How to play the shakeup in property, consumer habits

Clear trends and themes have emerged in investment markets as a result of the pandemic and its effect on discretionary and non-discretionary spending and where we live. In the following wire, we explore these themes – which were also the focus of our most recent webinar.

“Bricks and mortar” drives markets

Joined by my fellow portfolio manager, James Delaney, we discussed the current housing boom and how long it can continue. We also explored a related theme of consumer spending and how it has shifted one year after the first COVID lockdowns.

Detached dwellings, in particular, have benefitted, as people seek more space at home when they are prevented from travelling too far from their homes due to stay-at-home orders and border closures.

What’s interesting are some of the disconnects from the fundamentals, and the shifting patterns.

Yes, we’ve got rates at record lows and the RBA actions to extend that out into 2024 has driven a lot of pricing strength. But only a year ago we were worried about housing markets collapsing, largely because immigration had been cut to zero.

At the same time as free-standing dwellings have seen a real surge in demand, spurred on by the government’s Homebuilder grants, we’ve also seen an oversupply of apartments.

As a result, apartment prices have not experienced the same gains as stand-alone homes. Flagging demand for inner-city properties is also the result of many people embracing the opportunity to move out of the city given the widespread adoption of the work-from-home way of working.

Who are the winners and losers?

One of the biggest winners is building materials company CSR Limited (ASX: CSR), and James Hardie Group (ASX: JHX) is in a similar position, along with exposure to US housing. And this strength in housing is a global phenomenon, not just here in Australia.

Inner-city apartments notwithstanding, the booming housing market isn’t just good news for property, it also has flow-on effects on other sectors. The strong residential real estate market has translated to high demand for mortgages, which is good news for lenders and also service providers such as mortgage insurers.

It’s worth noting the lending sector is strong for another reason. At the start of the pandemic, many lenders made very large bad debt provisions, assuming borrowers would be stretched as a result of the pandemic leading to shutdowns in many areas of the economy. These provisions, at least in Australia, have proven to be too generous, largely due to government stimulus programs helping borrowers to meet their obligations and taking the pressure off lenders.

Some of the companies to keep an eye on here include corporate credit providers like Australian Financial Group (ASX: AFG), which will continue to be in a strong position over the next 12 months.

While this environment has been good news for financial institutions and also the housing market, concerns are emerging about whether the market is running too hot. Governments and regulators are also worried about housing affordability. As a result, some countries are taking action to moderate house price growth.

As examples, New Zealand has taken steps to cool its housing market and Canada has recently tapered its bond-buying program. The Reserve Bank of Australia has not given any indication it’s going to steer away from its "lower for longer" approach to interest rates. But that does not mean investors should not be informed by actions in other jurisdictions. It’s a trend of which our portfolio managers should be aware, as these same trends could play out in other markets.

What’s happening at the checkout?

Turning to consumer spending patterns, one of the fundamentals the investment team is always curious about is the connection between housing market movements and consumer spending, and how this may play out across the companies in our portfolios.

Retail spending is highly correlated with house prices. So when house prices are strong, we’re much more likely to buy a new car, renovate and buy furniture and appliances. But this trend often reverses as interest rates and home loan repayments rise, and people are less inclined to spend money on non-discretionary items.

The investment team is closely watching shifts in consumer spending as a result of the pandemic, investigating whether and when these shifts normalise and who the winners are in the short, medium, and long term.

When it comes to discretionary and non-discretionary spending, consumers will look for alternate ways to spend their money if recreational travel remains off the table. We look for retailers with a real digital capability that may have been so far been largely overlooked by investors. Some of these companies include Accent Group (ASX: AX1) which distributes performance and lifestyle footwear through Athlete’s Foot and other brands.

Retailers that are strong omnichannel marketers that have a demonstrated ability to do online fulfilment are well placed, especially those with strong national store networks, so they can easily deliver orders on the same day they are placed.

This is a real advantage over online competitors that rely on big fulfilment centres for retail distribution. Achieving same-day delivery is going to be very difficult for these operators and require significant capital expenditure to maintain their competitive position.

Some other call-outs here include Breville Group (ASX: BRG) and consumer electronics retailer JB HiFi (ASX: JBH). JB HiFi has managed to grow its business through a whole range of cycles.

It hasn’t struggled through COVID, and while it certainly may be “over-earning” now, it has done well at adapting its business model for changing conditions.

There are others that have been left behind, including names like building materials and cement company Adelaide Brighton (ASX: ABC), which has a higher exposure to the apartment market that has been suffering, as mentioned earlier.

Automotive retailer A.P. Eagers (ASX: APE) is another company that has been left behind. We regard it as another “over-earner,” despite the market having considered it a persistent winner.

When to buy and sell

The team at Sage Capital aims to position its portfolio to benefit from the trends discussed above. These insights help to form a view on when to rotate in and out of stocks exposed to the housing market and the retail sector.

As for the future, there are still many unknowns. These include the COVID-19 vaccination rollout in Australia and around the world and how that may affect international border openings and the future of international travel. The way these themes play out has implications for any investments exposed to the movement of people and goods across borders.

As a long-short manager, the investment team is able to use its shorting powers to benefit from a falling market. At the same time, it can go long stocks when markets rise. This investment style, and the diversified nature of the portfolio, help mitigate risks and provides protection when markets correct.

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