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Hedge Clippings | 08 December 2023

There may have been a change at the head of the Reserve Bank board table, but whoever writes the Governor's statement and media release following the meeting is stuck in a groove. Apart from the absence of Philip Lowe's favourite "narrow path" term, the perils of inflation and the necessity to curb it are pretty much a copy and paste from prior months, which we suppose is inevitable.

Equally consistent is the warning that the board won't hesitate to act as required, and that while the numbers are encouraging, they're not sufficiently clear to say that the battle has been won. However, the September quarter GDP figures released on Wednesday show a pretty clear picture, with growth of just 0.2%, down from 0.4 %, 0.5% and 0.9% in the previous quarters. If it hadn't been for government spending and fixed capital expenditure both rising by 1.1% then the picture would have been different. Household spending was flat - understandable given interest rates having taken effect, and the household savings to income ratio fell for the 8th straight quarter to 1.1%, its lowest level since December 2007.

There are still some economists hanging out for one more rate rise in February next year when the RBA board reconvenes, but surprises aside, we doubt it.

On a different note, the ABS released their population projections - carefully noting they're not forecasts - indicating that by 2071 (when yours truly will well and truly have left the stage, or if not, won't have any marbles left) the current population of 26 million will have grown to between 34 and 46 million, and the median age to have increased from 38.5 to between 43.8 and 47.6 years. Given the current traffic problems, and the plans for high-rise development to house them all, and the fact this is apparently the hottest year on record, we're glad we won't be part of it.

Among the assumptions from the ABS are that net overseas migration will average 225,000 people (medium estimate) and up to 275,000 based on a higher estimate. Given migration this year is tipped to be well over 400,000 that's likely to be conservative. Hedge Clippings isn't anti-migration per se, we just hope that various governments work out the logistics, housing and infrastructure required to accommodate the increase.

Finally, "pretty boy" Ablo and "potato head" Dutton wished each other happy holidays as the Federal Parliament broke for Christmas this week. With no pollies to listen to for the next 2 months, at least the levels of hot air should decrease.

News & Insights

New Funds on FundMonitors.com

Investment Insights: The ups, the downs, and the future of the economic cycle | Touchstone Asset Management

The weight loss drug shaping-up as a gamechanger | Magellan Asset Management

November 2023 Performance News

Argonaut Natural Resources Fund

Rixon Income Fund

Bennelong Australian Equities Fund

Delft Partners Global High Conviction Strategy

4D Global Infrastructure Fund (Unhedged)

Bennelong Concentrated Australian Equities Fund

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The weight loss drug shaping-up as a gamechanger

Magellan Asset Management

November 2023

The world is awash with news that a drug designed to treat type 2 diabetes has also been approved to help achieve weight loss. Glucagon-like peptide 1 -- or GLP-1 -- is considered by some as a wonder drug and a new weapon in the public health battle against obesity. But what are the wider implications for the investment world? In this episode of Magellan In The Know, Portfolio Manager Nikki Thomas is joined by three Magellan Investment Analysts: Emma Henderson, Wilson Nghe and Tracey Wahlberg. Together they discuss the investment landscape surrounding GLP-1, looking at the pitfalls and potential financial benefits for sectors from healthcare, food retailing and restaurants to fashion, exploring which parts of the consumption landscape could be winners or losers. 

Funds operated by this manager:

Magellan Global Fund (Hedged), Magellan Global Fund (Open Class Units) ASX:MGOC, Magellan High Conviction Fund, Magellan Infrastructure Fund, Magellan Infrastructure Fund (Unhedged), MFG Core Infrastructure Fund

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Why are property prices surging as rates are rising?

Montgomery Investment Management

November 2023

In the thriving metropolises of Australia, the real estate horizon is gleaming brighter than ever. House prices have surpassed previous highs, putting a final nail in the coffin of those pessimistic forecasters who predicted 25-30 per cent declines.

The latest figures show a surprising twist in Australia's property market, as the largest and costliest city shatters its previous real estate records. Across the nation, we're seeing a similar trend, with the PropTrack home price index indicating a national median home value increase of 0.36 per cent in October, achieving a new high.

Sydney, once the face of declining values due to higher interest rates, has made a dramatic comeback. Home prices in the city are at an all-time high, with the median dwelling value reaching $1.07 million, marking a steady 11-month rise and a commendable annual rise of about 7.5 per cent.

Other capitals like Brisbane, Perth, and Adelaide have also hit record values, defying earlier expectations. Even as interest rates have climbed, these cities have witnessed robust growth, thanks to a mix of factors, including renewed migration, a limited supply of stock and tight rental markets.

Though Melbourne's and Hobart's prices are yet to surpass their previous highs, they're on an upward trajectory, while Perth boasts the most vigorous annual price surge, and Adelaide impressive growth year-on-year. Brisbane shares the spotlight with Sydney, with home values at all-time highs.

A month ago, in a blog post entitled Don't Sell! House Prices Must Go Up, I wrote; "At the same time the population is surging (thanks to government policy), a downturn in housing construction has gripped the country. Australia is witnessing a steep decline in new home sales, and ...the Housing Industry Association was recently reported to be predicting a slump in construction activity by 2024, intensifying existing housing shortages and making homeownership unattainable for many Australians."

One month in since that blog was written, and prices are fast reflecting those circumstances.

And while there's no shortage of real estate agents willing to predict what property prices will do next, you can put them all away. A year 11 business studies student can tell you property prices have to rise, or at least remain elevated if they have already risen. And that's because when demand rises (immigration) and supply falls (construction has slumped) prices can only go one way.

So, what's ahead for home prices? While the threat of inflation could prompt further rate rises, the ongoing housing shortage is likely to offset keeping property prices resilient.

In essence, the sustained rise in property values across most of Australia's cities prompts a reflection: were the property bears too quick to predict doom? Current trends suggest they might have underestimated the market's resilience.

Author: Roger Montgomery

Funds operated by this manager:

Montgomery (Private) Fund, Montgomery Small Companies Fund, The Montgomery Fund

Why Europe is the region leading sovereign green

bond issuance and what we expect for the last three

Ardea Investment Management

November 2023

Funds operated by this manager:

Important Information

This material has been prepared by Ardea Investment Management Pty Limited (Ardea) (ABN 50 132 902 722). Ardea is the holder of an Australian financial services licence AFSL 329 828 and is regulated under the laws of Australia.
This document does not relate to any financial or investment product or service and does not constitute or form part of any offer to sell, or any solicitation of any offer to subscribe or interests and the information provided is intended to be general in nature only. This should not form the basis of, or be relied upon for the purpose of, any investment decision. This document is not available to retail investors as defined under local laws.
This document has been prepared without taking into account any person's objectives, financial situation or needs. Any person receiving the information in this document should consider the appropriateness of the information, in light of their own objectives, financial situation or needs before acting.
This document is provided to you on the basis that it should not be relied upon for any purpose other than information and discussion. The document has not been independently verified. No reliance may be placed for any purpose on the document or its accuracy, fairness, correctness, or completeness. Neither Ardea nor any of its related bodies corporates, associates and employees shall have any liability whatsoever (in negligence or otherwise) for any loss howsoever arising from any use of the document or otherwise in connection with the presentation.

Investment Insights: The ups, the downs,

and the future of the economic cycle

Touchstone Asset Management

November 2023

This article looks at some of the current challenges faced by the consumer market and explores macroeconomic trends affecting the market.

As primarily bottom-up investors, we can often get an edge by talking to a company's customers, suppliers, and management teams to assess quality - which is not always done well in the market. And this bottom-up work often leads to the formation of strong top-down views. For example, in 2021 we were confident that inflation was strengthening and would come in above market expectations and lead to higher interest rates. Now, our view is that inflation has peaked, but will remain elevated for some time.

Along with inflation and its impact on consumer spending, there's a lot of global macroeconomic volatility impacting the market.

An update on consumer spending

Let's start with a quick recap of the most recent reporting season.

This brought about a wave of volatility in the stock market, with one in every eight stocks experiencing movements of over 10% in response to their results, which is twice the usual average. This period was characterised by price-to-earnings (PE) expansion, explaining much of the market's upward movement. Investors seemed willing to look through some of the soft results by cyclical companies and buy them regardless, leading to PE re-rating. But they also sold defensives that had earnings misses - which could be seen in the earnings revisions. The average earnings upgrade was only 2.7%, and the average downgrade was around 9%.

The reporting season proved to be a tough one for consumer stocks, marked as the worst in 13 years. More than half of consumer companies downgraded their earnings by over 10%. Several factors played a role in this underperformance, as we had expected.

A significant part of the impact can be attributed to the peak effect of the transition from fixed to variable mortgage rates. Additionally, the phase-out of low and middle-income tax offsets, which provided households with tax refunds, created headwinds. As households steadily deplete their savings buffers, the effects rippled through to earnings. The struggle was evident not just in the earnings reports, but also in high-frequency retail spending data from Kepler, which showed a drop as steep as 12% year-on-year and real per capita consumption plummeting by as much as -5%; an unprecedented decline.

In terms of categories, electricals were particularly weak, but there were some doing quite well, such as those that thrive in good weather conditions (e.g. Wesfarmers, thanks to Bunnings' results).

Inflation is staying high

While inflation may have peaked, it is expected to remain elevated for some time across the globe.

We are particularly concerned about the situation in the US, where fiscal spending continues at an unsustainable rate, and is contributing to higher bond yields. While those yields are rising, it is not solely due to inflation. There's a shortage of demand for bonds, which propels interest rates upward.

The current conflict in the Middle East, while socially devastating, also has strong financial impacts. Tensions lead to higher oil prices globally, further increasing cost of living. We were already positive on oil because we thought supply would be under pressure, but again, that just gives us confidence with a higher oil price that inflation will remain elevated.

So, what does this mean for Australia?

We believe wages growth will remain strong here, because of our relatively rigid wage setting mechanism. We also believe energy prices are expected to remain high, so we're in a similar situation where inflation, while it may have peaked out, should remain quite high. And as we saw recently, the RBA implemented another rate hike.

At the household level, the pressure is at its peak, with the transition from fixed to variable mortgages and the depletion of savings buffers taking its toll. Approximately 60% of households have already exhausted their savings, a figure expected to rise to 80% by the year's end.

Overall, as we expected, we saw a per capita recession but not an outright recession, and we can hopefully look forward to better conditions as we move through 2024.

A bit on banks

For a while, we've held the view that the banks' margins were too high and would come down. The recent  reporting season appeared to confirm this view, with pre-provision operating profits broadly disappointing as bank margins were squeezed. Offsetting this, credit costs continued to surprise positively, resulting in earnings that mostly met expectations.

We still see a lot of competition in the sector and rising costs impacting in the year ahead. We also forecast an increase in bad debts, as losses begin to normalise from its current very low levels. This will likely result in lower earnings for the sector over the next 12 months.

We have owned NAB, and we think that's the pick of the bunch - relatively less exposed to some of the concerns we have and looks more reasonable. But if anything, across our portfolio, we make a lot of being index unaware, and this is a great time where we think there's more opportunity out of sight of the major sectors of banks and resources, into some of the other areas where we see more quality on offer at better value.

The end is near (for the economic cycle)

Despite the challenges, there are still opportunities in the market for investors who choose wisely. And while it's felt like a long, volatile cycle, we are nearer to the end than the beginning.

For some time, we've been talking about our expectations for earnings downgrades. In mid-late 2022, the market had 12 months forward EPS growth of around plus 8%. That's fallen by 14%. Expectations are now for EPS to decline in 2024 by around -6%.

Notably, the downgrades have been largely due to resources. Industrials have actually been surprisingly resilient, so we still think there'll be further modest weakness in earnings, perhaps low to mid-single digit downside. But what will be different is that the downgrades are likely to come from the industrials.

How we're positioning the portfolio

Our approach is to own the higher quality cyclicals - preferably those that have used the period of weakness over the past couple of years to improve their businesses, in anticipation of rates peaking and the next cycle commencing. For example, we invested in James Hardie this year, which has been a good call. While we knew the company could be impacted by higher US interest rates, those rates now mean less building. So, if anything, there's more of an undersupply of housing in the US as we move through the next cycle - a little bit of pain now, but potentially more upside later.

Another sector we are overweight in is energy, with companies like Ampol showing strong performance due to our positive outlook on oil.

There's been a lot of talk recently about the impact of GLP-1 drugs like Ozempic on healthcare stocks. It's meant that some of the healthcare stocks, which are in the bucket of defensives and are high quality companies, are now particularly cheap. We think in some instances they've been dealt with too harshly. In the longer term, we don't think health care stocks will be impacted by GLP-1 drugs, and therefore, oddly enough, it's actually the defensives that are quite often looking attractive now.

CSL, for example, is the top ranked stock in our universe on our quality value matrix. Even if we take the extreme view as to the uptake and adherence to all correct protocols by people that take GLP-1 drugs, CSL may see some competition in parts of its portfolio, but there'll be minimal impact. At a recent investor day, CSL's management forecasted double-digit earnings growth, with increasing return on capital. So, there's still positive feedback from the industry.

Overall, the market looks relatively reasonably valued, perhaps even marginally overvalued. So, when you put all that together, given we know the market will look through the last part of the earnings downgrades, we're now starting to think about what we want to own for the next cycle.

Funds operated by this manager:

Touchstone Index Unaware Fund

The content contained in this audio represents the opinions of the speakers. The speakers may hold either long or short positions in securities of various companies discussed in the audio. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the speakers to express their personal views on investing and for the entertainment of the listener.

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