3 areas of the Aussie stock market I think could outperform this year

I've picked out three sectors that could do well over the rest of 2023.

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Key points

  • Some tech companies are growing quickly yet higher interest rates have punished their valuations
  • Retailers face uncertainty in the shorter term but this could be the time to pounce
  • Pain on the stock market has hurt fund managers but a stock market recovery could be a good tailwind

The ASX stock market has seen its fair share of volatility over the past year and a half. But the gyrations could mean some sectors are primed to outperform.

Certainly, strong inflation and higher interest rates have hurt investor confidence and valuations in some industries. But for me, the more fear and pain there is, the stronger chance I think there is of a rebound at some point.

Higher interest rates are, in theory, meant to hurt asset prices. I think the valuation hit is a long-term opportunity to buy some ASX shares in the following industries:

Technology

ASX tech shares have been among the hardest hit since November 2021. If the market is expecting significant growth over the coming years from a business, then higher interest rates mean investors need to (in theory) discount the valuation more to get back to today's value. That method of valuation is called a discounted cash flow.

However, the underlying businesses' operations haven't really changed just because interest rates have gone up, so we're able to grab businesses for a cheaper price.

Some ASX tech shares have already risen quite nicely this year. But I believe some names can keep rising as interest rate rises are paused and the companies are able to demonstrate that their revenue and scale can continue to improve.

Which ones on the ASX stock market might be able to do well? I'm backing companies that are growing revenue and margins such as Xero Limited (ASX: XRO), Megaport Ltd (ASX: MP1), Frontier Digital Ventures Ltd (ASX: FDV), and Airtasker Ltd (ASX: ART).

Retail

It's understandable investors are being cautious about some retailers – if households are spending more on interest, rent, food, and energy, then they'll have less to spend at shops and online.

Demand for retail products may be fairly cyclical, so I think this time of weakness is an opportunity to buy before a potential turnaround.

At the moment, I think there are two main areas where there could be good opportunities – youth-focused retailers and house-focused retailers.

Younger Aussies may be less exposed to higher interest rates because they're less likely to own a property, while also benefiting from wage growth and the low unemployment rate. I'm thinking about retailers like Universal Store Holdings Ltd (ASX: UNI) and Lovisa Holdings Ltd (ASX: LOV) that could be ideas here.

Businesses focused on selling house-related products may see short-term demand drop. But Australia's growing population and then the eventual economic turnaround could help drive share prices higher for names like Temple & Webster Group Ltd (ASX: TPW), Nick Scali Limited (ASX: NCK), Adairs Ltd (ASX: ADH), and Beacon Lighting Group Ltd (ASX: BLX).

Fund managers

Falling asset prices are a big headwind for fund managers because many generate their revenue and net profit after tax (NPAT) from the size of their funds under management (FUM).

Stock market investors have been quite pessimistic on a number of fund managers in Australia, but I think many of them will continue to make solid profits. When asset prices stop falling, this could drive their funds under management (FUM) and share prices higher as fund flows and FUM growth return.

Some of the fund managers I'd look at to try to capture this rebound include GQG Partners Inc (ASX: GQG), Pinnacle Investment Management Group Ltd (ASX: PNI), Australian Ethical Investment Ltd (ASX: AEF), Charter Hall Group (ASX: CHC), and DEXUS Property Group (ASX: DXS).

Foolish takeaway

I think an improvement in the economic situation, such as a halt to interest rate hikes and/or a decline in the inflation rate, could be a positive catalyst for valuations in the above sectors.

Of the three, I'd go for the technology sector because of the underlying advantages it usually has when it comes to stronger operating margins. It also has the ability to grow quickly over the long term because of the intangible nature of software.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Adairs, Australian Ethical Investment, Frontier Digital Ventures, Lovisa, Megaport, Pinnacle Investment Management Group, Temple & Webster Group, and Xero. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended Airtasker. The Motley Fool Australia has positions in and has recommended Adairs, Pinnacle Investment Management Group, and Xero. The Motley Fool Australia has recommended Australian Ethical Investment, Frontier Digital Ventures, Lovisa, Megaport, and Temple & Webster Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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