Summary:
Yesterday evening Clime’s Chief Investment Officer, John Abernethy, presented on LiveWire’s Buy Hold Sell with two other seasoned investors about the current market backdrop and how to extract value during the current challenging conditions. With 99 years experience between them there are some great insights discussed, formed on a 3-5 year view.
The importance of not cutting interest rates in Australia and further debasing the currency cannot be understated. This leads to an environment that perversely, actually encourages frivolous borrowing, and penalising savers who have worked tirelessly to accumulate wealth. In this situation, increased inflation and simultaneously increasing interest rates could be disastrous to overly geared households. Luckily, the panel don’t see short rates meaningfully rising in the near-term in Australia. The EU and Japan also look to be settled as their economies’ growth have both stalled. There appears to be growing acceptance of a small (0.25%) rate rise in the US, but the FED appears to be getting ‘jelly legs’ and hesitating in implementing the rise.
Greater market distortions lie within the bond market. Bond prices have reached ridiculous levels recently, manipulated by central banks via quantitative easing strategies to enact local currency controls. A major correction is due here. Meanwhile, falling bond yields are pushing investors to draw yield from other sources i.e. equity markets. This in turn leads to a greater PE expansion in equities, in some cases much higher than the potential for growth.
From a return standpoint, the S&P 500 is heads and shoulders above the ASX 200, while they’ve both tracked upward since 2009. This is due to a phenomenal amount of liquidity being pumped into the system. Long bull markets have historically ended abruptly and painfully, but we can’t be sure when, or what the catalyst might be.
Although the ASX is tracking north, it is still some 1200 points below its 2007 peak. We are now in record-breaking territory with our longest sustained period without a new peak. It is a two-tiered market and index growth in Australia is driven predominately by the middle and small caps, not the large-caps.
From a short-term perspective, the momentum is in the mid and small-caps. Small-caps are hitting new peaks and driving unprecedented growth. Now, whilst interest rates are low and money is cheap, valuations are certainly elevated and investors are definitely paying for this growth.
Some great opportunities in the mid/small-cap range include Ardent Leisure, and Clime Investment Management, CIW, also got a plug. Ardent are currently offering a 4%+ yield. They are rationalising their portfolio of businesses with a deliberate, calculated focus on Main Event. This is their biggest business in the US and represents significant upside.
CIW is touted as having a good management team with $600 million in FUM and a market cap of about $15million on the core business. Compare this to Contango who listed in the last few days with a market cap 5 times this at $76million, yet only $650million in FUM – one of these could be undervalued by the market.
The mid to lower end of the market may offer compelling growth but don’t ignore the large-caps, there is still some very good companies there. But beware; it’s still not an overly attractive place to invest unless you are happy with relatively low return dominated by yield. There are problems with margin compression among Telco’s, retailers and major Banks, and the resource sector is in oversupply, but they are still paying dividends. Now, investors need to be selective as these dividends are plateauing, or even declining, in some cases.
Valuable offerings in the top segment of the market include ANZ, Transurban and Spark Infrastructure. Although ANZ recently announced a decline in future dividends, their share price actually rallied. Generally, the share market is intelligent and mature. New dividend levels were set, allowing the business to grow and the market rewarded that. The market will not reward uncertainty, and plenty of public companies like trading in uncertainty with dividends.
Transurban has come off very quickly. At $12 it’s a bit silly, but at $10.50 cum 25c dividend, they are worth a closer look. Relying on yield as opposed to growth is less than ideal, but nobody can predict share price and a 5% dividend yield is a nice certainty. Spark Infrastructure are a similar story – recent price declines expose a 7% yield with distribution guidance out to 2021.
In conclusion, conditions look to be a little ‘long in the tooth’ for an aging bull market run but investors ought not to panic. Luckily Australian rates are significantly higher than the rest of the world, you just need to be selective when shopping for equities.