Why we prefer the ASX mid-caps after February reporting season

While Australian companies fared better than expected, we think the market is a touch too optimistic on Australia’s economic outlook. Inflationary pressures are more pronounced locally than globally, requiring the RBA to keep rates on hold for longer. Companies also noted an acceleration in labour costs, driving the implementation of cost management initiatives to protect margins. For our part, we believe there won’t be any rate cuts until Q4. 

Looking ahead, we could see a paradoxical dynamic play out where economic growth is resilient but mortgage stress increases. Australia’s migration surge will support aggregate spending but a "higher rates for longer" environment squeezes household budgets. In this environment, we could see a mid-caps rally, supported by overweight exposure to cyclical sectors such as industrials, consumer discretionary and real estate. Mid-caps reported the highest upward price target revisions.

VanEck recommends an underweight position to the big five banks, notably Commonwealth Bank (ASX: CBA), which we think is vulnerable to a market correction.

Stretched valuations fail to capture the heightened mortgage stress risk. Price to earnings is trading at the upper bound of its historical average and is also the most expensive bank when valuations are compared globally. 

In contrast, we like the prospects of mid-cap industrial companies Aurizon Holdings (ASX: AZJ) and Cleanaway Waste Management (ASX: CWY). These companies offer pricing power which will keep profit margins resilient in an elevated inflation environment.

VanEck offers two ETFs that provide direct and overweight exposure respectively to Australia’s mid-caps and industrials sector, VanEck S&P/ASX MidCap ETF (ASX: MVE) and VanEck Australian Equal Weight ETF (ASX: MVW). MVW equally weighs the largest and most liquid stocks on the ASX, meaning the allocation is underweight large caps and notably the big five banks while remaining overweight mid-caps.