Nowadays, it's easy for investors to become overly preoccupied with the larger macroeconomic picture. Nonetheless, such a preoccupation is perfectly understandable given that issues such as the US-China trade tensions continue to ratchet up on an almost daily basis.
Only last week, the most recent broadside to be fired came in the form of China's devaluation of its currency, which subsequently sent markets into a tumble.
But for Kate Howitt, the portfolio manager of Fidelity's Australian Opportunities Fund, the irony of her position is that when she is out and about talking to investors, everyone is always interested in the "top-down stuff", despite her approach being firmly in the bottom-up camp.
"I don't think that, sitting here in Sydney, I'm going to be the person who's going to pick how the trade war is going to end up and then how that's going to flow through," Howitt told a recent media roundtable.
"Nevertheless, you know, people will go, 'Yeah, but what do you think anyway?' So, I will talk a little bit about macro stuff. But when it comes to actually putting together a portfolio of stocks that I think are going to help someone have a good retirement, I am fortunate that I'm here at Fidelity with a really good team of analysts –I think 140 analysts around the world – who can help us identify individual stocks.
"So, what I'm trying to do in the portfolio is much more identify stocks that are going to outperform individually, rather than try to pick stocks that are going to benefit from the macro view of the world going a certain way."
"Cascading attractiveness" of asset classes
But even though macro themes are not the primary drivers of her portfolio, Howitt has spent some time gathering her thoughts about the effects of quantitative easing and how the theory is supposed to work in practice. The theory behind quantitative easing is supposed to make the yield on safe assets so unattractive that people will move out the risk curve, and she says this is precisely what has been happening.
Investors who wanted to just own sovereign bonds or term deposits found that they just couldn't get any return, and they had to go out the risk curve into the likes of equities, property, listed and unlisted property trusts, as well as alternatives.
"Everyone has been herded out to these by the wall of money created from quantitative easing. So, this has kind of been a deliberate strategy."
And given that a lot of this QE has been what's driving equities, Howitt explains that, as often happens in markets, investors now find themselves in an "ugly contest". While some of the more cyclical equities may look as though we're heading into a recession, Howitt points out that most investors would agree that this is better than a bond, where they know they're getting a negative yield.
Other stocks may look ugly because their valuations are so stretched. However, they may still have some growth left in them, and that may be better than what investors may be able to get in most other places.
Therefore, Howitt says, there is a kind of "cascading of attractiveness" of asset classes, with equities a beneficiary of this negative-yielding world.
The more downward pressure on the returns that investors can get on safe assets, the more they move out the risk curve. While the rate an investor may get on their term deposit will not pay the bills, they can buy the equity of the bank, thereby bringing fresh money into the markets.
The joys of agnostic pragmatism
Regardless of the macro backdrop, Howitt says the beautiful thing about working at Fidelity is that the shop doesn’t have a house style, a house process, or a house philosophy.
There are a lot of investment firms that are identified with a value philosophy or a growth philosophy which states that the way you make money in markets is to exploit "anomaly X" or "inefficiency Y".
But Fidelity has always been much more pragmatic.
"We've always said, firstly, individual performers are going to generate the most outperformance they can when they do it the way that makes sense to them. And so, we are a bit agnostic and we'll incubate anyone who can outperform," she says.
"I've had colleagues who have 'very seriously been growth'. I've had colleagues in Asia who have been 'very seriously momentum'. I've had colleagues who had been in special situations."
Howitt points out that in Australia she has found that a strong style bias is not terribly helpful given it is such a small, narrow market. She therefore likes to own some growth stocks and some value stocks.
In other words, she has a very healthy respect for "Mr. Market".
"We know that Mr. Market is sometimes going to go rampaging on long after you think it's sensible or might be in the doldrums long after you think it's necessary, and we are not paid to be investment theory purists," she says.
"We're payed to outperform for our clients. So, if outperforming for clients means owning stocks at very stretched valuations, then I'll have a portion of my portfolio in those stocks."
A relic from an age of barbarians
In a world of stretched equity valuations and asset classes of varying degrees of attractiveness, where is Howitt finding her "winners" in the ugly contest?
Firstly, Howitt notes the tight correlation between the massive amounts of negative-yielding debt around the globe and the direction of the gold price (below, top right).
As negative-yielding debt increases, the gold price is going up. And this is just the gold price in US dollars. In Aussie dollars investors also get a "currency kicker," and it's going up even more. So, why does that make sense?
It comes back to the "ugly contest". If you want to invest, you value an asset. But how do you value an asset such as gold, which has no cash flows to discount back?
As Howitt says, gold has always been something of an enigma that its sceptics dub a "barbarous relic" that only has value for historical reasons and possesses no inherent value because it has no cash flows.
But in the current global scenario, investors would be thinking that if their choice is between assets which have a negative future return or gold, which has zero future cash flows, then gold "actually looks all right".
Howitt says that even if some of those hot tech stocks on their extended valuations mean revert, that's a negative return too.
"So, we're in this ugly contest of assets where you've got negative-yielding debt, you've got potentially overvalued assets, overvalued equities, or cyclically risky equities … and then you've got gold. It doesn't give you anything positive, but it shouldn't lose anything either."
Howitt also argues that the direction of the gold price is very likely northwards. There's about US$80 trillion of equities in the world right now, with around US$50 trillion of that in the US. There's also about US$50 trillion of bonds.
Hypothetically, she says that if 1% of overpriced equities and 1% of the most negative yielding bonds decide to go across to gold, that's almost US$1.5 trillion of money that could be looking to buy gold. The value of all the gold that's ever been mined is about US$8 trillion. On a generous estimate, the value of investible gold is about US$3 trillion.
"Potentially, you've got something in the order of US$1 to US$1.5 trillion trying to buy an asset class where the base is maybe US$3 trillion maybe. So, directionally … you would say supply and demand means the gold price is going to go up from here."
Mirror, mirror – who is the ugliest of them all?
But when getting down to brass tacks, Howitt is quick to reiterate that she is very much a stock-specific active equities manager.
"My clients are giving me money to be invested in Aussie equities. They're not giving me money to do the asset allocation decision. So, they'd actually be quite cross if I went back to them and said, 'Hey, that fee you're paying me, I'm actually just putting it in the bank'."
So, amid the thick of the global ugly contest among asset classes, what does Howitt like among Aussie equities? Among some of her preferred exposures, she describes Sydney Airport (ASX:SYD) as a "really nice bond proxy earnings generator".
Howitt also thinks rare earths miner Lynas (ASX:LYC) is an interesting commodity stock despite it having had a torrid time in recent years. She said the company managed to survive courtesy of its Japanese, European and US clients not really wanting to have to buy a core input for all their electronics and defence equipment from China.
She is also a fan of jewellery store operator Lovisa Holdings (ASX:LOV). "The main reason I own that is it's rolling out across the US … most of the consumer names that you could own are really leveraged to whether the Australian consumer spends or doesn't spend, whereas Lovisa is leveraged to things they can control, which is rolling out stores into new markets."
Howitt also has a big bank in her top 10 holdings. As she points out, there are different ways to make money when it comes to the banks. Investors can try to make money by going in and out of the sector when everything's going to be really good or bad for the banks, or like Fidelity, can try to make money off the differences between the banks.
"So, Commonwealth (ASX:CBA) is our preferred bank. The scale that they've got gives them an enormous benefit … we see a differential in execution capability and fundamental positioning, mainly on the scale side, between them and some of the other banks," she says.
Invest confidently through cycles
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