Rates, US recession risk, Chinese growth and government intervention will set the underlying economic picture for Aussie stocks this year, says Pendal’s CRISPIN MURRAY

• Aussie equities remarkably defensive
• Four issues will drive the underlying economic picture
• Find out about Pendal Focus Australian Share fund

AUSSIE equities have proven remarkably defensive over the past 12 months compared to global shares and other asset classes — delivering a 6.5 per cent return in the year to February, says Pendal’s head of equities Crispin Murray.

The recent ASX reporting season delivered an earnings revisions distribution — the ratio of upgrades to downgrades — in line with long-term averages as a post-Covid sales boost dissipated.

Earnings are on track for 2 per cent growth in 2023 and 1 per cent in 2024, Murray says in his new biannual Beyond The Numbers webinar.

That means a material decline in shares is unlikely over the course of 2023, he says.

“However, if we do get the RBA forced to hike rates far higher than the economy can absorb — and we do get a downturn — then we’re going to see much more material downgrades.

“That is the risk scenario for the market. But that is not the scenario we expect.”

Remarkably defensive

Why have Australian companies proven relatively defensive over the past year?

Partly it’s structural, he says.

The Australian share market skews to financials and resources. Banks have benefited from higher interest rates and commodity prices have buoyed the mining companies.

But a more important underlying explanation is the rise in company earnings that has meant that even as stock valuations fall in the face of higher interest rates, stock prices have been largely unaffected.

“What we’ve actually been able to achieve in Australia is a derating of the market without the actual market having to drop because earnings revisions were positive and these were positive across all parts of the market,” says Murray.

“Even the industrials really haven’t been exposed to an economic slowdown and they were bouncing back from impacts of the pandemic.

“Where we are sitting today, we’re quite comfortable with the overall rating of the market.”

Four key issues

Four key issues will drive the underlying economic picture for Australian companies, Murray says:

1. The risk of a US recession

The US economy is proving more resilient than many people thought, Murray says.

“There has been a material change in US interest rates and for a lot of people that was inevitably going to lead to a recession — but it so far has not.

“There is clearly now a school of thought saying that the US economy is more resilient.”

He says some measures of monetary tightening suggest the worst has past, setting the US up for soft landing.

On the flipside, a “very negative” yield curve and the biggest ever one year decline money supply growth since the 1930s indicates tough times ahead.

“As we stand today, we would expect perhaps a mild recession — we’d still be somewhat cautious.

And that’s why we believe that you still need to be very careful about what you’re paying for certain companies in this market environment.”

2. The outlook for Chinese growth

The growth of China is a significant factor in the success of Australian corporations.

Murray says the key question for investors is how much Chinese growth can accelerate out of the zero COVID period.

“China dealt with COVID very differently to the rest of the world.

“They did not throw anywhere near as much stimulus at their consumers so they saw consumer spend falling well below trend for an extended period.

“So the first thing that will underpin Chinese is growth is a return to that trend level of consumption and that in itself can add 2 per cent to 3 per cent to growth over the next couple of years.”

Growth could be even stronger if Chinese consumers dip into the money they have saved like their counterparts in the US and Australia.

“There is a big debate about whether this will happen,” says Murray, noting Chinese people are typically quite cautious in terms of their saving to protect themselves and their families’ health care and education.

”But clearly, China is in a far better position today than it was six or 12 months ago.”

3. Interest rates and their impact on the Australian economy

Closer to home, the trajectory of the Australian economy is a critical driver of corporate earnings and an important factor in determining which parts of the market to invest in.

The key to the economy is interest rates.

Mortgage repayments in Australian households as a percentage of disposable income have risen in line with rates, but there has been a change in mix — as people pay more interest they are cut back on principal payments.

This is a reversal of the recent past, when low interest rates allowed higher principal repayments.

“This probably explains why we haven’t necessarily seen any real effect on consumption — as those interest payments are going up, we’re just compressing the principal repayments.”

Murray says that, as a proportion of household income, interest repayments are unlikely to reach the heights of the GFC and should remain below the levels of the early 1990s.

“This doesn’t mean we won’t still see a material consumer slowdown, because the rate of change is material. But it’s not as bad as perhaps it is perceived. In my view, we will not get a recession here.”

4. The growing influence of Australian government policy

A growing trend towards government policy intervention is becoming an issue, says Murray.

Partly, this is evident in the recent regulation of the gas industry and the stepping up of Australia’s carbon reduction pathway.

Murray says he is also hearing from banks that they are concerned about the potential for more regulation on deposit rates.

Companies with a high share of labour costs could also be impacted by the government’s push for real wage increases.

Overall outlook

Overall, 2023 will be a good year for investors with deep insight into individual companies, Murray believes.

“Today reminds me of 2012 going into 2013, where the markets were very thematic — and that’s creating a lot of stock opportunities.

“We are seeing this as a great time to identify opportunities and really differentiate and get some insights into the stock.

“We’re very confident on the outlook.”

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About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

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