When you look at the overall performance of the Australian share market a bit closer, you’ll notice that the gains were essentially made in the first half of the year. In the second half, the market was merely treading water. I think this lack of progress will continue this year.
I don’t think Covid is going to be a concern anymore, instead, we now have a more formidable opponent – the US Federal Reserve. QE is ending and rates are going up next year. The end of QE sucks out liquidity from the market, and rising rates makes very expensive stocks a bit less appealing. To counter this, however, economic conditions look good, and we should continue to see companies grow their earnings. What does this mean for the market? These competing forces could give us a year where the index doesn’t do anything or heads lower.
Great opportunities
Having said that, there will be some great opportunities and rallies along the way, but we must be selective on what to buy and quick when it comes to selling. A lot of people don’t realise that stock prices don’t solely rise because of earnings growth. Part of the rise in share prices over the last few years can be attributed to QE and falling interest rates.
As we enter a period of lower liquidity and higher rates, you will find that many investors, amateur and professional, suddenly won’t be able to understand why their superior stock-picking skills aren’t working anymore. Was it their brilliance, or was it the money printing propping up their share prices? For this year, I think it will become harder and it will be more of a stock picker’s market. The rising tide of money printing won’t be there to paper over any poor investment decisions. It will be a market where we need to keep an eye on what the Federal Reserve is doing with QE and interest rates as this can have more of a bearing on stock prices than the underlying business. Companies that trade on a high P/E for instance will be more susceptible to these changes.
Having said that, you don’t want to swing too far in the other direction and buy lower-quality businesses because they appear “cheap”. I think one of the most resilient sectors in 2022 will be resources, and this is where I believe there will be opportunities to make some good returns in a potentially flat market. Global growth should support commodity prices, resource stocks tend to be less susceptible to interest rate movements, and they are also a good hedge against inflation.
My eye is also on contrarian options
Although trading resource stocks is my strategy going into this year, I always have my eye on the contrarian option. The current narrative is that inflation is going higher, rates are going up, and QE is ending. We need to be alert to this being incorrect. That is, what if supply issues are dealt with pretty quickly and the inflation readings fall faster than expected? That would reset the market’s expectations for rate rises and the party is back on.
With the market seemingly very one-sided when it comes to thinking rate rises will come earlier than expected, we need to be aware of what will happen if the market has got it wrong. However, assuming that we continue on the current path, we should be wary of stocks that are sensitive to rising rates, and the resources sector is one that should provide not only some shelter but some opportunities.
My favourites
I favour stocks that are large and liquid and are at the quality end. I am also targeting those that look strong on the share price chart. Firstly, I think iron ore prices will head back up. I like the look of FMG and BHP here. They seem to have found a base after their recent falls and they look like they will head higher from here. MIN is another one that looks to be recovering from recent falls. Apart from iron ore exposure, MIN also has exposure to lithium. Speaking of lithium, IGO, PLS, and AKE are set to continue their uptrends after spending the last few months consolidating those big moves from earlier in 2021. Finally, Lynas (LYC) is the largest rare earths producer outside of China. It has been a good trading stock for us and I expect it to remain so during the year.
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