Our outlook for the banks remains positive. As we enter a period of RBA rate hikes, margin pressure will likely ease, driving earnings growth over the medium-term. However, risks remain for Aussie banks as rates rise. We delve into the 1H22 results and outline our reasoning for an overweight to the banks.

2022 has been a tough year so far, with both equities and bonds delivering negative returns, though the Australian equity market has fared better than global equities. While the list of concerns has been growing (inflation, Russia/Ukraine, China growth), front and centre has been the fear that high inflation will prove structural, forcing overtly tight central bank policy and raising the risk of a recession next year.

Last week the RBA hiked rates for the first time in 12 years, raising the cash rate from an all-time low of 0.1% to 0.35%. Several more rate hikes are likely in the next 12 months. Currently, we believe that RBA rate hikes will not be a significant headwind for equities. However, a rate hike environment would likely result in prolonged volatility until the market gets more clarity about the end game.

As expected, the US Federal Reserve hiked interest rates by 50bps last Wednesday, lifting the target federal funds rate to a range of 0.75% to 1%, the first 50bps rise since early 2000. Meanwhile, the RBA increased the cash rate target by 25bps to 35bps, its first rate hike in almost 12 years.

Since December, risk aversion in equity markets has shifted as inflationary pressures and higher bond yields have placed downside pressure on equity valuations. However, over the last month defensives have started to outperform the market, from healthcare and consumer staples to utilities.

Australia’s headline CPI in the first quarter jumped by 2.1% on the previous quarter, well in excess of the consensus expectation of 1.7%. This marks the largest quarterly rise since the GST-driven spike in mid 2000, though Australian inflation is still well below most other major economies.

Over the last 2 years the focus list has benefited from stocks where we have identified hidden value. We find this subset of the portfolio can provide great returns that are less correlated to the rest of the market. One such stock that has taken our eye is Tabcorp (TAH).

Our quarterly managed funds report outlines the pathway best-suited to deliver on our current asset allocation strategy.