The Iceman Cometh: Death, taxes, a 25bp rate hike and a portfolio skewed toward lenders and staples
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The good folk at the RBA meet today @ 2:30pm (Sydenham time) to make a call on the cash rate.
Of some 23 sterling market economists surveyed by our annoying direct competitor Bloomberg, 11 forecast a 40 basis point (bps) increase to 0.75%.
Eight expect a 25bps hike to 0.6% and three expect 50bps to 0.85%.
Azeem Sheriff, markets analyst for CMC Markets APAC and Canada, told Stockhead there’s pretty clear consensus among economists that a rate hike is imminent with the chance of anything less than 25bps ‘almost negligible.’
“With the impending June decision three things are certain – death, taxes and the RBA hiking at least 25bps,” Sheriff said.
But while the RBA began hoisting the cash rate in May – from 0.1% to 0.35% after an era of a record, near zero cash rate – Sheriff warns a 40bps rate hike could further dent confidence in the already diffident consumer housing market, with house prices already starting to drop from May’s rate hike, first time since COVID-19 arrived, bags packed on our doorsteps.
For now, Azeem says, given the global economic state of play and assuming the RBA Board, led by Governor Philip ‘The Iceman’ Lowe, continue to be “a patient bunch and like to observe conditions”, the logical outcome is a 25bps lift.
Last week the Aussie trade balance was in surplus $10.49bn with net exports up 1% and net imports down 0.7%, while the lower Aussie dollarbuck was giving exporters more bang for their dollarbuck. Importers on the other hand had to pay more AUD to obtain goods from overseas which restricted their trade/orders.
“On these releases alone, the RBA won’t appear to require an aggressive hawkish stance to increase the cash rate by 40bps, making 25bps more appropriate as all data was more or less in line with expectations.
“My money is that the RBA still maintain a patient stance and will observe how another 25bps may impact the economy, preparing for another 25bps in July’s meeting, in preparation of getting ‘ahead of the curve.'”
A potential second rate hike in 12 years has direct implications on housing and equities.
Sheriff has his beady eye on the ASX this arvo for any upward movement across the Financial sector, Consumer Discretionary and Consumer Staples – sectors which benefit from rate rises on the whole.
Real Estate and Industrials, he warns, generally feel the pinch from higher financing costs and reduced capital expenditure.
“Although the RBA doesn’t focus on dwelling prices, they’re very aware of the relationship between house prices, consumer sentiment, spending and financial stability – so hiking rates too quickly can risk house prices falling dramatically, which it already has begun, having a rippling effect on the economy.
“Preferably, it would be easier for house prices to adjust progressively with consistent incremental rate hikes, becoming less problematic for the economy,” he says.
On the property front, Eliza Owen, head of research at property data firm CoreLogic, says the math is pretty simple – higher interest rates limit borrowing capacity, so they influence the number of buyers in the market.
“For this same reason, rising interest rates tend to put downward pressure on property prices.”
As the Australian housing market enters a downturn phase, the number of sales and listings that take place nationally are tipped to fall from recent highs.
In May, there were 39,790 estimated sales settled across Australia. Eliza says while that’s high for this time of year, it is almost 27% lower than in April of 2021.
“In fact, monthly sales volumes across Australia have generally been trending lower since November last year.”
Historically, possibly because we’re both insane and stupid, more properties tend to get bought when property values are rising.
According to CoreLogic, at the moment both sales and values are broadly moving in line with one another, making it hard to determine which of the two factors is a leading indicator of market conditions.
“On the one hand,” Eliza says, “a decline in sales numbers reflects a decline in demand, as the absence of buyers forces vendors to lower their prices.”
“On the other hand, falling prices can reinforce lower sales numbers, because property price falls may deter buyers who consider purchasing in a falling market more risky.”
Australia’s ‘turnover’ rate (how much of the country’s housing stock is sold) bottomed out in mid-2019 at 4.0%, which also marked the trough of the last dwelling price cycle. Then the national turnover rate hit a decade high of 6.2% through the recent record peak growth period in 2021. At the end of the March quarter, turnover had eased to 6%.
“In a way, lower advertised listings during price falls points to an element of stability in the housing market over time. As long as potential home sellers are able to meet their mortgage repayments, there should be relatively low instances of forced sales,” Owen says.
“Instead, more sellers may choose to hold their property during a downswing, and try to list when they can capitalise on higher prices.”
Aussie sectors which generally benefit from a rising cash rate are usually counting their dollarbucks in the Financials sector.
Here we can find “peeping about under the huge legs of the big four banks”, the wee banks, the listed fundies, the insurers, the investment vehicles, the brokers and the broken, – like you, Magellan.
When rates rise this sector is its own little wonderland of increased profit margins as higher returns flow onto other interest rate sensitive parts of the economy, delivering increased spreads and juicier net interest margins (NIM). On the whole it’s a big net positive to the banking sector’s earnings profile.
Sheriff also says both Consumer Discretionary and Consumer Staples tend to maintain their growth in rising rate environments from consistent high demand, improved employment, wage and income growth resulting in higher expenditure.
On the flipside, CMC Markets say stay clear of the Industrials/Mining and Real Estate sectors, which might cop more headwinds via the rising costs to finance equipment including CAPEX, construction and development.
“Costs will rise from higher interest rates therefore reducing their ROI, return to shareholders and ultimately a lower share price.”
Datt Capital’s Emmanuel Datt says the last time we saw these economic conditions was back in that beautiful place we call the ’70s. When the energy sector stood up and said ‘we’re really going to enjoy this oil shock’. By comparison, he adds, the worst returns were coming from the technology sector.
“Value and small cap assets performed best throughout the decade, with growth assets and government bonds providing the worst relative returns.”
Datt’s top three sectors are Energy – previously cheap and unpopular thanks to ESG mandates and a clear beneficiary of inflationary energy prices; Agriculture – defensive and with lower returns; as well as ‘Tangible goods and commodity producers’ – which will benefit from the trend towards greater localisation.
When it comes to rising rates and equities, Ron Shamgar likes to name names and believes EML Payments (ASX:EML) is the number one ASX beneficiary from rising rates.
“As an e-money issuer globally, they currently hold a growing balance of customer card funds worth $2 billion and EML gets to invest those funds but at the moment, with rates at zero, aren’t making any return.
He says investors should think that for every 1% rise in rates across US/UK/Euro, EML earns $20m of incremental profit.
“Hence if rates rise 2-3% next couple of years, EML will earn an incremental $40-60m of profit – which is 2-3x their current profitability.
“We don’t believe investors have fully grasped this and this is why EML is our top pick for 2022,” Ron says
Shamgar also reckons People Infrastructure (ASX:PPE) – a provider of workforce solutions (mainly in health and IT) – is a massive beneficiary of wage inflation driving higher margins, as they earn a commission.
“In addition, low levels of unemployment in Australia, and a high turnover of employees, are all factors seeing higher demand for PPE services.”
“The next catalyst for the stock are acquisitions which they have been very disciplined on,” he said. “Our valuation is $5.00.”
OFX (ASX:OFX) is provider of Forex services to consumers and corporates globally.
“As revenue is transaction based, OFX is a beneficiary of elevated inflation,” Shamgar explained. “Management has upgraded FY22 guidance from 10% growth to 17-22% revenue growth and we think that’s conservative based purely on Q3 run rate.
“The acquisition of Firma in Canada should see EBITDA grow to $55M in FY23 which places OFX on 10x EV/EBITDA valuation.
“This in our view is cheap compared to global peers and we think OFX is worth $3.00.”
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.