In Brief: Sectors & Stocks For A Volatile 2022

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Weekly Broker Wrap, In Brief: Preferred equity sectors; interest rates and suggested stocks.

– Expect increased volatility on world equity markets in 2022
– Quality defensive shares are preferred 
– RBA cash rate to lift to 1.75% to 2.00% by the end of 2024
– Potential for a -5% to -10% drop for overseas and local shares
– Wilsons' Focus List and Conviction Insights for Australian shares

By Mark Woodruff

T Rowe Price leans toward quality defensive shares in volatile times

Contradictory fears of policy withdrawal and higher inflation suggest a difficult quarter or two lies ahead for financial markets.

Increased volatility is an inevitable consequence, and the flipside of extreme monetary accommodation, according to T Rowe Price, while the hangover from massive fiscal stimulus is fiscal drag. The latter is considered a looming headwind for economic growth and company earnings, marking a new “deceleration phase” for the market cycle.

While the global economy is back in a firm growth trend and no longer requires exceptional policy support, T Rowe feels markets may still protest loudly when support is withdrawn next year. 

Globally, inflation surprises to the downside are expected in the second half of 2022, as production normalises in most economies. Meanwhile, Australia is not believed to have an inflation problem at all. With GDP growth averaging no more than 1% over 2019-21, there is a large margin of spare capacity. Moreover, the delta and omicron variants are expected to weigh on economic activity and dampen growth and inflation. 

What does all this mean for equities? T Rowe Price estimates slowing growth is a headwind for earnings, particularly for Cyclical and Value stocks and believes quality Defensive shares are more suited to 2022’s market environment.

While the first rate hikes in Australia are expected later in 2022, they may not prove to be such a big headwind for Growth stocks, in T Rowe’s opinion.

National Australia Bank’s timeline for interest rate rises

National Australia Bank economists also expect uncertainty and volatility in 2022.

They forecast the US Federal Reserve will hike interest rates three times in 2022 and the RBA will lag this timeline until mid-2023, while awaiting a pick-up in wages growth. However, financial markets are considered likely to challenge the ‘gradual process’ messaging from the RBA. 

While NAB estimates the RBA cash rate will lift to 1.75%-2.00% by the end of 2024, five factors that may alter the tightening schedule are explored.

The first is around wage expectations, which according to recent surveys remain low, though the NAB will be monitoring trends given the RBA’s view that wages growth at 3% plus is needed to sustain inflation at 2-3%.

Another key unknown is how self-sustaining will economic activity be once stimulus is withdrawn. Markets are currently pricing a lower peak for interest rates than was the case prior to the pandemic and NAB agrees.

Thirdly, the range of ever-present covid scenarios (vaccines, variants and booster shots) is explored, a subject upon which I’m confident the reader is fully apprised via the daily press.

The bank will also be monitoring developments out of China where the outlook in recent months has dimmed, following efforts to reign in excesses in the property market and struggles to continue with a zero-covid policy. However, there’s considered new hope from recent comments by President Xi “ensuring stability is the top priority for the economy next year”.

Finally, the NAB expects downward pressure globally on inflation from a tilt towards consumption of services over goods, which should lessen impacts felt from supply chain disruptions. 

Wilsons suggested stocks

Wilsons backs what is now becoming a common theme of 2022 equity market volatility.

A quick -5%-15% drop in US and local shares is not out of the question, should the Federal Reserve become more hawkish in a persistently high-inflation and slowing-growth environment.

Nonetheless, the broker sees a constructive backdrop overall in 2022 due to the fading influence of the pandemic domestically, along with reopening, consumer savings, corporate spending and continued policy support.

Wilsons predicts the first signs of easing inflation will emerge by late in the first quarter of 2022, and the initial rate rise is likely to be from 2023, ahead of the RBA’s current thinking.

The broker has compiled a Focus List of stocks that is positioned for an improvement in earnings through thematic exposures in quality Cyclicals, many of which can manage any inflation risk that may arise by passing on higher costs.

These include Seven Group Holdings ((SVW)), Macquarie Group ((MQG)), James Hardie Industries ((JHX)), Insurance Australia Group ((IAG)), Qantas Airways  ((QAN)), Oz Minerals ((OZL)), News Corp ((NWS)), Santos ((STO)), BHP Group ((BHP), the major banks and Judo Capital ((JDO)). 

The broker feels companies with pricing power like Aristocrat Leisure ((ALL)), James Hardie Industries and Seek ((SEK)) should also be able to defend margins by pushing through price rises.

To insure to some extent against volatility, Wilsons includes in the Focus List the relatively defensive HealthCo Healthcare & Wellness REIT ((HCW)), Telstra ((TLS))), Northern Star Resources ((NST)) and Insurance Australia Group.

The broker also retains key overweight positions in CSL ((CSL)), Goodman Group ((GMG)) and Xero ((XRO)).

Emerging companies make up just below 20% of the Focus List, and include EML Payments ((EML)), Silk Laser Australia ((SLA)), Telix Pharmaceuticals ((TLX)) and the previously mentioned Seven Group Holdings, HealthCo Healthcare & Wellness REIT and Judo Capital.

In a separate exercise, analysts at Wilsons have been tapped for their strong conviction ideas (Conviction Insights) which are arranged under four key sub-headings.

ARB Corp ((ARB)) and Collins Foods ((CKF)) are grouped under Food & Agriculture/Automotive, while Plenti Group ((PLI)) sits under Consumer Discretionary/Diversified Financials.

Under the umbrella of Healthcare/Biotechnology sit Aroa Biosurgery ((ARX)) and Immutep ((IMM)), while ReadyTech ((RTH)) is self-evidently filed under Technology.

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