What investors can learn from disasters, and a big risk the market has missed

From central bank actions, including the RBA’s record-breaking 0.5% hike (our largest ever consecutive rate increase), to the war in Europe, and COVID’s relentless onslaught, there’s a confluence of macro events currently.

As a career-long specialist in fixed income, such “consequential events” have taught Jasmin Argyrou some of the most important lessons.

“Far-reaching themes and narratives have defined and changed markets over the course of two decades. What I learned over the course of my career was etched into sharp relief during times of crisis,"  says Argyrou, the head of fixed income and economics, wealth management at Credit Suisse Australia.

In the following interview, Argyrou reveals how her team is currently positioned across different credit assets. She also discusses the equity market, the most important economic indicator right now, and the biggest risk the market has overlooked.

What’s one thing you learned from each of the asset managers you've worked with and how do you apply these lessons at Credit Suisse?

I have learned the most from working through consequential events, when far-reaching themes and narratives defined and changed markets, over the course of two decades.

When I first started life in fixed income markets, Australian bond yields simply reflected the cycles in the domestic economy. Monetary policy was conventional and economic cycles were moderate.

Then the GFC struck and the simple relationships between domestic economic data and bond yields began to change. Secular stagnation was the enduring theme that emerged and although it took a while to reach Australia, eventually our bond market followed the gravitational pull lower in global yields. The pandemic may have marked an end to that era, or it may have just injected an enormous amount of volatility into our economic life, and when this cycle ends – be it in a recession or in a regular slow down – we will return to the pre-pandemic, post-GFC norm.

So, putting that together, I first learned that macro-economic analysis – for the purposes of figuring out the economic cycle – was immensely useful for deciding whether Aussie bonds were cheap or expensive.

Understanding the importance of acquiring deep insights into global macro developments came later. A good example happened during my early years in markets. I came across a speech by then IMF Chief Economist Raghuram Rajan, which really struck a chord, in the way few papers do. I saved that speech and found and read the research paper behind it. Rajan was sounding the alarm long before the financial crisis of 2007-08 arrived. He was explaining, to use his term, the ‘fault-lines’ in the financial system. A few years later Lehman Brothers collapsed, and the rest is history.

What I learned over the course of my career was etched into sharp relief during times of crisis. When the euro crisis exploded in 2011, I was sitting at my desk, watching my Bloomberg screen, and the spreads on Italian to German bonds suddenly ballooned as the European trading session opened. I remember that precise moment so clearly. I had fleshed out a detailed base case view about Australia and the Australian bond market, but in that moment, I realised I had to trash it.

Fortunately, I had also carefully described the main risk to my view and decided on a signpost for it – widening spreads on Spanish versus German bonds. Although the crisis didn’t start in Spain, that day’s event triggered a change in my view and the strategies attached to it. The lesson was clear. Good portfolio management is not about getting your predictions right every time, it is about managing risk intelligently. This takes having both the discipline and process to be able to enact a change in view.

In the Discretionary Portfolio Management team at Credit Suisse Wealth Management, we manage multi-asset class portfolios. Through these, we access the global spectrum of opportunities within both equities and fixed income, as well as alternatives.

Our Global Chief Investment Office (CIO) produces regular, wide-ranging research and investment views. We also benefit from cross-asset-class insights. What we can observe in one market segment – like fixed income – has implications for another – like equities. This means we have both the analytical capability and the opportunity set to exploit opportunities and seek the best expression of a market theme. I find this personally rewarding because we have the ability to be more impactful when managing portfolios for our clients.

With the many macro events now – central bank actions; the war in Europe; ongoing global supply chain challenges; COVID in China and elsewhere – how do you translate these into portfolio decisions?

These are all global developments, so we look to leverage the immense capability we have in our global CIO team who cover every market and every geography.

One way to translate these events is to consider that a considerable degree of the high inflation we are seeing, originated in commodity markets. The war in Ukraine exacerbated that of course. 

High commodity prices produce both winners and losers in terms of countries and industries. That is a good starting point when choosing which market segments to prefer in portfolios.

In terms of major central bank action and inflation, the US is the place that can withstand the highest cash rates, has the tightest labour market and the fastest wage and price inflation. That has been the case for some time. So, when we reduced the sensitivity of our portfolios to rising yields, we did it in market segments that were directly impacted by US Treasuries. The risk/ reward of that position was favourable, and it didn’t require the ability to predict CPI releases.

We think COVID in China is now in the rear-view mirror and the main theme coming from China is large-scale policy easing. If you focus on yesterday’s story, you miss tomorrow’s opportunity. We have examined the COVID challenges and have been positive on Chinese equity markets.

The scale of RBA's recent rate hikes has surprised many market watchers. Where do you expect rates will be by the end of this year?”

We expected the RBA to raise the cash rate by 40bps in June. The 50 bp hike revealed that the RBA is not concerned about the level of the cash rate being in multiples of 0.25%. We think the RBA will wish to reach a cash rate of 2.5/ 2.6 percent as quickly as possible, so by year-end.

What’s your current view on equities and how are you currently positioned in this asset class?

We see tactical opportunities in equities. Following the 20% plus drawdown year-to-date, multiples have corrected and there is a lot of bad economic news that is now priced in. There is also a lot of fear and panic driving markets. This invariably leads to overshooting.

What are some of your preferred equity sectors currently and how are you getting exposure to these?

The evolving stages of an economic cycle can be seen in differential performance across industries, even more than across geographies. More recently we have taken advantage of this by favouring health care. 

Health care is relatively immune to the economic cycle, and typically does relatively well in a rising real yield environment (such as the one we are in). It can also withstand the impact on profit margins from rising input costs. It’s a defensive sector. It is also a good way to manage downside risk to our positive equity market outlook. 

In Aussie equities, we are underweight REITs because, unlike healthcare, it underperforms in a rising real yield environment.

How has your fixed income allocation shifted since the end of 2021? What’s your biggest sector weighting now? And your smallest?

We tactically reduced sensitivity to US yields in March this year. We also rotated into emerging market corporate bonds earlier in the year. We like this sub-asset class because it compensates investors with a good spread buffer and has supportive credit fundamentals, something which has been overlooked and under-appreciated by many investors. This part of the bond universe is also generally shorter in duration than other segments, so that has helped in reducing the sensitivity of our portfolios to rising yields.

In Australian bonds, we see more value in corporate bonds than we have in a long time. Spreads have widened due to a global retreat in risk appetite and the prospect of an economic slowdown. This spread widening event is very different to previous ones. Normally credit spreads widen as government bond yields fall. This limits the absolute rise in corporate bond yields. Not so now. The absolute level of corporate bond yields in Australia stands higher than they have in many years. In fact, the yields on offer in AUD investment-grade bonds are so high that these bonds can now rival equities in terms of future return potential. All you need is a long-term horizon to enjoy the income that these securities can finally now deliver.

Which parts of the Alternatives asset classes do you favour and why?

Generally speaking, alternative investments can be more complex than traditional investments, however, we have tactically allocated to commodities, to reflect the upside risks to inflation.

What are some of the most important indicators you’re watching now and how do these affect your decisions?

A useful indicator during this time is the demand/supply gap in employment that Fed Chair Powell cited in one of his recent speeches. I have replicated it and constructed it for Australia, so I can monitor it every month.

This indicator captures the degree of tightness in the labour market far better than the unemployment rate and has predictive qualities with respect to wage growth.

The evolution of wage growth will determine the likelihood of a wage-price spiral and that will ultimately decide whether central banks shift monetary tightening into even higher gear, something that would increase the risk of a recession.

What’s the biggest risk that you think the market has overlooked?

The market is pricing in a sizeable probability of recession. We will have a downturn globally, and we are approaching the twilight of this very fast, pandemic-induced cycle. Recession risk is certainly not underappreciated.

Financial markets tend to overlook longer-term risks.

Every crisis casts a long shadow. The Asian crisis of 1997 set in motion the savings glut which ultimately caused the GFC and the euro crisis. What imbalances have been created by our efforts to shore up the present at the expense of the future?

When I ask myself this, the biggest risk that comes to mind is that of climate change and general mismanagement of the environment. Humans have been favouring the present since day one. Large-scale deforestation was an issue as far back as the Roman empire.

In the years and decades to come, the blowback from this will be widespread enough to impact financial investment strategies. This is because it will impact economic growth, the viability of different industries, and the flow of labour and capital.

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