ASX 200: brief snapshot for 2023

The ASX 200 is widely regarded as the financial benchmark of the Australian economy, much akin to the US’s S&P 500, or the UK’s FTSE 100. Down just 4.5% year-to-date, the index has been one of the better performers of the 2022 bear market.

A key aspect of aspect of the ASX 200, much like its international counterparts, is that its performance is dictated not just by Australian internal economics, but also by the wider global picture, and in particular, Australia’s largest trading partner China.

For context, S&P global data shows that financial services stocks constitute 28.7% of the ASX 200’s weighting, materials make up 24.2%, and healthcare 10%. These three sectors are disproportionately impacted by global movements.

The mathematically observant will note that all other sectors combined, most of which are domestically focussed, comprise less than half of the ASX 200’s overall performance. In addition, the healthcare sector is dominated by non-volatile AU$144 billion CSL Limited, which has remained largely flat in 2022.

This leaves the performance of financials and materials in control of the ASX 200.

ASX 200: financials stocks 2023

Australia’s largest banks — Commonwealth, Westpac, National Australian, ANZ, and Macquarie — are the main beneficiaries of rising net interest margins. Ultraloose monetary policy is over, as the Reserve Bank has brought the cash rate up to 3.1% in an effort to bring 6.9% CPI inflation under control.

Governor Philip Lowe has a mandate to bring inflation down to within a range of 2% to 3%, and has consistently warned he plans to raise the cash rate until this is achieved.

Of course, domestic inflation is only one factor sending rates up. The central bank is to some extent constricted in its ability to change course by the US Federal Reserve, which is expected to increase the federal funds rate to between 4.25% to 4.5% today.

Forex demands mean that Australia must remain currency competitive. For perspective, while a strong US dollar benefits domestic commodity sellers, it makes imports more expensive as most imports are priced in US dollars, which further drives inflation skywards.

As locals will know, a key inflationary problem is the real estate market. At 10.5%, housing was by far the largest contributor to CPI inflation in October, but rising rates alongside supply side inflation could cripple the market next year, bringing a whole new set of problems for the ASX 200.

Indeed, a September Digital Finance Analytics model shows that in a worst-case scenario, house prices could fall by 44.3% from their peak by the end of 2025. But predicting the outlook for 2023 is extremely complex: SQM Research predicts a modest rise in national prices if the Reserve Bank keeps the cash rate below 4% and inflation drops to 5%.

It’s worth noting that the estimated total value of residential real estate fell from AU$9.6 trillion in December 2021 to AU$9.4 trillion by November 2022, with annual sales falling by 13.3%. CoreLogic’s Head of Research Eliza Owen notes that ‘the pace of decline has been slowing on a broad basis since September. While this may be seen as a positive by some, there is still risk of the decline re-accelerating in the year ahead.’

Naturally, higher interest payments only benefit banks if consumers can afford to keep up repayments. And at 6.45%, the average discount variable mortgage rate is at its highest in over a decade, and double that of the 2021 average for a typical 20% deposit mortgage.

ASX 200: materials stocks 2023

ASX 200 titans including BHP, Rio Tinto, and Fortescue make up the bulk of the second-most important ASX 200 sector. And while commodities have enjoyed a bull run in 2022, most commodities have come down from their record highs over the past few months.

Iron ore prices are on track to end 2022 at their lowest in several years and will likely continue to dip through 2023 as China and Europe cut steel output while supply simultaneously increases. On the other hand, Goldman Sachs and the Bank of America expect copper to rise to $9,750/t in 2023 and potentially up to $12,000/t respectively as supply constricts and the energy transition continues.

Of course, the true risk to the materials sector as a whole is the prospect for a severe global recession, which could see all commodity prices fall in typical cyclical fashion. This would not only hit the ASX sector hard, but also the Australian dollar which all ASX 200 stocks are traded in.

The IMF’s World Economic Outlook report argues that ‘the worst is yet to come,’ and 2023 will at the very least ‘feel like a recession.’ The financial agency envisages more than a third of the global economy contracting next year.

It’s not hard to see why. Excessive quantitative easing throughout the pandemic has left governments loosening fiscal policy to help citizens, while central banks tighten monetary policy to prop up the economy. The volatility needs only a spark to set off a meltdown.

The largest risk to the ASX materials sector comes from China, by far Australia’s largest two-way trading partner, which accounts for between 31% and 36% of trade. China’s housing and EV markets demand copious amounts of Australia’s metals — Chinese real estate accounts for as much as 40% of GDP by some measures — and both could be on the precipice.

Evergrande contagion, power shortages, ‘zero-covid’ lockdown cycles, and faltering faith in the mortgage system could conspire to wreak havoc.

The ASX 200 would not be far behind.

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