Thursday, March 30th, 2017
DW: Hello again everyone, David Walker from StocksInValue. Pleased to be back with you for this video version of The View. I’m pleased, once again, to introduce John Abernethy, Managing Director of the Clime Group. There’s a lot happening as we record on Wednesday. The ASX is falling more heavily than it has for a while as markets start to sense that the Trump trade might be over. We’ve also had updates from central banks over the last week, the G20 meeting as well, and some weak economic data in Australia. So, could I ask you John to form a narrative about what that means for ASX investors? They are quite concerned about their portfolios, how far the markets come back. Should they be investing more money into the market now or wait a few days, what’s your overall take?
JA: Oh, I don’t think we’re in a serious correction, but I think the markets are pulling back from excesses. Those excesses are generated by the lower interest rate environment, which even though our macro view is that interest rates are on the rise, the rise is going to be very slow. So there’s no reason to get worried about it, but certainly be aware that markets are elevated because of those low interest rates. We have excessive PE’s in America and probably parts of Europe. We’re now seeing interesting readings on inflation – it’s not elevated inflation, but it is inflation around two percent which was the target rate for central banks. We had an inflation rate in the UK last night of about 2%, so a little bit concerned there. It’s almost a post-honeymoon period with Trump. Now we get into the marriage and we’ll see how developments come through. Certainly, he’s got problems with the Congress and Senate of America trying to get some of his economic policies through, so it’s a bit of a wait and see at present.
DW: Will he get any stimulus through, or was the Trump trade all just a myth?
JA: Markets anticipate news and it’s probably right that the markets jumped a bit, because the profit numbers weren’t bad for the December quarter which came out of the election. Then you have the tax-cut program, which is obviously EPS policy. So that’s yet to happen but the market would anticipate that happening and a pro-growth fiscal policy is positive for markets. All of those things would have led to growth, and it’s easy in retrospect for markets to rally. Now the problem is reality coming through, so markets have probably run too hard too quickly. I think they’re going to be disappointed on timing – I think we discussed that this morning in our investment meeting. The timing of Trump’s stimulus is probably going to be pushed back a bit because he has got a bottleneck and he’s also got political issues around the world. None more significant than the revelations about the Russian influence. So we’ve got problems in terms of implementation.
DW: Will the market also be confused by the Fed withdrawing accommodation and Trump wanting to dial up his stimulus?
JA: Yellen talked about that slightly last week in the interest rate increase, but the things I got out of that were that they are still on watch for the fiscal policy. She’s not firm either way. She’s not adopting policy on the assumption that it’s going to happen, she’s going to wait until it happens and then she’ll adjust. But the other thing she said was that she’s not going to decrease the balance sheet of the Fed Reserve and I thought that was significant. That means as bonds mature and interest is paid on the US$4.5 trillion of balance sheet, which the Federal Reserve owns (the bulk of which is government bonds), that she is reinvesting that money back into the bond markets. The bond market is still under the influence of the Fed Reserve and when we invest in the market we have to understand that the bond rate is not giving you a proper indication of risk-free rate of return. It’s still corrupted by central banks – not as significantly in America as in Europe, but still $4 trillion of bond holdings is a significant influence over the bond market. So bond yields, whilst we think will go up, the influence of the Central Bank will make sure that they don’t go up in a hurry, so it’s a slow grind cycle.
DW: Is it possible markets could just resume rallying?
JA: Yes. I think pull backs are a bit of a buying opportunity. More so in Australia, because we don’t see elevated markets like we have in the US or European market. Pull backs in Australia are more attractive to us as investors at this point. I still think that the Australian dollar is beginning to drift down. I know we’ve had a rally in the last week, so I’d be more looking at off-shore investing – more in selective stocks, which have growth, but certainly some significant weighting to US dollar cash. We can begin to get yield on the US dollar cash, which is helpful. When you swing back to Australia, the only concerns we have (and we talked about this in our investment committee this morning) was obviously the central bank discussion. I know you’ve got a view on this you might want to share with the viewers.
DW: Just before I do I might remind our viewers that this is why we have that 5% position in USD – US dollar cash ETF in the Model Portfolio for the reasons that John was just arguing. On Australia, if we do get a pull back in the markets, which stocks do you like? Should investors stay focused on large-caps which will benefit from more world growth, or should they start to return to those mids and smalls?
JA: In some of my presentations recently we’ve done some charts regarding the outperformance twelve months ago of the mid-cap sector over the big-cap sector, and in the last six months there is clearly an outperformance in the big-caps above the mid-caps. Now, that outperformance was really because mid-caps were overbought and it was excessive pricing. We’re now seeing reasonable pricing in the middle market as these stocks pull back, and some of them quite aggressively. So stocks we’d avoided are now coming into the frame to look at – you’ll be buying some of them in your portfolio. I’d be looking at some of the growth opportunities in the middle market. Yes, there are some stalwarts there – Nick Scali and the like that are well funded. But there are some other stocks, that I don’t want to float just yet, which I think are interesting. But the value is appearing in the middle market of Australia, not so much at the top end of the market. The top of the market is an oscillating market – it goes back between resources, banks, telco’s and retailers. It goes up and down. As for the outperformance of resource stocks in the last three months – well you can see quite a bit of weakness in BHP today and that’s continued on for the last few weeks. That’s a weakness despite quite strong iron-ore prices. I think the market clearly overshot on BHP in anticipation of what its growth profile was. We’re just staying on the outlook for commodities, we’re not as bullish as other investment houses.
DW: On banks, banks have had a pretty good run so far this year. Should investors be buying banks in this fall back?
JA: There is some opportunity to top up but you couldn’t be aggressive. The Reserve Bank is flagging issues for the housing market and I think regulation and qualitative controls are coming – so there will be some slowdown. You can’t be bullish on growth in banks, the scenario is a work through. They’ve had a reasonable rally but now I think the work through is coming. But with the banks who are cum dividend I think there’s probably an opportunity to pick up that dividend and not have too much capital risk.
DW: On retail conditions, this morning we were discussing RCG Corporation. It is one of the smaller companies that we like that has pulled back quite a good way, really just on general weakness in retail spending post boxing day. There is nothing wrong with the company, it’s executing well and we like the management. Are retail stocks getting to the point where they’re oversold? That share price chart for RCG looks like capitulation selling.
JA: Well, when you start seeing markets pull back on the risk of Amazon coming here, and Amazon will come, but it will take a minimum of 3 years, probably five years, before they have an impact. It’s a reason for hedge funds to short stocks, not really a rational reason for investors to pull out of them. So this pull back in retail is probably an opportunity. The Australian economy is still fairly sound based on inbound tourism, which we talk about constantly. The numbers are astronomical and I keep on saying the impact of the inbound tourism, mainly Chinese (talking about 1.3 million this year maybe 1.4), they spend money. Retail is not buoyant, but is supported by inbound tourism so I wouldn’t get so negative as many people are in that sector.
DW: Just finally, last question, China – it’s always the source of the the big risks that could come from left field. A monetary policy accident, a surprise currency devaluation, a collapse in the housing market. What’s your current view on China and the risk it poses?
JA: Well, one thing I agree with Trump is that China operates its economy on the basis of what is good for China, so I’m on the side of China will do whatever it has to do to maintain growth. Recently it put up interest rates, which suggests to me that it’s not about stymieing growth it’s about stymieing speculation in property. They’ve got lots of levers and they’ve got more levers to control their economy than many other economies around the world. They don’t print money, their interest rates are well above inflation and they run trade surpluses and current account surpluses. They do have tremendous power to control their economic growth, so that is not a big concern at this point to me. For the people pointing to leverage in the Chinese economy, it’s no greater than the economies of Europe, Japan and America, and indeed Australia. When you look at the total debt to GDP – yes sectors of the property market are excessive, but the overall debt to GDP is no more excessive than the rest of world and they have a growth of 6% when the rest of world is growing at 2. I think it’s, again, all overstated.
DW: One last quick question on China, will we have a trade war between China and the US, or do they have too many mutual interests in common to let that happen?
JA: I still think there’s going to be an adjustment to tariffs. The tariff adjustments are coming from Trump. Some of them will go through to the keeper without much problem. They won’t be anywhere near thirty odd percent, they’ll be probably 5-10% and at the end of the day, I think we’ll find even despite that, American corporations aren’t going to have a massive renaissance and they’re not going to be reinvesting in labor intensive manufacturing in America. The good news, this could push up inflation, push up interest rates, push up the US Dollar and we get the world growing in some sort of inflation cycle as opposed to growing in a deflation cycle, which is not good.
DW: John, thank you very much. A stimulating discussion as always and thank you for watching. Once again, any macro queries or comments please post at the bottom of the screen below this video. Thanks very much for watching and we’ll see next time.