Seeking returns - has everything changed?
At Crestone’s most recent investment forum, we asked panellists to debate the risks to an otherwise improving economic outlook and address how markets may respond to a near-term spike in inflation.
In particular, we asked panellists to discuss where investors should be seeking protection and returns in their portfolios, given elevated valuations and likely volatility.
The panellists were:
- Carmel Hourigan - Office CEO, Charter Hall
- Tim Samway - Executive Chairman, Hyperion Asset Management
- Andrew Maple-Brown - Co-Founder and Managing Director, Maple-Brown Abbott Global Listed Infrastructure
- Vimal Gor - Head of Bond, Income and Defensive Strategies, Pendal Group
George Tharenou - Chief Economist, UBS Investment Bank
- Scott Haslem - Chief Investment Officer, Crestone Wealth Management
- Ed Blight - Head of Sales, Crestone Wealth Management
Overall, our panellists see few headwinds to a strong recovery in growth over the coming couple of years.
However, there is a strong sense that “everything has changed” in regards to the rules governments and central banks are following, and this would require investors to increasingly take a long-term perspective when assessing value via equities.
Moreover, most panellists believe a post-virus world would continue to exhibit lower trend growth and inflation than the last century.
As such, returns in fixed income would
continue to be challenged, while unlisted real assets (property and infrastructure) are
viewed favourably as a means to protect against inflation and lift returns with
relatively defensive assets.
Four key themes from the forum:
- We are no longer in a world of policy conservatism — There are few headwinds to a strong rebound in global growth in 2021, as economies reopen on the back of an increasingly successful vaccine rollout and massive policy stimulus. For now, medium-term fiscal rules, such as balanced budgets, are largely being ignored while central banks flag a long period of free cash. Australia looks well placed to outperform, with activity likely to regather to levels not seen prior to COVID-19 by mid-year.
Near-term inflation pressures are likely to recede in H2 2021 — While inflation is likely to rise
materially in coming months, led by a rebound in oil prices and supply pressures as consumer
demand recovers, elevated debt burdens, ageing demographics and advances in technology are
widely seen as likely to keep inflation contained over the medium term. Globally, unemployment
rates remain above pre-COVID levels.
Valuations may be less stretched when you dig below the surface — Equity investors need to
focus on businesses with long-term earnings streams, rather than labour over short-term price-earnings ratios. In contrast, the fixed income asset class is seen as a difficult place to find
returns, with credit markets increasingly being driven by flows. Despite a likely rise in bond
yields, bond rates are likely to remain low and valuations within property and infrastructure have
not increased materially
- Unlisted real assets can provide a meaningful hedge to inflation risk — The search for defensive assets with yield is increasingly leading investors to look at unlisted property and infrastructure assets. While discipline is required in regard to market segmentation, inflation-linked revenue is increasingly favoured. Real assets also capture opportunities around online purchases, decarbonisation and electrification.
Is the global recovery still on track?
After 2020’s global recession, ongoing massive stimulus and
progress on a vaccine, we believe growth will recover midyear or in H2 2021: We asked our panellists what the likely
strength of the recovery is and when pre-COVID activity
levels will be regathered.
George Tharenou, Chief Economist at UBS Investment Bank, has been relatively bullish on Australia since late last year—this is due to the shift by policymakers away from traditional fiscal conservatism (ie balanced budgets, surpluses and medium-term fiscal rules).
He expects Australia’s growth to return to pre-COVID levels around mid-year, which is now in line with consensus. What will be key is if the growth rate continues to beat expectations (which he expects it will). He sees the backdrop of policy support as strong and as continuing to underpin growth.
Tharenou added that Australia is in a relatively better position than the rest of the world as the economy has been opened and economic mobility normalised quicker than elsewhere. The ability to recover from COVID-19 is also likely to be more sustainable in Australia, as the hit to the labour market has been less than in other major economies. Direct wage subsidy measures, like JobKeeper, have maintained the connection between activity and employees. He also sees the labour market as close to the point of a self-sustained recovery, and that it is already not far off pre-COVID levels.
Vimal Gor, Head of Bond, Income and Defensive Strategies at Pendal Group, is unsure whether the inflationary pulse and reflation we are seeing can last. The recent pick-up in yields has led to a technical washout (i.e. selling) of small positions. Gor cannot see the Reserve Bank of Australia (RBA) or US Federal Reserve (Fed) moving rates any time soon. While the market is beginning to price rates remaining on hold before rising aggressively, he does not see this happening. Gor explained that the carry trade in some yield curves has become very attractive. In terms of inflation, he sees this remaining strong for the next three or four quarters—however, he feels the key question is what level inflation reverts to. "
Prior to COVID-19, growth was low, as was inflation, but the pandemic has muddied that picture. The question to grapple with is whether we gravitate back towards where we were in 2018 or where we were 10-20 years ago."
Will a pick-up in growth lead to a structural rise in inflation?
Gor does not see a pick-up in growth leading to a structural rise in inflation, as the ageing demographics and increased debt burden are likely to suppress any material pick-up in bond yields. He also expects the RBA and Fed will eventually take a more aggressive approach to holding back bond yields than they have to date. Real yields initially fell but now nominal yields have risen faster than break-evens, which has caused real yields to rise. He sees this as a threat to risk assets and the economic growth picture. He, therefore, questions how long the Fed will be willing to let real yields rise.
Carmel Hourigan, Office CEO at Charter Hall, echoed similar views, noting she has observed a pick-up in activity in real estate.
“There is a lot more confidence and money is flowing through freely. Maintaining cost-outs, which were implemented by businesses due to COVID-19, will be important going forward.”
Tim Samway, Executive Chairman at Hyperion Asset Management, expanded on this point. He feels capital-light businesses will accelerate particularly quickly.
“While it is terrific news, the better news is the next 20 years looks pretty flat and there will be opportunities to pick up great investments as they will stand out in a dislocated market.”
How might Australia's relationship with China change over the next three to five years?
When asked if our relationship with China should still be regarded as a benefit, Tharenou noted that our exports to China are still very high. For all the negative rhetoric about the relationship, Australia is actually generating a very large trade surplus, which is supporting the currency and growth.
While this is a good result, it does limit the impetus on the Australian Government to rethink or redirect its strategy. This is something that could be negative in the long run. Tharenou also observed that we have seen resilience in commodity prices, particularly iron ore— while for more challenged commodities, such as coal, Australia has managed to redirect supplies to other countries. However, for some small sectors, and at the company level, the impact has been severe. While Tharenou originally thought the problem would resolve itself, he is now not so optimistic.
Are there any 'black-swan' events that could set us off the road to recovery?
Hourigan believes the biggest threat to recovery is a new COVID-19 variant, which could derail the vaccine roll-out, cause another lockdown, and create a stop-start scenario, which is not ideal for corporates.
Gor suggested that if US policymakers were to aggressively increase stimulus, as
opposed to the Fed hiking rates or tapering, this could pour fuel on the fire and
push asset prices higher, which may be difficult to control. He suggested that
climate change stimulus and equality stimulus are some of the ideas that have
been floated as possible additional fiscal spending forces in the US.
The Crestone view: Highly accommodative policy, together with a
likely successful vaccine rollout, should underpin a strong growth
recovery both in Australia and globally in 2021. Near-zero policy rates
are also likely to provide more impetus to rising asset prices than
rising consumer prices. We still favour returns in equity over fixed
income. Other than equities, we believe property (residential and
non-residential, listed and unlisted) is likely to be an increasing
beneficiary of low rates and a hedge against inflation risks.
How should we think about valuations?
We asked panellists how we should think about valuations
now that cash rates are close to zero. What are some of the
risks building in fixed income markets, and could rising
yields thwart equity markets?
Samway agreed with Haslem’s take that price to earnings ratios are a poor valuation metric for long-term investing. He went on to note that, historically, the challenge has been that investors are reluctant to look beyond a couple of years.
However, as business models have improved and technology has become more advanced, it is becoming easier in some areas to look beyond a couple of years with a greater degree of certainty. Unlike 30-40 years ago, businesses have now become more global and platform-based, and many markets have evolved to a ‘winner takes most’ scenario and it is very hard for new entrants to join.
“It’s easier to get a clearer view of a dominant player in a dominant market for a longer period of time. That’s driven a lot of the rise in these shares and I’m confident they can continue to deliver and do exceptionally well.”
Samway feels that platform-based businesses have done reasonably well in a
terrible year and should do exceptionally well in a good year. He feels comfortable
with where valuations are now and thinks they look better than they did in
pre-COVID. This was because income for thematics, such as e-commerce, digital
payments and workforce management, has actually been brought forward by the
pandemic and this has validated Hyperion Asset Management’s thesis.
Is the recent pull-back in performance for some of these names likely to be short-term or longer-term?
Samway sees short-term pull-backs as a buying opportunity. “While we’ve seen a small pull-back in economic growth, one of the main drivers has been low population growth. What worked in the last 10 years is likely to work in the next 10 years, underpinned by low population growth.”
Andrew Maple-Brown, Co-Founder and Managing Director at Maple-Brown Abbott Global Listed Infrastructure (MBA), highlighted that the drop in bond yields supports valuations.
However, MBA looks at enterprise value/EBITDA (earnings before interest, tax, depreciation and amortisation) and, on average, its portfolio has been trading the same as it has been over the past 15 years.
He acknowledged that this has been a surprise as he would expect long-duration assets to be supported by low discount rates (raising valuations). Also, in the US, tax rates and interest costs have come down. One would normally expect these factors to push up multiples, but they are not seeing this in listed infrastructure and so they remain reasonably comfortable.
When asked about the discount rates analysts are currently using, Maple-Brown said that not many people in equity markets have been using spot rates. While bond yields have doubled, they are still lower than where they were at the start of last year, so we are still operating in a low bond rate environment.
“For the last 30 years or so we’ve had lower lows and lower highs, so the bond rate environment continues to support valuations.”
Maple-Brown explained that even if inflation were to break out, monetary policy is still very loose so central banks would be able to control inflation pretty quickly. At MBA, he explained that they are using long-term US bond yields of around 3.5%, while equity discount rates for the lowest risk stocks are around the mid-7% range. Therefore, a 40-50 basis point move in US Treasuries would mean very little from MBA’s perspective. Within real estate, Hourigan is comfortable with where valuations are.
“When you think about where bond yields are and where the premiums are on cap rates, at historical highs, valuations have really not budged.”
She explained that some of the weakness in the real estate sector through the pandemic has been offset by a compression in cap rates and discount rates, which has actually helped property funds. At Charter Hall, they feel comfortable with where valuations are — particularly for assets such as government leases, secured cash flows and long-term leases, where they are seeing a lot of demand from buyers. While retail is interesting, she is nervous about regional shopping centres and the impact of e-commerce. However, cap rates have been unwinding in these sectors and there will come a time when the value of land increases the attractiveness of these assets.
The Crestone view: Valuations in traditional asset classes remain
above long-term averages, suggesting heightened volatility in 2021
as investor sentiment shifts around. We continue to focus on quality
companies and non-US equity exposures which would benefit from
an expected cyclical recovery globally, while also remaining short
duration in fixed income. We continue to favour selected unlisted real
assets (property and infrastructure) where valuations are
Where would you invest your marginal dollar on a 12-month view?
- Carmel Hourigan - Office CEO, Charter Hall: Real assets and residential housing
- Tim Samway - Executive Chairman, Hyperion Asset Management: Sustainable growth equities and real assets
- Andrew Maple-Brown - Co-founder and managing director, Maple-Brown Abbott: Toll roads and electric utilities
- Vimal Gor - Head of bonds, income and defensive strategies, Pendal Group: Bitcoin
- George Tharenou - Chief Economist, UBS Investment Bank: Residential housing
Are equities expensive?
Don't miss our CIO Scott Haslem, in an interview with Tim Samway, Executive Chair of Hyperion Asset Management to discuss equity valuations, concentrated investing and some of the investment themes they are pursuing. Follow Scott here to be notified when the wire is published.
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