If the world thought 2020 was "unprecedented", then what, my friends, could we describe as the seven months we have seen so far of 2021?
In just over half a year, we have witnessed a major rotation from growth stocks to cyclical, economically-buoyed names, before another reversal back to tech-heavyweights and growth.
Equity markets around the world have reached new all-time highs (S&P/ASX 200, the NASDAQ, the S&P 500, the Dow Jones Industrial Average, the Nikkei, the KOSPI, the DAX, to list off a few) while many national borders and homes (hello, another four weeks of lockdown for NSW) remain shuttered in the face of a new COVID-19 variant.
Meantime, everyone and their neighbour is losing their minds over inflation - everyone, that is, except bond markets.
The gauge of bond-market inflation expectations, breakeven rates, has been sliding since mid-May and has barely moved at all over the past month. And yet, just two week's ago US consumer prices posted their largest gain in 13 years, increasing 0.9% in June and its index storming 5.4% ahead over the past year.
With so many factors pushing one way and pulling another, we took the opportunity to find some signals amid the noise and speak to nine managers from the Pinnacle stable to find out their one big idea in their asset class for the year ahead.
And luckily, they believe there still is plenty of opportunity for investors. You just need to know where to look for it.
Firetrail Investment's Blake Henricks believes the major opportunity in the market over the coming 12 months is energy, and in particular, brent oil.
He argues that demand for the commodity has been better than expected, firstly because of the vaccine rollout and secondly thanks to the recovery in various fuel sources.
"Pre-COVID, the global oil market was running at about 102 million barrels a day. In June it was running at 96 million barrels a day. So there's already been a huge recovery and most of the difference is just jet fuel," he says.
Meanwhile, the supply side has been under pressure, with investors increasingly pulling back from brent oil producers for three major reasons, Henricks says.
"The first reason is that many of the large listed companies have delivered disappointing returns over the last 10 years despite quite high oil prices. You look at Exxon, it's done about a 6% ROI when oil has averaged about $68 a barrel," Henricks explains.
"They're definitely pulling back from investing and trying to get returns up to something that's acceptable for shareholders."
Other major reasons for this change in the oil supply cycle include ESG concerns, and a lack of funding as "the cost of capital for investing in new oil assets is rising".
"When you put it all together, we've seen a sharp snapback in demand, supply has been impacted, and as a result, we're likely to experience quite high oil prices in the medium term; before demand starts to taper off in the back half of this decade," Henricks adds.
So what companies, in particular, will benefit from this new supply/demand dynamic?
Glad you asked.
"That's where it gets quite exciting," Henricks says.
"As an example, just in the past quarter, the oil price is up over 20%. But many of the oil companies have underperformed the market by close to 20%. So there's a big opportunity that's opened up in our view across all the oil stocks."
Henricks names Oil Search (ASX: OSH) as his winning pick, pointing to its "tier one assets, long life in their PNG oil project, alongside some pretty attractive growth options" for his bullish outlook on the stock.
Palisade Investment Partners' Roger Lloyd, an infrastructure specialist, believes that "nobody will be investing in coal-generating assets in this country" over the years ahead.
"The transition to a decarbonised economy is massive. It's on everybody's lips and minds," he says.
"We're one of the larger independent, renewable energy generators in the country with 750 megawatts of power generation - which is large, for those uninitiated in this."
In fact, Llyod's portfolio is exposed to a large number of wind farms, particularly in South Australia and Tasmania, to take advantage of the decarbonisation thematic.
"(No pun intended) the tailwinds are the fact that we have a huge appetite for investment directly into renewable generating assets," he says.
Llyod believes that this trend will accelerate significantly over the next few years. Not just in wind and solar power, but in ancillary services like building batteries to store up power for when the winds don't blow and the sun doesn't shine.
3. Inflation is set to detonate expensive stocks...
Spheria Asset Management's Marcus Burns believes that the biggest change over the coming 12 months is the word on every investor's lips: inflation.
He argues the kryptonite of equities markets is going to blow up “concept stocks” or those companies that are aggressively priced which are pinned by the hopes and dreams of an entrepreneur and very little else.
“One recommendation is to carefully look at what you own… I've never seen such a bizarre situation where a flood of retail money has come in, pumped up these 'concept stocks' where some of them don’t even have a concept in my mind,” he says.
“There are billion-dollar valuations with absolutely nothing there."
But that doesn't mean the market is absent of opportunities. In fact, Burns believes that in the event of severe rerating, investors will be able to uncover some cheaper stocks with good fundamentals.
“I think, bizarrely, you'll see some stuff that is really cheap, those really fundamentally good stocks that are being ignored because they might be low growth or might be cyclical,” he said.
“Frankly, they could go up a lot if people rotated into them.”
Longwave Capital's David Wanis notes that, against the backdrop of the tumultuous year that was 2020, we saw the highest proportion of listed small and microcap stocks that have never made a profit in years.
"Our big idea is just to stay focused and not get tempted into owning these stocks," he says.
"I know it’s a bit boring, but if you look at our top 10 positions at the end of the month, we have companies like Metcash, Newscorp, CSR – these are relatively boring stocks and not the sexy small caps that dominate the market at the moment."
He recommends investors prioritise quality companies at reasonable valuations over these spicy small and micro caps.
"Stay disciplined, stay focused and ignore the hype," Wanis says.
"Use the distraction of other more speculative investors as an opportunity."
5. That aside, private markets are looking attractive...
Metrics Credit Partners' Andrew Lockhart believes in the current low-interest rate environment, private market opportunities may provide investors with the returns they are looking for.
He notes that he is seeing a significant rotation by large institutional investors into alternative private market transactions, such as airports and other major private-public partnership (PPP) projects.
“We continue to see substantial growth in demand for credit and increasing interest from investors," Lockhart says.
"For instance, earlier this year, we acquired a portfolio from Investec Bank for around $1.3 billion and saw very strong support from our institutional clients to support that acquisition."
Metrics was also able to raise close to $200 million for its MCP Master Income Trust (ASX: MXT) - which was used to support the acquisition of that portfolio.
“In terms of one big idea for the year, increasing growth of private markets investments would be the opportunity," Lockhart says.
6. ... As are utilities (and particularly those with renewable exposure)
Resolution Capital's Jan de Vos believes there is one local utility that combines "predictable returns with growth through renewable development."
"AusNet (ASX:AST) is an Australian utility which owns many of the electricity poles and wires in Victoria and provides predictable and growing cash flows," he says.
"Whilst these cash flows are always attractive, they are especially in demand in the current low-interest rate environment."
AusNet is a fully regulated monopoly and bears no volume risk. It is therefore resilient to changes in activity and well-positioned to benefit from the trend of decarbonisation. As de Vos explains.
"Australia is blessed with incredible renewable resources and pleasingly the electricity grid is greening rapidly," he says.
"This will continue because fossil fuel generation is unable to compete as renewables are cheaper plus coal generation plants are ending their life cycle. Also, customers are increasingly wanting renewable power."
To have any chance of meeting Paris carbon reduction targets ‘everything’ needs to ‘electrify’ and electricity generation needs to decarbonise. These new wind and solar farms need to be connected to the grid, de Vos says, and the grid itself needs to become more resilient through more transmission lines within and between states to accommodate the intermittent nature of renewables.
"This provides a great opportunity for utilities to connect renewables into the grid by building the high voltage lines to carry the electricity from the solar and wind farms into the cities," he says.
"In Victoria, AusNet is in a great position to do this. Interestingly, a lot of the renewables activity is in their unregulated business and we believe this will be the growth engine for AusNet in the coming years."
The company is currently trading with more than a 5% dividend yield, which de Vos believes will continue to grow at around CPI.
"The reason why the dividend growth isn’t higher is that they need to fund the aforementioned CAPEX. This sector also has significant interest from private equity and pension funds, which are often paying prices way above where AusNet is trading," he says in reference to a bid recently received by peer Spark Infrastructure (ASX:SKI).
7. And there's no place like home ... If you are thinking about income
Plato Investment Management's Dr Don Hamson says he is bullish on the outlook for dividends coming out of the Australian market - with the local economy still ticking on despite recent lockdowns.
"We've been seeing some great dividends coming out of the iron ore miners, but we're also very bullish on the banks as well, as they release some of those bad debts that they provisioned for," he explains.
"Last year, the top six dividend payers were three banks and three iron ore miners. We are bullish on all of them."
Retirees and other investors who rely on term deposits and other income-generating vehicles will have no respite from low-interest rates over the coming 12 months, Hamson says.
"But there are some great earnings and dividends coming out of Australian shares," he adds.
In particular, he points to Rio Tinto (ASX: RIO), Fortescue Metals Group (ASX: FMG) and BHP Group (ASX: BHP) as dividend darlings within the iron ore mining arena. He also believes we are likely to see some big dividend payouts from the Big Four banks.
"The outlook for miners is pretty good. I know there are a lot of naysayers that want to call these things down because they've seen the cycles before. But the good news this time is we haven't seen massive investment from any of the big iron ore miners, so you're not seeing huge amounts of new supply come on board," Hamson says.
"Australia and Brazil have the lion's share of high-quality iron ore and that hasn't changed. China still wants to reduce pollution so the only way they can do that is with high-quality iron ore."
Similarly, Hamson is bullish on the banks - and points to strong loan growth and Australia's positive housing market dynamics for his rosy sentiment.
"The banks are a lot stronger than I think anybody thought; they're releasing some of those reserves that are no longer needed and they have loan growth and they're focusing on cost-cutting," he says.
"They'll be reducing headcount, focusing a lot more on using apps and technology to streamline their businesses. That's where the big banks have an advantage over the smaller players."
8. So it's probably no surprise then that the US is looking vulnerable
Given the significant long term outperformance of the US versus the rest of the world, the question on Jacob Mitchell of Antipodes Partners' lips is whether this dominance can continue, with US equities currently making up 67% of the MSCI World Index.
"As a part of our process, we're always looking at the anomalies, and the biggest anomaly that we see today would simply be the premium that you pay for a US stock versus a similar stock in a similar industry globally. On average, that's close to a 40% premium," he says.
Antipodes uses EV to EBITDA and CAPE (cyclically adjusted price-to-earnings) to analyse companies and capture leverage, Mitchell explains, and notes that the US equities market has been priced on 20 times since the firm's lookback period in the mid-'90s.
"The rest of the world is on 12 times," he says.
And while the US has benefited from tailwinds from its weighting towards internet software stocks over this period, Mitchell notes that taking these exposures away paints an entirely different picture.
"If you go back to 2012, the rest of the world had actually outgrown the US over 10 years by about 3% per annum," he says.
"Now, in the last 10 years, that has switched. It's reversed in favour of the US, but it's only about 2% per annum. To pay a 60% premium for that, for a small growth differential, seems somewhat extreme."
Fast forward to next year, Mitchell argues that many parts of the consumer complex that have benefited during COVID may start to go into reverse.
"Now, there'll be other parts that take up some of the slack. You've got excess savings, not all the stimulus has been invested, not all of it's been spent.
We think a fair chunk of the US stock market is exposed to consumption and you need to be very selective around that going into next year," he says.
But that’s not to say Mitchell and the Antipodes team are completely avoiding the US. He says pragmatic value opportunities do exist for investors looking in the right places.
"We are being very selective with our US exposures and certainly, from a benchmark relative perspective, we don't think there's a case to be overweight the US market. We don't see the margin of safety from a valuation perspective," Mitchell says.
9. And last, but certainly not least - why the RBA is likely to be slow on increasing interest rates
Coolabah Capital's Ying Yi Ann Cheng says her team has been focused on two major questions; the impact of border closers on employment and what borders reopening could mean for inflation and RBA policy.
“Before COVID, there were 334,000 non-residents in Australia that had jobs, which then left shortly after COVID-19 hit," she explains.
"We modelled that that could have the effect of artificially reducing the unemployment rate by as much as 2%."
Ying believes these jobs were not actually charted when they were held by non-residents in the ABS' labour force surveys, and thus, they are essentially not new jobs.
"These are old jobs that have shifted from non-residents to residents, but they look like new jobs. But of course, not all of these jobs have been filled and this is why we're seeing advertised vacancies raising to highs," she says.
When borders reopen and students and skilled migrants return to Australia, this phenomenon should reduce, as these jobs go back to non-residents, Ying says.
The big question then, is 'When will the borders re-open?' And it's something the team at Coolabah has been researching for months.
"We believe that the borders won't reopen until one, the federal government holds an election and then two, we get to herd immunity," Ying says.
The forecasting model that Coolabah uses has three phases. The first being a linear growth rate of 20% to 80% of adults being vaccinated, with a slow down in phase two between 80% of adults to 90% of adults as they chalk off the vaccine. Phase three is essentially the time to assess the second dose.
"There is a certain degree of resistance. And that's definitely the experience that we're seeing on our end as well," Ying says.
She believes that 70% of the total population (the 90% of adults figure) will be vaccinated by early next year.
"Of course, if Australia does speed up its vaccination rate and as more Pfizer and Moderna vaccines become available, it's possible we could get to 90% of adults before the end of the year," Ying says.
"And then all this opens the way for the federal government to hold the election in March because by then, everyone who wants to be vaccinated will be vaccinated. And then that paves the way for the borders to reopen in the future, likely April to June next year."
Because of this, Ying believes that inflationary headwinds are likely to emerge between June 2022 and June 2023.
"We think this is why the RBA is being very patient and it will likely be slow on easing and also slow on interest rate increases," she says.
"It wants to be confident that we get sustainable wages inflation to hit its targets in a world that is characterised by open borders as opposed to closed borders."
How would you describe 2021 - and what's your best idea for the year ahead?
Very few of us expected that we would once again be in lockdowns with the Delta strain of the COVID-19 virus threatening both our livelihoods and lives. So, how would you describe 2021 - and what's your best investment idea for the months ahead? Let us know in the comments section below.
Register for the Pinnacle Investment Summit 2021 - The road ahead with an enduring edge
At the Pinnacle Investment Summit 2021, discover your edge for the road ahead during a series of exclusive digital presentations from more than 15 investment managers and a line-up of guest speakers. Register here for the summit on Thursday 5th August. If you can’t watch on Thursday anyone who is registered will be able to access the summit content following the conclusion of the event.
We will also have coverage of the Summit in the coming weeks.
Please be advised the Pinnacle Investment Summit 2021 is designed for wholesale investors only.
Never miss an update
Enjoy this wire? Hit the ‘like’ button to let us know.
Stay up to date with my current content by
following me below and you’ll be notified every time I post a wire
Livewire Exclusive brings you exclusive content from a wide range of leading fund managers and investment professionals.
........
Livewire gives readers access to information and educational content provided by financial services professionals and companies (“Livewire Contributors”). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.
Never miss an update
Get the latest insights from me in your inbox when they’re published.
Sign In or Join Free to follow and be notified when I next publish
.jpg)
