The vicious cycle of equity valuations

Marcus Bogdan

Blackmore Capital

“Having badly misjudged the strength of inflation over the past year, central banks are now anxious to convey the message that they are determined not to repeat the mistakes of the 1970s.” - John Plender Financial Times September 2022

In the shadow of a dramatic rise in government bond yields, the ASX 200 fell 6.20% in September. An aversion by investors to higher yields had a significant impact on Real Estate (-13.6%) and Technology (-10.6%), whereas Materials (-2.3%) and Energy (-3.8%) recorded the smallest falls in September. 

The market still faces headwinds

It is self-evident that the optimism in stocks which manifested itself as earnings recovered strongly from the depths of the pandemic has now been deflated. Equity markets are facing five main macro headwinds, notably rising rates, slowing growth, elevated geopolitical risks, stubbornly high inflation, and a strong US dollar. This has created a vicious cycle for equity valuations with the ASX 200 12-month-forward PE compressing from over 18 times to ~13 times this calendar year.

RHC and the healthcare industry

At a company level, the KKR-led Consortium bid for Ramsay Health Care (ASX: RHC) collapsed in September following the announcement that the Consortium was not able to improve the terms of an Alternative proposal ($88 cash for first 5000 shares then $78.20 cash + 0.22 Ramsay Sante shares). 

Notwithstanding this, the ~20% fall in Ramsay’s share price now offers medium-term valuation support. Critically, the latest Medicare Data and industry feedback suggests that the delayed recovery in healthcare procedures is now showing tangible signs of recovery. Faced with an unprecedented backlog in elective surgery lists healthcare providers are well-placed for a sequential recovery in earnings.

The impact of AGM season

In the immediate future we believe that the financial pressure of tighter financial conditions will continue to weigh on equity market valuations. Yet despite a myriad of economic headwinds, it is noteworthy that the recent earnings reporting period conspicuously highlighted that underlying demand remains strong, supported by a robust labour market and well capitalised corporate balance sheets. We expect the upcoming AGM season should provide insight into whether there are signs that recent rate hikes are beginning to moderate economic activity.

Portfolio implications

From a portfolio perspective, we can continue to favour companies that offer stable growth in the consumer and industrial sectors, in healthcare as earnings recover from pandemic disruption, and in the energy and resources sector where structural shortages in supply should support higher prices as the global economy decarbonises. 

Long term investors, not speculators

With over 25 years’ experience of being dependable custodians of investor capital, we have navigated through a myriad of market cycles and delivered capital accretion by applying our time-tested investment framework with relentless discipline.

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Marcus Bogdan
Chief Investment Officer
Blackmore Capital

Marcus is the co-founder and CIO of Blackmore Capital. Marcus' career spans over 27+ years focussed on Large Cap Australian Equities including work as a research analyst at McIntosh/Merrill Lynch, Portfolio Manager at Cooper Investors, and CIO...

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