can benefit.
But it is in the sharemarket where investors must move first in order to be able to keep ahead of inflation. They need companies that can offer rising dividends and, most importantly, stocks that can put through price rises when they come down the line.
What might this change look like for the Australian investor?
The standout sector bracing for a sell-off is technology. Investors in the nation’s All Tech index are in for a trouncing – over the year to date, it is now down about 20 per cent, which is twice as much as the broader market.
But more generally we may now be compensated for the relatively light weighting tech has on our market, which is dominated by banks, miners and industrials.
In fact, the miners would appear to be the standout sector in the months ahead, if current commodity price assumptions hold. The combination of core earnings from staples such as iron ore, topped off with the promise of battery metals such as copper, offers a strong backdrop from the major miners that may deliver dividend yields of 10 per cent-plus.
Banks may prosper too, though the picture is mixed. Higher rates should mean better margins for the best run banks, but a range of other issues could provide a drag on earnings, from higher wage costs or any extension of the recent reversal in consumer sentiment.
The strongest case is made for major stocks that can make their own prices. Value stocks will typically have strong numbers, an improving outlook for profits and dividends and ideally a share price that has yet to fully reflect the big swing to value.
Watch the improved outlook for BHP, CSL, Woolworths and blue chip stocks at all levels over the coming months.
Conservative fund manager SG Hiscock offered an example of the big switch being played out in the market this week when it explained how it was selling out of Reliance World Wide, a plumbing parts multinational much favoured by institutional investors, and buying into Computershare, the staid but reliable share services company where inflation and rising rates should be a tailwind.
In the months ahead, we will see these sort of trades repeated endlessly across the wider market.