Are we investing at the peak?

Being an astute investor isn't just about finding the next great opportunity. It's also about keeping an eye out for risk and knowing what to do about it. For the head of active quantitative equity at State Street Global Advisors, Bruce Apted, there are three key risks to be on the lookout for. 

Apted and his team scan 16,000 securities using real-time data and in doing so, have a sound method for picking stocks that won't be buffeted by headwinds. 

Peak-cycle risk (the risk of investing at the top of the market) is a common theme around earnings season when a lot of hype and commentary builds up around the market darlings and household names. 

"I think we've been through a period where we've had very little stock market crash - other than the massive correction we had with COVID in the last 12 months - we've had hardly any pullbacks and that's not normal. At some point, we will expect to see some kind of correction," said Apted. 

In this video, Apted takes us through what he has identified as the causes for a market correction and some of the key indicators to look out for.  

Bruce Apted

Head of Portfolio Management – Australia, Active Quantitative Equity

State Street Global Advisors

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This transcript has been edited for clarity.

Mia Kwok:
Looking at risk and the risk landscape for Aussie equities, what's the roadmap ahead? Could you tell us what are some of the risks on the horizon for Aussie equity investors?

Bruce Apted:
I think it's a question of one of the things you raised earlier about "buy the rumour, sell the fact". So we've seen very clearly from the U.S. reporting season that we've had very strong numbers coming through from companies, but I think that's yesterday's story. 

And so looking forward, I think one of the things we'll see in the Australian landscape is that there's going to be greater uncertainty with respect to the guidance outlooks that companies will provide. 

We know that the banks are all going to look very good compared to 12 months ago. I mean, everything has improved for most banks from an operating perspective. And we're seeing an improvement in the dividend profile, we're seeing buybacks, we're seeing improvements in terms of provisioning.

Everything has kind of been going their way for the last 12 months, but we also know that much of the state is now in lockdown, and things won't be as good on a forward-looking basis. So I think that will be reflected in and less optimistic guidance statements, which we'll see probably reflected in some adjustments to earnings profiles for the next one and two years. And I think that we'll probably see some of the steam or some of the hate come out of some of those names that have run quite hard into this reporting season. And that's almost exactly what we saw in the U.S., so I think that could easily play out in Australia, and that's something that we're certainly thinking about.

MK: What are some of the macro-environmental risks that you're seeing in the market right now?

Bruce Apted: 
We touched on one of the key risks in the market earlier in discussions about U.S. earning season about kind of the buy the rumour, sell the fact concept. But it's also what sits very close to that is the peak-cycle earnings risk. So we've had these very high growth rate numbers, and where to from here? So I think that's definitely a risk. I think the other big risks that we're seeing coming through is around inflation and central bank policy. 

And we noticed, from looking at the statements that came out from companies in the U.S. and other parts of the globe, that the mention of inflation was the highest that we've seen in 20 years. So, as expected, seeing that we're actually seeing some inflation coming through. And, also in terms of supply disruptions, that's another thing that came through, one of the themes.

In terms of inflation and the Fed, I think that the market has now, for the last few months or so, has been focusing more on tapering and when that will happen. And, as payroll numbers continue to print very large numbers, that puts pressure on the Fed to start to change their language with respect to policy. And we're seeing more and more statements talking about policy changes after the end of 2022. So that is now in the picture, and that is definitely a risk for equity markets. I mean, I think we'll see some more volatility on the back of that.

I think some of the other risks out there is obviously, in Australia, we're very close to what's happening with respect to Delta. I think we all felt like this virus was sort of under control, and then we got a new variant. And so there's always a risk there's another variant that could come along that maybe the vaccines won't be so effective against. And so that's certainly a risk.

I think probably the final one that I sort of would have in the back of my mind is just around trade, continued trade, tensions with respect to the U.S. and China. So they're probably the big ones on my mind at the moment.

MK: Could I ask with the outlook for inflation, particularly in the U.S., what you're expecting to see from the central banks in response to that?

Yeah, so central banks, part of their mandate is to maintain price stability and inflation targeting. And they've said, in August of 2020, they came out and said they're willing to let that go more than they have previously. 

That was a big change in policy. 

But it's quite interesting because, as we get closer and we actually start to see these inflation prints starting to come through, there's obviously the big question of how much is permanent versus transitory? And clearly, there are massive base effects in inflation as we see in earnings as well.

So I think they are looking through some of the pricing flashing, but it puts pressure on them to start thinking about how they're going to manage that as long as we're seeing increasing growth coming through in a strong economy that's broadening out. 

And if we do start to see wage pressures building, then it does put pressure on the Fed to, firstly, change their language and then, ultimately, react in terms of some form of tapering.

It's within their mandate, so they have no other choice really but to respond to that at some point.

MK: And so what do all these different risks do to your fund and how do you put yourselves in a position to either avoid or just to mitigate some of these upcoming risks?

Bruce Apted:
Yeah. So that goes back to our investment process again. 

When we're looking for these companies, we're interested in a cohort of stocks that have these high-quality characteristics of reasonably priced, proven operating environment, but that risk also having low-risk profiles.

So you can think about them as being sort of the more stable businesses. If there is an economic shock, they are less impacted. So they're less cyclical and more stable businesses that can grow, despite if economic growth does come off. So that's a core tenant to how we like to invest, and we find that when we invest that way, we get most of our out-performance when markets go through more difficult periods. So when markets are rallying 30% in 12 months, that's not a great environment for us. But if we do see more moderate returns from equity markets and more volatility at more normal levels, then we tend to see some out-performance coming through from that process.

So I think we've been through a period where we've had very little stock market crash, other than the massive correction we had with COVID in the last 12 months, we've had hardly any pullbacks and that's not normal. 

So, at some point, we will expect to see some kind of correction. One of those risks that I mentioned could be the driver of that. And we're positioned well for that through our very defensive type of investing in stocks that have those elements of quality, value, and sentiment are also lower risk profiles.

MK: And what are some of the indicators you're keeping an eye on for a correction or a pullback? Are there key data points that you've got on the radar?

Bruce Apted:
Yeah. I mean, I think you want to always be quite open to looking at lots of different things because that's just the nature of financial markets is that risks can come in from lots of different spots. 

Some of the key things that I will always look at if I'm trying to gauge what the marketplace is pricing in terms of central banks being aggressive or loose in terms of their policy. I think the yield curve, the 2-10-year yield curve is going to give you a sense of what the fixed income market is thinking about Fed policy.

So that's always a good one to look at, and we've seen that flattening in recent times. And that's a sign that the outlook there is changing a little bit, so that's a good one to watch. 

I think the other one, obviously that's critical and we're right in the spotlight at the moment is with respect to earnings season and guidance from companies and what that's going to look like. 

So we'll be tracking that very closely over a period over August, of course, to see if those trends emerge the way we expect them to. And so they're probably the big two elements that we'll be tracking closely over the next little while.

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