Crispin Murray: Underlying growth will support equity markets

There are just too many cooks in the kitchen. The market has welcomed new entrants at various experience levels throughout the pandemic and we've found ourselves in an overly speculative and exuberant market. It's all become a whisper game. Everyone has an opinion. Everyone can tell you whether we're in a bubble and everyone can give you their prediction as to when that bubble will burst. 

However, one person who won't tell you we're in a bubble is Crispin Murray, Head of Equities at Pendal Group. 

Murray, one of Australia's most recognised and respected Fund Managers has managed to outperform the market four out of the last five years, having experienced a negative return in only four periods since 2005. And, in a recent webinar, Murray provided his thoughts on current market movements, explaining why: 

• A bubble is a genuine concern, but equities still have more room to run
• Value stocks are in a prime position to outperform growth stocks 

In this wire, I unpack Murray's outlook for markets, the concern behind the recent bond yield run and reveal Murray's four tips to portfolio construction for today's market. 

The macro view: Equities have further to run 

The market has been consumed with bubble talk, inflation talk and rising bond yield talk. And while a bubble growing or even bursting should be on the minds of investors, it's not happening just yet. 

One consideration investors are failing to make is the impact of government stimulus says Murray. Australia has experienced the highest level of monetary stimulus since the second world war, allowing for unprecedented levels of liquidity in the market. This, combined with low level interest rates is encouraging equities to run as hard as they can, for as long as they can. 

Source: Pendal, Bloomberg, JP Morgan 

Ultimately, the government's efforts to pump stimulus into the economy, combined with the RBA's decision to keep interest rates low for the foreseeable future, will eventually strengthen the economy. According to Murray, this is what will allow equities to run. 

"The underlying growth in the economy is actually going to be the factor that ultimately wins through and supports equity markets."

Murray says there are many consistent factors in the market, including fiscal stimulus, monetary stimulus, the vaccine rollout and excess savings, which will allow for continual growth and will be encouraged by policymakers. Given this is happening consistently, and across the world, Murray isn't phased by the idea of a bubble. 

Worried about the rest of the world? Don't be. The US has excess savings, allowing for money to continuously be thrown into the equity market is also building a stronger runway for equities to run. 

Source: Pendal, Goldman Sachs 

The macro view: Bonds
What can bond yields tell us about growth versus value?

Long live the debate between growth and value. 

Pendal has been observing the famous rotation beginning in November of 2020 from the much loved and over-run growth stocks to the once dry and tasteless value stocks. According to Murray, it is value's time to shine after a long decade of being overlooked. 

"The dominance of growth in the market is beginning to shift."

Murray cautioned against being dismissive of bond yields and called out the belief that equities are removed and unaffected by rising bond yield. 

"Even though we think equities will be resilient to rising bond yields, that rise in bond yields does have a big effect on what's going to perform in the market."

Source: Pendal, Bloomberg 

By examining the chart below, Murray provided his case as to what bond yields mean for value versus growth and for the market as a whole. 

Source: Pendal, Datastream 

I know, I know ... what do these charts mean?

Kindly, Murray broke them down for the viewers. 

The breakeven inflation rate (Chart 1) represents market sentiment and whether investors are confident in global growth. When this rate begins to rise, cyclical stocks follow. History shows that there is a strong correlation between the outperformance of cyclical stocks and an increase in the breakeven inflation rate (as shown above). This is the current stage of the cycle that we are in: cyclicals are outperforming and investor sentiment is strong. 

Nominal bond yields (Chart 2) are typically the middle point according to Murray. As the nominal bond yield begins to rise, we see financials come out of their corner with boxing gloves on. A higher nominal bond yield rate allows for more opportunity for financials, particularly the banks. All of a sudden, not only are cyclicals performing but alongside it banks and financials begin to get their boost too. 

"This is a very unique situation because if you get an environment where resource stocks, cyclicals and the financials perform concurrently... it leads to a squeeze on the market. This means you get a large portion of the market underpinned and performing very well."

Finally, real bond yields. The final chart demonstrates how growth stocks have benefitted immensely from the discount rate effect. In a low yield world, growth stocks have been pushed higher by investors whilst value stocks have been left out in the cold. With bond yields rising, the opposite should occur, says Murray. 

"We are now seeing the rolling over of the performance of growth stocks and it is coinciding with this rising real yield environment."

All you have to do is look at the price of commodities rising and growth stocks sinking for his point to be proven. 

Building a portfolio for the current environment 

Get out your pens and pencils and write this down because Murray has provided viewers with four tips for investing in this overly speculative market environment. 

1.  Protection against change in policy direction 

If the last twelve months have taught Murray anything, it's that no matter how much conviction you have in your ideas, you can never account for everything. Defensive members of the portfolio are important regardless of where the market is heading. These include low gearing, predictable companies with strong free cash flow. Whilst Pendal is bullish equities for the midterm, you can never be too careful.

Stock ideas: Evolution Mining (ASX:EVN), Amcor (ASX:AMC), Atlas Arteria (ASX:ALX)

2. Pricing power plays 

These are the stocks that are leveraged to the potential inflationary pressures we're beginning to see. These are companies that are also somewhat defensive as they have brand power and have relied on this to pass through the pandemic. 

Stock ideas: BHP (ASX:BHP), Santos (ASX:STO), Metcash (ASX:MET)

3. Franchise winners benefitting from the release of pent-up demand 

Remember the COVID-19 shutdowns? Well these are the companies who saw it as an opportunity to restructure their business. They're in good industry structures, they have strong market positions and they have high free cash flow. 

Stock ideas: James Hardie (ASX:JHX), Nine Entertainment (ASX:NEC), Aristocrat (ASX:ALL)

4. Re-opening plays 

Everyone loves a stock for the reopening. The stocks that were COVID losers but have been able to recover better than market expectation. The stocks that will fly to all new highs with the re-opening of the economy and society. 

Stock ideas: Downer (ASX:DOW), QANTAS (ASX:QAN), Westpac (ASX:WBC)

And for all you tragic lovers of growth stocks, Murray gave you a few ideas of those he thinks will be able to survive despite the massive rotation into value. 

Stock ideas: Xero (ASX:XRO), CSL (ASX:CSL), Pushpay (ASX:PPH) 

Well, folks, you heard it here first: equities are running and they're going to continue to run, and growth may be dead (with the exception of a few). Bond yields are rising, earnings are increasing and it may even seem no bubble on the horizon is forming. 

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