2023 has got off to a shaky start for equity markets. What is your outlook for the rest of the year?
I think by year end, we should be looking at a pretty good equity market. Since the start of the year, we’ve seen a lot of volatility, whether that’s due to the banking crisis or other market uncertainty. But my view is that we are right in the midst of that challenging period. Looking forward to the second half of this year, I think the equity markets will do very well.
What’s driving that optimism?
First of all, we have already started feeling the pinch of higher interest rates. We’ve started seeing some casualties from the rapid rate hikes around the world, with the collapse of Silicon Valley Bank and Credit Suisse. A lot of the weaker banks in the US are also under pressure because of a run on deposits by investors looking for higher return rates on their deposits. Our view is that, right now, this looks reasonably contained. On the plus side, this pressure is tightening financial conditions in the US and acting almost like additional interest rate increases. This means the Fed [Federal Reserve] won’t have to put up interest rates as much as previously expected. The last rate rise was 25 basis points, when it was expected to be 50, and there is every chance that the Fed is going to slow down when it comes to rate rises.
Back in Australia, even though the economic conditions still feel pretty good, the RBA [Reserve Bank of Australia] is conservative. They want to see the impact of interest rate rises and they don’t want to see a run on the banks (although our banks are obviously in a far better position). So they paused rate rises this month, which I think is a positive sign. Central banks are very pragmatic; they don’t want to create any financial stress and they are quick to step in and provide liquidity when there is a loss of confidence. So, putting all that together, I think that rate rises are not going to be as severe as we previously thought. That is good for underlying corporate fundamentals, as well as the equity market outlook because valuations are underpinned by interest rate fluctuations.
Secondly, when it comes to slowing economic conditions, the one thing we need to remember is that the equity market is always looking forward 12-18 months. So, we are buying future earnings, not what things are currently. Although it doesn’t feel like it yet, we are going to have a slowdown in Australia and, when that happens, corporate earnings will come off. This is not yet reflected in analysts’ expectations, which are always too high, but particularly so in a weak economic environment. So, right now, we are in the middle of these expectations being downgraded to a point where they become more realistic. To be clear, I don’t think Australia’s going to go into recession. I just think corporate activity growth for the next 12 months is going to be slower. I think earnings need to be downgraded by 5 to 7 per cent over the next few months.
Once we get that out of the way, the equity market looks pretty good. Inflation is on the way down, apart from employment costs. Energy prices year-on-year are coming off. Food inflation is coming off. Border mobility is coming though, so hopefully there’ll be more labour. Interest rates are on pause. Corporate earnings will be downgraded, but they will still be very healthy. So we will be able to grow from there.
So you are expecting an earnings rebase by August?
That’s right. Profit warnings will probably start in May and between May and August, you will see earnings rebase. I think we’re not far from the bottom of the earnings cycle, so in the second half of the 2024 financial year, you will see earnings grow quite meaningfully. Don’t forget China’s reopening is going to be a huge driver for the Australian economy. The Chinese government is pumping a lot of money into the economy to hit the growth target they set. This is great for us because there’ll be more demand for infrastructure, commodities, education and travel. There is a lot of benefit coming Australia’s way and that is going to ramp up over the next six month.
That’s the longer-term view. But remember, in the short-to-medium-term, as earnings rebase, that will become a buying opportunity. That’s when you want to start buying some of these companies. You may not be able to pick the exact bottom, but over the long-term, they will look incredible value.
We recently went through reporting season, when I know you would have spoken to dozens of CEOs and CFOs. Are there any trends you are anticipating out of those conversations?
The big one is continued pressure on cost, due to rising inflation and the lack of labour availability. So we should continue to see margin pressure coming through when companies report again in August. On the demand side, we should continue to see a slowdown and at a faster rate than it is currently, particularly in consumer and housing-exposed goods. A lot of companies we have spoken to post-results have indicated that things are slowing very quickly. That is why we are expecting earnings downgrades over the next three months.
Your Alpha Plus fund is a long-short fund. Are there any particular companies that you liked coming out of reporting season – and any that you are shorting?
We really like REA Group, which owns realestate.com. We bought a lot more of the company during the reporting season because, while near-term earnings look tough, this is clearly a winner on a longer-term view. This is the type of business you want to buy when things are difficult because they have such a high return on equity. And if things do turn out to be a lot worse than expected, they can cut costs really quickly because it’s not a fixed cost business. Secondly, the company is not just a volume story. It has all these other products, which can generate high income in addition to the listings. There is so much going for this business that when the share price falls due to near-term cyclical pressure, it’s really a buying opportunity.
As for companies I didn’t like, oh gosh. Can I not name names?
OK, but how about the sectors that you don’t like at the moment?
We think consumer is going to be a tough sector. Travel will be very good, but consumer discretionary – namely, retailers – are going to be in a really challenging place. Housing turnover is slowing and house prices have fallen, and normally they’re a lead indicator for consumer spend. Plus, we’ve got mortgages rolling to higher rates in the next few months, so consumers are really going to be tightening their belts. I don’t think this is going to be too big a problem for the overall economy because there are other factors offsetting this, but this is a sector where we will continue to be underweight.
One area we think is being overly rewarded at the moment is the consumer staples. I know this sector is regarded as defensive, but when consumers are under pressure, they are going to shrink their basket size and switch to home or cheaper brands. That means potential earnings pressure for these companies, yet they are still looking pretty expensive relative to other consumer names. I think over the next few months, you will see their share prices becoming a bit more volatile.
We’re also neutral-to-underweight the Australian banks. I think their best days are behind them. Until now, they have benefited a lot from higher interest rates and a good operating environment, but the competition for mortgages is about to get even fiercer. Right now, it seems that their upside potential is not there compared to sectors like resources, which is more exposed to China reopening. The banks will still be OK when it comes to providing income or buybacks, but they’re not really going anywhere.
So, you don’t hold any banks in your portfolio?
I bought Macquarie. I think it’s a much better proposition as it really gives both a growth and global angle. Also, whenever commodity prices are going through volatile periods, they seem to do really well, so I think this year is going to be incredible again. There’s something special about that business.
I also have a bit of National Australia Bank because business is doing a little better there, but net-net, I think domestic banks are going to be challenged.
What’s your current gross exposure?
Whenever I see a lot of opportunity in the market, I tend to increase my gross exposure. That means, I short more companies and I buy more companies, so I expand. When there’s a period where I don’t see many opportunities, I shrink my exposure, so I have less shorts and less longs.
Right now, as market volatility increases and stocks get sold down, we are seeing more opportunities, so we have actually started expanding our gross exposure.
But how does your current position compare to normal levels of exposure?
Normally, we would sit at about 150% gross exposure, so that’s 125% long and 25% short. Right now, we are sitting at about 130% gross exposure. But this position is quite dynamic. For example, in January, when the market had a big rally, we actually shrank our gross exposure because we decided to take our profit. We actually went quite low, but now we’re expanding out again.
You’re obviously very positive on the Australian economy, but what about the US? Are you expecting a recession there?
I think the risk of recession in the US is pretty high, but that’s not as bad as it sounds. When people hear the word recession, they think it’s a crisis. That’s not the case. Already, the financial conditions for a lot of US businesses has deteriorated and we’re seeing all these headlines about companies laying off people. But this had to happen in order to contain wage growth. So, I think the US will reach a technical recession in the third quarter of this year, which is what the Fed was trying to engineer so that they can start cutting rates again. I read an interesting statistic the other day that the time it takes Central Banks to get from the last rate rise to the first rate cut is, on average, nine months. That’s not very long, so there is light at the end of the tunnel.
I think, for Australia, things are different. We were slower with our rate rises and our wage growth was not as bad. Plus, our banks are well capitalised. They’re nothing like the US banks.
At our recent Women Investor events, we got a lot of questions about active versus passive investing. Given the current market volatility, has passive investing had its time? Is it now a stock picker’s market?
That’s a good question. And the answer is, I think so. As active investors, this is really “our” market, where we get to pick the turning points. This is when we start winning a lot more money and generating returns.
Passive investing will continue to do well because asset prices will continue to grow due to the growth in pension and super funds. But is passive investing going to continue to take market share? I think this is the year where they won’t. When we look at the performance of passive versus active investors, active managers are actually doing a lot better at the moment. Passive investing leaves too much opportunity on the table. So I think that the trend of market share gain for passive investors is going to stop.
You are one of the few senior female fund managers in Australia. Do you find high net worth’s and institutional investors increasingly looking for gender diversity in their investment managers?
A few years ago, the super funds started talking about a target of 30 per cent, on the path towards 50 per cent. So there’s definitely a lot of demand for female managers and we’re seeing a lot of hiring programs that are targeted towards bringing female talent through. We are definitely seeing changes, but it’s a slow process. Ultimately, we need to have more women in senior positions where younger women can look up to them and know there’s a possibility of getting there. There also needs to be more workplace flexibility, especially around the childbearing years because we tend to lose a lot of talent then. It’s a really good trend and it is happening – but it could happen faster and better.
The other message I really want to get across is that females actually make really good investors. We aren’t here just because of a quota; we are actually good at what we do.
What are the two key lessons you’ve learned during your investing career?
The first one is don’t follow; get away from the herd mentality. Work step-by-step to develop your self-confidence and to gain the courage of your convictions. Once you’ve built enough confidence in what you do, you need to back yourself and take that leap of faith. This is particularly true for women, because they tend to be a bit less confident to start with.
The second lesson is to make sure you do your homework properly. In the early days of my career, when I was a young analyst, I used to cover retail stocks. One time, I didn’t go to visit all the stores for one of the companies I covered and it turned out to be a disaster. That’s when I learned you have to get out there to understand the value proposition to the customer and whether the company will continue to do well or badly. You’ve got to kick those tyres!
Finally, we’re incredibly grateful for the work you do pro bono for Future Generation Australia. So why do you do it?
I feel so proud to be a part of Future Generation because that is my way of giving back to our community. I get to help these incredible charities, without any additional demands placed on my time. The challenge for all of us is that we all have such busy lives; I’ve got two little kids and then there’s work and everything else. Future Generation gives me the opportunity to give back while I’m doing a job that I really love. It’s such an amazing model. I’d love to do even more.