Pessimism plagues a market where many investors find themselves in unchartered territory. It has been a generation since investors have dealt with aggressive interest rate increases to tame out of control inflation. Volatility has increased significantly with periodic 3 to 4% plunges the new normal. It is all too easy at times like this to lose sight of our long-term financial goals.
As investors, we must remain laser focused on our goals and our plan for achieving them. This, hand in hand with pursuing the core tenet of investing – buying quality companies at a discount – is what will result in successful investing.
At Morningstar, we see the market selloff creating opportunities for long-term investors and encourage Aussie equity investors to look past inflation, rising interest rates, falling P/E multiples and a looming fear of an Aussie recession. We encourage investors to focus on the opportunities this has created in a fearful market where assets may be mispriced due to overstated worry.
Our Australian equity analyst team have conducted assessment of how sectors fair against the four risks stated above, but also the characteristics of individual companies that will perform well relative to peers.
Below: Many Australian sectors are at least partially insulated from inflation-related risks (Taken from ‘Market Selloff Is Creating Opportunities for Long-Term Investors’ Report, 17 June 2022)
The full report on Morningstar Investor, offered as a part of a free, four-week trial*, goes into the impact on each sector. The least vulnerable sector is Financial Services. Individual companies earning spots are highlighted in our July Global Best Ideas – a curated list of opportunities picked by our global analyst team each month.
For the Financial Services sector, we expect rising interest rates to benefit banks via higher net interest margins, and insurance companies via higher interest income on their investment portfolios, with relatively little impact on investment managers. Rising inflation will be mildly negative due to wage inflation in a labour-intensive sector, and if a recession were to occur, it would be negative for the sector due to rising bad debts for banks. We don’t believe the sector has experienced material P/E multiple expansion in recent years, due to falling interest rates, and we don’t expect material P/E ratio compression as interest rates rise.
On our Global Best Ideas list, Westpac (ASX:WBC) is our pick of the banks (end of June 2022), trading at a meaningful discount to our AUD $29 fair value estimate. We saw share price weakness due to disappointing guidance on net interest margins and operating expenses, but we are hopeful this will improve over time. As we noted for the industry, we see the bank repricing loans and generating better margins as the cash rate is increased. Westpac is Australia’s second-largest lender, number two in mortgages and number three in business loans, and this scale provides funding cost advantages.
Westpac has also had an uplift in costs due to customer remediation and a larger focus on risk management, but we don’t see these elevated levels continuing for the long-term. A combination of disappointing guidance and the bank losing market share has led to an undervalued opportunity. Westpac continues to sit on surplus capital, is well provisioned, and pays generous fully franked dividends.
For the second part of successful investing, sticking to your goals, you must not allow this fear and uncertainty to sway you from your plan. Markets will continue to rise and fall, and there will undeniably be more bull and bear markets to come. Zooming out on the performance graphs that we all obsess over allow us to see the spoils of long-term investing.
Aiding this is ensuring you’re only taking the risk you need to take and avoiding unnecessary volatility. A tool that many professional investors and money managers use is an Investment Policy Statement (IPS). An IPS is a mandate that sets out parameters for the types of investments that suit your portfolio. Having guidelines when choosing investments ensures that they are aligned with your goals from a risk, time horizon, and income/growth perspective. Our podcast episode on Investing Compass goes through how to create an IPS step-by-step.
Ultimately, there may be opportunities in the market to capitalise on whilst ensuring alignment with your goals and what you are trying to achieve. Otherwise, unnecessary risk may prompt poor investor behaviour, and be detrimental to you reaching your financial goals. This structure ensures you always have something to refer and go back to, and help with decisions when markets are hot, and also when they are cold.
Shani Jayamanne, Senior Investment Specialist, Morningstar Australasia Pty Ltd (AFSL: 240892).
The information in this article, prepared by Morningstar, is general in nature and does not consider the financial situation of any individual. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf . You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser.
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