Investment Update

Endorphin Wealth held a June update webinar with Isaac Poole, Global Chief Investment Officer and portfolio manager at Oreana Financial Services, and Avik Roy, Investment Director at Schroders.

Both guest speakers discussed the trends in the current economic outlook in detail, with Isaac focusing on a macroeconomic perspective while Avik honed in on his company’s approach to stock investments in relation to the current market and future predictions. We wrapped up with a Q&A, answering some pressing questions about the state of the current market.

Summary of Isaac Poole’s Talk

In assessing the current state of the market, Isaac prefaced his talk by stating he wished he could have a more optimistic outlook about the future. A series of concerns have translated into a downturn that raises apprehensions about a future recession, powered by the inflationary pressures that persist at elevated levels.

While this does not necessarily guarantee an increase in interest rates or inflation, banks might be compelled to push the rates higher as the economy is still responding well to these increased rates.

The RBA sent a warning out that people can’t expect a decrease in rates, and despite the economy’s resilience in the face of previous rate hikes, the central bank now feels confident to continue raising rates. However, the decision to hike rates is not without its reservations, as consumer confidence remains low, and there are concerns about the impact on household spending and the possibility of triggering a recession.

Inflationary Pressures and Interest Rates

The persistence of high inflationary pressures presents a significant challenge, and the process of reducing inflation back to the desired 2 per cent target appears to be a long and winding road. Isaac has assessed that the Federal Reserve and the RBA have space for one or two more rate hikes.

These institutions hope that by raising rates, they can mitigate inflationary pressures, and as they haven’t seen a lot of weakness in terms of unemployment rates in the face of those hikes, they have confidence that they can hike again without excessive risk. In spite of their rate hikes, the unemployment rate is below historical averages; it appears to be contributing to inflation rather than slowing it. The goal is to hike until unemployment rises alleviating some of the wage and inflationary pressures the economy currently faces. 

Consumer Confidence and Household Spending

Despite the central banks’ intentions, the excessive rate hikes are met with scepticism due to dwindling consumer confidence. Household spending, which constitutes two-thirds of the GDP, is significantly worse off than during the global financial crisis and the peak of the pandemic.

The window of opportunity for rate hikes is closing rapidly. The delicate balance between raising rates to curb inflation and avoiding a downturn caused by decreased consumer spending must be carefully managed.

Housing Market Dynamics

The national housing market has experienced a recent surge in prices, with heightened expectations for further increases. While this has brought about positive sentiment, it is important to consider the potential consequences of higher interest rates on the housing market.

There is a mass of mortgage holders expected to move from fixed-rate mortgages to a variable-rate mortgage, resulting in a mortgage cliff. As well as the expected RBA rate hikes, this approaching mortgage cliff is set to put further strain on households. 

Mortgage growth has already slowed considerably since last year, indicating a level of sensitivity to interest rate changes. Although expectations for rate hikes are present, the actual implementation and its impact on the housing market are still uncertain.

Recession Possibility and Economic Outlook

Considering the current economic climate, a recession appears to be a distinct possibility, not only for Australia but also for the United States. This would be a genuine recession, unrelated to the pandemic-induced economic downturn, however predicting the timing of a recession is always a challenge.

As business confidence has diminished, and consumer confidence has tanked, there’s a necessary caution in the market. We need to stay mindful of the potential for higher rates on different market sectors and their influence on overall market stability.

Avik Roy – Investment Director of Schroders

Market Uncertainty

The past few years have been a wild ride for the market, with major events causing ups and downs. Despite a recent 8% increase in global equities, there’s a general broad feeling of uncertainty due to unpredictable expectations and inflation, leading to market swings.

Reverse Trends

This year’s performance has reversed a lot of what we saw last year. Instead of certain sectors like oil and commodities going up while most others fall, the opposite is happening. We’ve seen a 20% difference in return between cheap and expensive stocks, favouring more value stocks, indicating that hubris has certainly returned to the market.

Power in a Few

A small group of stocks, known as the “large 7,” have been the main drivers behind the market’s overall returns, accounting for a huge 88% of the total gain. This concentration shows how narrow the market has become, which could bring more risk.

Value vs. Growth

Growth stocks, especially in tech, communications, social media, and online sectors, were the heroes of the market post-pandemic when we saw an optimistic bounce. But value stocks are now performing well, which is noted after this bounce where growth stocks did well after vaccines were introduced and value stocks did better than growth.

This is likely due to the current uncertainty around rates and the cost-of-living crisis – the market is on edge about interest rates and how they’ll affect future growth. Analysts have downgraded US banks, and there’s worry about the impact of higher rates in Australia. Depending on how rates play out, different scenarios could unfold, making risk management a challenge.

Diversification Dilemma

A good mix is important now but lean into high-quality, long-term investments where you can. The current market trends and concentration make it tough to diversify and take advantage of value investing. While portfolios may look good compared to the overall index, the overall market conditions create obstacles to diversification and value strategies.

Endorphin Wealth’s Client Q&As Asked to the Panellists

To Avik – Can you tell us about specific stocks you’ve bought this year and the metrics around that decision?

Avik mentioned that they looked for companies that experienced a fall but had unchanged business fundamentals. We found banks attractive to pick up now when they fall as well as apparel companies like Louis Vuitton (as luxury took a hit), pharmaceuticals (very defensive and strong companies), semiconductors (they feel and are linked to economic cycles), and we even took the opportunity to buy into Meta when it fell 70%.

To Avik – Are there regions you’re finding the most value in currently?

While the US hasn’t been attractive for a while, we’ve found some value there recently. There are also lots of opportunities in the UK and Europe, where banks and energy companies all fell in tandem. Consumer stocks are still quite attractive, and we can find them cheap in Europe. Finally, technology, AI and those sorts of growth stocks have good value in Asia.

To Isaac – What’s the worst-case scenario or base case of a recession, and how long will it go?

Isaac noted that recessions historically occur after the last rate hike, and the RBA is getting close to that point. The lag between the last hike and a recession is somewhere between 6-15 months, so we’re looking somewhere in 2024. It’s obviously hard to determine the duration, but it will depend on how far the RBA hikes rates and the unemployment rate plays a role in determining its length. Rate cuts could be used as a mitigation measure if the RBA hikes too high.

Isaac – After the next 1-2 rate hikes as you expected, what happens and how are you preparing?

Isaac mentions he doesn’t agree that recessions can be shallow. He said that central banks are typically reluctant to cut rates too soon, and recessions are often worse than they’re predicted because they grow on themselves. However, if they do hike to hike, banks are in a good position to make strong cuts to mitigate the impact. He suggested preparing portfolios for downside risks, adding government bonds, and diversifying to mitigate potential challenges in the next year. 

To Avik – What sorts of industries do you see an opportunity in if there’s a recession? What about consumer staples?

In response to opportunities during a recession, Avik highlighted that US AI tech-driven industries could perform well. However, he advised avoiding consumer discretionary stocks as people tend to cut back on spending during a recession. On the other hand, essential household goods should do well including drinks and product companies, of the likes of Nestle and Pepsi. Home builders and property-related industries could also be seen as having continued demand, and are a canary in the gold mine, as he put it.

To Isaac – Is now a good time to dive into S&P500?

Isaac acknowledged the risks but said it’s certainly a strategic option. He recommended a sensible strategy of diversifying assets, with bonds being considered cheap and equities being relatively expensive. He also suggested adjusting the dollar cost outlook to potentially benefit from changing market conditions.