Inflation, investing and what to look at on the ASX


Not a lot of people have been invested in an inflationary environment before, says SG Hiscock & Company portfolio manager Hamish Tadgell.
Essential infrastructure and commodities. | Image source: Sina Schuldt/picture alliance via Getty Images

Investors who have not experienced an inflationary environment might need to review their strategies, says SG Hiscock & Company portfolio manager Hamish Tadgell, who believes the investment landscape is changing.

“Not a lot of people have been invested in an inflationary environment before,” he says, and rising geo-political tension, changes in the availability of energy and labour, at a time of higher interest rates, higher inflation and higher costs, will contribute to lower real returns and put company valuations under pressure.

“Australia has outperformed most of the developed world this year and there’s no reason this shouldn’t continue into 2023,” says Tadgell. “We have a robust democracy at a time when a number of countries are seeing a hollowing out in their political systems and more of a divide between the left and right.

“Our superannuation system is also structured in a way that provides a strong basis for financial investment and security. We’re heavily resources-rich, in terms of both hard and soft commodities such as lithium, copper and nickel and gas, which will be important in the energy transition and is in demand from the rest of the world,” he says.

“Looking into 2023, we are conscious of balancing the headwinds from tightening financial conditions against the large de-rate we have already seen in valuations as real yields have increased.”

Tadgell says that if the inflationary impulse in Australia remains below European and US levels and the pace of RBA rate increases slows, it should be a further net positive for Australian equities to the extent it would help allay recessionary fears and concerns of higher bad debts cycle.

“It also needs to be remembered that ultimately the intention of central banks in raising rates is to tame demand and thereby inflation. This increases the risk that company earnings will eventually slow into next year,” he says, adding that equity markets are likely to remain volatile.

Commodities, gas and decarbonisation

He notes that clearly Australia has a lot of what the rest of the world wants. “We’ve got a lot of soft and hard commodities … copper and iron ore and nickel and those types of commodities are in strong demand are going to be a very important part of the decarbonisation” process and gas will be a “critical part of the transition to a lower carbon economy”.

“A lot of people focus on the speed of transition. I always talk about the speed and the reliability and energy security.”

Rising prices, or blackouts are disruptive to the economy, so gas will play a critical part by “providing that baseline capacity which is going to enable that transition to low carbon”, Tadgell says.

Small caps and consumer confidence

Rising mortgage costs could have a serious impact on spending behaviour in the first half of next year, and he says, “we are particularly cautious at the moment around consumer discretionary”.

“But we certainly see some opportunities in the small cap sector. Valuations have corrected quite significantly in some areas and that is certainly providing some opportunities, but it’s a case of being selective, and I think active, in this environment, given the risks.”

When borders reopened after Covid lockdowns there was “pent-up demand”, but travel right now is being constrained by where prices are at, Tadgell says.

“One of the things we are watching pretty closely is the Chinese airlines. If China starts to open up, I think you’ll start to see a lot of the Chinese carriers start flying in. That’s really important in terms of inbound because it starts to bring in additional volume and that should force domestic carriers to put more volume back on as well. The problem at the moment, I think is that the domestic airlines are still operating at sort of 60% to 70% capacity … With a bit more inbound people it would help the domestic market recover.”

Tadgell says he likes essential infrastructure (telcos) and essential services, but he said no matter what the company, balance sheets were the thing to watch.

Watch the balance sheets

“You really want to watch balance sheets at the moment … it’s one area that I think the market is not sufficiently focused on at the moment.”

He thinks there’s a number of companies that are unprofitable and says, “the question will be have they got sufficient cash to get them through?”

Companies that are burning cash could find it difficult to recapitalise in this market, Tadgell says, adding, “I think that as we move into next year, my view is that it’s going to be difficult to raise money in the secondary markets”.

“The markets have become a lot more discerning in terms of what they are prepared to fund. The idea that ‘we’re going to raise money and be unprofitable for another three or four years’ … It’s just not cutting it.”

This article represents the views only of the interviewee and should not be regarded as the provision of advice of any nature from Forbes Australia.  The article is intended to provide general information only and does not take into account your individual objectives, financial situation or needs. Past performance is not necessarily indicative of future performance. You should seek independent financial and tax advice before making any decision based on this information, the views or information expressed in this article.