• T. Rowe Price says Australia will likely face an ‘earnings recession’ in the second half
  • But Australia is best placed to benefit from any China-driven recovery
  • The fund manager is also bullish on lithium producers supplying demand for EV batteries

 

T. Rowe Price’s head of Australian Equity Randal Jenneke has warned that although there are many good long-term investment opportunities in the Australian market, the short term is highly dependent on navigating market volatility and a potential ‘earnings recession’.

Jenneke says that Australia will likely face an earnings recession in the second half of the year, thanks to the RBA and Fed’s rate increases over the past 12 months.

He likens the fall in earnings to Beckett’s play, ‘Waiting for Godot’, which is likely to cause volatility and test the share market’s patience over coming months.

“Volatility caused by short-term waves of over and under-optimism by markets appear likely to continue,” he said.

Jenneke also believes Australia is a long way from interest rate cuts, and even expects a few more rate hikes ahead.

However he reckons that it will not end in a big collapse like we had in 2008 and 2020.

“While a mild recession in order to bring down inflation seems likely, much worse economic scenarios similar to 2008 or 2020 are not on our radar screen.”

 

China and iron ore to be major catalysts

For many Australian investors, the current landscape feels like they are swimming against the tide.

“Fading economic growth, ingrained inflation, hawkish central banks, and falling earnings expectations. Add to this the lagged impact of past rate hikes, and it’s not a pretty picture,” Jenneke said.

He also explained that China’s Covid reopening so far has been pretty disappointing for the world hoping that it would jolt awake the global economy.

“We see China’s reopening in 2023 as initially having held out false hope for the global economy, and for a resources exporter like Australia.”

However, Jenneke says that Australia is best placed to benefit from any China-driven recovery in the price of iron ore, although for now the short-term trends in steel, cement etc are to the downside.

The recent “normalisation” of trade relations between Australia and China is also clearly a very positive development.

“Australia is one of the few countries that enjoys a significant bilateral current account and trade surplus with China,” he said.

Meanwhile, the big mining companies Rio Tinto and BHP have struggled recently due to the weakness in Chinese steel production largely driven by sluggishness in the Chinese property sector.

Whilst the Chinese property sector is showing tentative signs of stabilising, Jenneke says the market was expecting a faster improvement after the country’s economy reopened in December, but that did not materialise.

“Despite near term iron ore price weakness however, Australia’s mega resource stocks are well positioned for any improvement in Chinese steel production, have strong balance sheets and are producing very high levels of free cashflow.”

 

Long lithium, short discretionary

While he’s painted a subdued picture, Jenneke also says there are many quality growth companies that are both reasonably valued and well-positioned, noting that fallen angels in this environment present interesting opportunities for longer-term investors.

He says T. Rowe Price’s investment approach remains focused on the key drivers of excess return, ie: profitability, earnings growth, and valuation.

This is especially important against the current landscape, particularly as cracks have already started to appear in various sectors.

“We maintain a defensive posture in the face of rising earnings risks, and also continue to look selectively for opportunities in oversold growth names,” Jenneke said.

He remains cautious on consumer discretionary stocks, as the more cyclical parts of the market will come under earnings pressure going forward.

“We expect to see quality, defensive and growth companies outperform as their earnings prove to be more resilient.”

He’s also less than enthusiastic about energy and natural resources as global growth slows, but has made an exception for lithium producers supplying demand for EV batteries.

“We own a couple of lithium producers that we believe are well placed to take advantage of the strong demand for EV batteries, while recognising that lithium is only a niche sector within natural resources.”

In summary, Jenneke cautions against buying more expensive high P/E names, bank stocks, and businesses that are generally vulnerable to a cyclical slowdown.

“For now, we prefer to own quality defensive companies with lower earnings risk and more stable profit margins,” he concluded.

 

The views, information, or opinions expressed in the interview in this article are solely those of the fund manager and do not represent the views of Stockhead.

Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.

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