By Nick Hedley
While investors are preparing for a possible recession in the U.S., the outlook for Australian stocks is more positive thanks to attractive valuations and market dynamics that are shielding the domestic economy from global shocks, says Tim Rocks, chief investment officer at Evans & Partners.
Like many other allocators, Rocks remains cautious about the U.S. market, despite the recent decline in valuations. Macroeconomic risks are escalating as the Federal Reserve attempts to keep inflation in check.
However, equities in Australia and Asia were “oversold” in the first half of 2022, and Evans & Partners has been taking advantage of attractive valuations in the region, Sydney-based Rocks tells Markets Group.
The Australian economy is holding up relatively well, thanks in part to elevated commodities prices, which could boost mining investments.
At the same time, the labor market is on solid footing. At last count, the Australian Bureau of Statistics put the number of job vacancies in Australia at 480,100 – a significant increase since the start of the pandemic. Unemployment in June was at 3.5%.
Further, Rocks expects the new government, led by Anthony Albanese and his Labor Party, will increase spending rather than cut back.
Albanese has pledged to accelerate the decarbonisation of Australia’s economy, and this will generate more demand for “green” commodities such as lithium, graphite, copper, and aluminium.
The global decarbonisation drive, which has been accelerated by Russia’s war on Ukraine and Europe’s energy crisis, is expected to support long-term demand for these metals. Evans & Partners’ modelling shows that copper production is expected to fall well short of what is needed over the next decade.
All things considered, Rocks says a full-blown recession in Australia is unlikely. And since the economy is close to full employment, with high vacancy levels, job cuts in a downturn would probably not be widespread. This, in turn, will protect the housing market.
“I think Australia’s economic outlook is a lot more boring than many people expect,” Rocks says.
With domestic earnings forecasts being revised upward, valuations recently hit their lowest in a decade, barring the sell-off of March 2020.
Asia is also relatively compelling, according to Rocks.
“Two years ago, there were 1,000 reasons to exit China as COVID restrictions hurt the economy and regulatory developments impacted sentiment. But a lot of those risks are significantly turning, and I see no reason why China won’t slingshot out of lockdown like other countries did, particularly with the amount of stimulus coming through ahead of the Communist Party National Congress in October.”
While most large economies are edging closer to recession territory, Rocks says China “is in a totally different part of the economic cycle. Yet markets don’t reflect that – valuations are low.”
As such, high-beta Chinese equities, including tech stocks listed in Hong Kong, could be poised for a recovery.
Meanwhile, Rocks says fixed income is looking slightly more attractive as an asset class, although “we want to see the reestablishment of some kind of term premium – investors aren’t currently being rewarded for taking on duration risk.”
If inflation proves to be sticky rather than transitory, this is not yet priced in, he adds.
Elsewhere, some currencies “are really interesting”, including the Australian dollar, which has held firm thanks to high commodities prices.
Evans & Partners has been trimming its exposure to alternatives, partly on concerns that the big pool of capital raised by private equity firms in recent years is not being allocated.
Rocks is also wary about private credit. “Wherever there’s been a flood of money, there will be disappointment when the tide goes out, and private credit is one of those areas.”
In recent years, private credit funds have mopped up segments of the market that banks were avoiding, implying a transfer of risk from banks to private investors. Some funds may struggle moving forwards.
Rocks also believes “the great unwind of crypto” could be unfolding as high levels of leverage in the digital currency market are exposed by the withdrawal of liquidity.