Higher interest rates means opportunities to buy quality stocks on the cheap. This is the time to build your portfolio! Times have been difficult, but our Blue Chip Value Portfolio performance continues to exceed the market because we are able to combine a macro view with our value process. On the one hand, as we have seen this week, interest rates are going up, while on the other, Blue Chip stocks provide valuable protection against this, when purchased at the right price. Fast growing Small Caps provide an even more important counter to the destructive consequences of inflation.

Our pivot towards defensive holdings late last year (Issue 116) has maintained a combination of returns from both income and growth. These are stocks that can maintain earnings growth despite weak consumer sentiment/spending. The new entries are performing well, some like Rio Tinto (RIO) bouncing back after weakness; others, like Qantas Airways (QAN), which are more dependent on consumer spending, weakening after experiencing strength. These are the new entries:

• AMP Limited (AMP) 

• APA Group (APA) 

• Coles (COL) 

• Lendlease (LLC) 

• Qantas Airways (QAN) 

• Rio Tinto (RIO) 

• Transurban (TCL) 

We increased our weight in Telstra (TLS), which has climbed, although the same can’t be said of our investment in the IGA supermarkets brand owner and wholesaler Metcash (MTS).

We are also happy with maintaining the twin pillars of the portfolio – banks and resources. We reduced our holdings in the banks, having sold a third of our holdings. This was a good move, both sectors have been underperforming – resources due to the downgrading of growth expectations in China; and banks, due to concerns around increasing economic stress (see our note on ANZ). But we are happy holders in both cases. The big stocks in each sector provide strong value propositions because of their diversity of earnings and strong income generating potential.

Broadly speaking, our economic view hasn’t changed, which we discuss below. Read more about ASX Blue Chip stocks.

ECONOMIC ANALYSIS

The interest rate rise this week puts the domestic cash rate at 4.1% and forecast to go higher, but still well behind the US rate of 5-5.25%. Moreover, inflation is coming down, but it’s still close to 6%, while in the US it’s running lower at 5% (headline).

There has been a great deal of comment about the weak economic numbers this week, with focus on the weaker than expected 0.2% growth in the economy for the three months to March, as measured by the inflation adjusted gross domestic product. But the bottom line is that interest rates are heading higher because the key metric, nominal GDP, unadjusted for inflation and approximates aggregate demand, continues to be too strong, growing at 2.1% in the last quarter, which annualised is 8.4%. This is well below its double-digit levels in 2021/22, but is well above growth in aggregate supply.

Whatever happens, we are stuck with an economy growing, in nominal GDP terms, at 5% ahead of business as usual conditions, which assumes that the pandemic didn’t occur. In other words, aggregate demand (nominal GDP) is at a level 5% higher than aggregate supply. In order for inflation to be curbed, this 5% gap needs to be suppressed. Supply cannot simply be ratcheted up in the short-term, no matter how much RBA Governor Philip Lowe rails about the key being improving productivity (the lack of which is a global phenomenon).

Prior to the pandemic nominal GDP was running at 5.5%, or thereabouts. Inflation was below the RBA’s target range of 2-4%, which was the case for a number of years. During the pandemic, nominal GDP was supercharged by a combination of loose monetary policy and fiscal stimulus. Basically, this stimulus brought forward spending, or economic activity that would have happened between 2025-30 into 2020/21. The sting in the tail is that today the economy has no more excess capacity; aggregate demand and aggregate supply are not in sync and inflation is the result. This, not wages, or “unit labour costs” is why the inflation genie is out of the bottle.

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