Weekly Reports | Sep 23 2022
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Chance of a global recession, Australian equity valuations, winners from food & beverage inflation, and more rain expected.
-Oxford Economics does not see a global recession
-Australian equity valuations fair, says Wilsons
-Jarden pricks its winners from ongoing increases in food & beverage inflation
-BOM warns of a wet spring and summer, impacting general insurers
By Greg Peel
Oxford Economics continues to believe the global economy will narrowly avoid a recession, despite expecting the US, Canada, and most of Europe to fall into recession at some point over the next year or so.
Avoidance of a global contraction while several large economies fall into recession wouldn't necessarily be an unusual outcome, Oxford notes. Since the 1980s, there have been nine advanced economy recession clusters, but only five of these have coincided with two or more consecutive quarterly falls in global per capita GDP – the benchmark for a global recession.
Oxford points out that all five US technical recessions since 1980 have coincided with a global recession. But the economists expect the upcoming peak to trough GDP fall in the US to be far smaller than in any of the previous five slumps. Therefore, it is reasonable to believe a global contraction could be avoided.
However, it wouldn't take much additional advanced economy weakness to mechanically push the world into recession, Oxford warns. But risks aren’t solely tilted to the downside. In particular, a sharp drop in European energy prices and/or decisive action by governments to protect the economy from the energy shock could lead to milder recessions in Europe.
The only region Oxford sees as escaping two quarters or more of falling activity is Asia-Pacific. For most economies that do fall into recession, the duration is expected to be only two or three quarters, and all the quarterly contractions in activity within the advanced economies take place between now and the June quarter next year.
Australian Equity Valuations
Australian equity valuations have experienced one of the largest reversals of any major market, Wilsons notes, down -30% from the peak in December 2020 on a forecast price/earnings basis (and down -15% this year).
The market currently looks undervalued, Wilsons suggests, relative to its own long-term average, and appears attractive compared to global peers. Buoyant earnings in the resource sector likely overstate Australia’s valuation appeal to a degree, but Wilsons thinks domestic valuations are at least fair.
Although valuations are a key signal over the long-term, they are just one piece of the puzzle, along with factors like monetary and fiscal policy, the near-term economic outlook, sentiment and positioning.
Understanding how these factors evolve through the cycle and what investment horizon they provide signals for is helpful in determining the weight to give them, the analysts note. Lower valuations partially reflect the rising interest rate environment and concerns that earnings will be subject to significant downward revisions reflecting slowing growth.
Wilsons remains Neutral on equities, waiting for a confirmation of a sustained cooling in inflation and policy hawkishness before considering an upgrade.
On the subject of inflation, Jarden surveyed 56 Fast Moving Consumer Goods retailers earlier this month and to Jarden, the results were clear.
Inflation will accelerate. Prices increases of 8.6% have been put through with 72% planning further increases in 2022.
Aldi will re-accelerate. The value shopper is returning and Aldi is forecast by Jarden to be the second fastest growing retailer over the next 12 months, with Woolworths ((WOW)) number one. Expectations have moderated for IGA (Metcash) and online in general. Supplier margins are under pressure, while retailers are faring better.
Price increases trail cost inflation for suppliers, Jarden notes, while retailers are creeping up prices and pushing for terms, suggesting further gross margin expansion to come.
But the market outlook is challenged. Caution exists around the ability to generate volume growth over the next 12 months, with 2.9% annual market growth the consensus forecast.
Jarden views this as too low, and continues to see upside risk in 2023. Overall, Jarden views the survey results as positive for listed retailers, with Woolworths to outperform, as will all retailers with scope to improve margins via cost leverage and terms.
Woolworths and Treasury Wine Estates ((TWE)) remain the key picks across the FMCG space, but Jarden sees all of Woolworths, Treasury Wines, Coles ((COL)), Metcash ((MTS)) and Costa Group ((CGC)) as price-setters that can benefit from inflation.
Rain Rain Go Away
The Bureau of Meteorology notes all three main climate metrics point to a very wet spring and wet summer in parts of Australia. La Nina is back, the Indian Ocean Dipole (IOD) is negative, and the Southern Annular Mode (SAM) is positive.
The BOM’s models suggests La Nina may peak during spring and return to neutral in early 2023, the negative IOD should continue into late spring, and the positive SAM is expected to continue for three months.
La Nina is associated with elevated rainfall in northern and eastern Australia in spring/summer, a negative IOD usually brings elevated rainfall across all of Australia, and a positive SAM mostly impacts NSW and Victoria. Put it all together and eastern Australia in particular is in for a wet time.
JPMorgan notes, unsurprisingly, that such a set-up historically leads to increased catastrophe costs for general insurers. La Nina years have seen average catastrophe cost of -$3.9bn and negative IOD years of -$2.2bn, separately, compared to an overall average of -$1.8bn for all years.
La Nina and a negative IOD do not often converge, JPMorgan notes, but costs when they did in 1974 and 201 averaged -$6.76bn.
After two years of climate disasters, from fires to floods, reinsurance cover against catastrophe costs has weakened materially for both Insurance Australia Group ((IAG)) and Suncorp ((SUN)), JPMorgan warns.
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