At the start of reporting season, investors are braced for earnings downgrades as a result of higher interest rates and consumer caution. Williams is most worried about earnings downgrades for consumer-exposed retail companies and the building sector. The difficulty for investors is to determine what is already priced in. For example, James Hardie has sold off by 35 per cent in the past 12 months, and may well already have adjusted for expected earnings downgrades.
Nathan Bell, portfolio manager at Intelligent Investor, says that companies with business models likely to struggle in the higher interest rate environment are those that have borrowed lots of money, particularly for shorter terms. He suggests many of the new breed of fintech companies could have this issue exposed if higher interest rates send a deflationary pulse through the economy.
Williams believes that business models most at risk are those that are not yet profitable and hence rely on equity markets to fund their operations. This is prevalent in the tech sector, and investors should exercise great care when investing in companies that do not make a profit.
Investors are always wise to be aware of stocks that are being heavily shorted. A short position is essentially betting against the market, and the short position profits when prices decline. Some of the most heavily shorted companies in the ASX200 include Megaport (tech), Sayona Mining (resources) and Core Lithium (resources).
Williams nominates REIT managers exposed to the retail sector as a source of potential danger as they continue to face a difficult environment amid a softening economy. They are also negatively affected by rising rates on valuations and borrowing costs.
Dive is cautious on the iron ore sector, which has been a short-term beneficiary of China amending its COVID-zero policy on the basis that it leads to a rise in construction activity.
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Dive’s concern centres around China recently announcing the establishment of a centralised state-owned buying company for iron ore, to consolidate the purchases of iron ore for the 20 largest Chinese steel makers. This will likely reduce the pricing power that the four main iron ore producers enjoy from selling to a fragmented group of steel makers.
With China consuming 70 per cent of globally traded iron ore, Dive believes more disciplined, centralised buying would put downward pressure on the price of iron ore.
Bell is wary of the oil and gas sector. He says that although a higher oil price may increase short-term profits, paying high multiples for capex-heavy companies that don’t control their product prices is usually a recipe for disaster.
Avoiding permanent capital loss increases investment returns. This year has its unique list of things to be wary of.
