“It gets harder from here” for investors
“What matters is the level of dry brush and tinder, accumulated in the last cycle and this one, and the little discounting of the prices of financial assets,” he says. “So if we get a Minsky moment, asset prices will fall below what the fundamentals would dictate. It happens in every cycle and is a painful process.
Closer to home, Yarra Capital Management’s head of Australian equities, Dion Hershan, is also worried about the possibility of a disproportionate drop in the ASX, given the hardness of valuations.
To be clear, Hershan points out that he is far from joining the bearish camp. .
“We think it gets harder from here. It’s probably time to consolidate and it’s definitely time to step forward and think about where we are in the cycle.
October’s reputation as a dreadful month for investors could be somewhat overestimated, analysis of the All Ordinaries over the past 70 years by CommSec chief economist Craig James suggesting that while major falls in 1987, 1997 and 2008 are etched in the memory of the market, the index has actually gained ground in 34 of the last 70 October.
Nonetheless, the first full trading week of the month suggested that October may live up to the reputation for volatility, as the ASX 200 rose 1.3%, retracing part of its loss of 2.2. % Friday.
While the old saying goes that the key to happiness is low expectations, Hershan says that doesn’t seem to apply to local investors, who expect another solid year to come.
While the market generated 28% profit growth in 2021, Hershan says this was due to two scarce bargains in Australian markets, two main sectors: record iron ore prices for our big miners and costs almost non-existent bad debt for banks.
“Either isolated would have been huge, but having both at the same time masked a certain fragility in the corporate sector,” he says.
Market consensus is for 15% earnings growth in 2022, which would push earnings back above pre-COVID levels. But Hershan has doubts.
For starters, the two 2021 deals will not be repeated, with iron ore prices likely to continue to decline and bad loans in the banking sector likely to rise slightly over the next two or three years.
There is also the question of the medium-term damage to the economy caused by the pandemic – the hundreds of billions of dollars in new debt incurred; the probable decline in years of activity in housing construction; two years without migration; and the brakes on the export education and tourism sectors.
Then there are concerns about rising costs and falling revenues. The government’s stimulus measures are expected to rise from around $ 250 billion in 2021 to $ 41 billion in 2022 and while pent-up consumer demand is not lacking, Hershan says the crazy spending will not be distributed evenly, with Service-based sectors likely profit at the expense of goods.
On the other side of the ledger, costs will increase. Energy costs are clearly rising, labor markets are tight, and many of the costs businesses suspended during the pandemic – travel, marketing, bonuses – will need to be reinstated.
Beyond that, Hershan sees a series of other worries looming over capital markets. One is the level of complacency and speculation still present in the markets. But he is also monitoring geopolitical issues such as the situation in China. Hershan says the economic boot of 2021 appears to have reversed, with the country’s power supply crisis and real estate disruption looming on the horizon.
Monday reported that struggling Chinese developer Evergrande’s Hong Kong-listed shares have been suspended for no reason; Chinese media suggest another Chinese real estate giant, Hopson Development, to buy a 51% stake in the empire’s most valuable listed company, Evergrande Property Services, for around $ 5.1 billion of dollars.
While this may ultimately be a sign that the Chinese government is trying to find a solution to Evergrande’s $ 300 billion debt crisis, the trade suspension did little to calm investors’ nerves.
Robert Almeida doesn’t see Evergrande as China’s Lehman Bros moment, which plunges the economy as a whole, like the Lehman collapse in the United States in 2008. Unlike the GFC, which surprised policymakers and markets in 2008, Almeida says China has been closely monitoring growing risks in the real estate industry for years and working to ease the bubble.
The government is unlikely to be surprised by the potential collapse of Evergrande and clearly has the resources to cushion the blow if it wishes.
But like Hershan, Almeida looks at the big picture and sees a shift – or even a reversal – in pro-growth economic policies of the past two decades. The overall impact of policies seen in recent years, and particularly in recent months, suggests that investors should be prepared for further regulatory reform and lower growth.
“It’s very different from the last 20 years,” says Almeida. “And this is of course happening at the same time as the world experiences negative supply shocks, fading stimuli, central bank tightening and excessive asset valuations. It’s a difficult combination.
Almeida also thinks it gets harder from here.
He says economies are being rocked by a reversal of the unintentional feedback loop created by central banks as a result of GFC.
Rather than being invested, the easy money of the post-GFC period was borrowed for stock buybacks and capital returns. Supply chains have been stretched to extract maximum costs, payment terms have been stretched and funded to improve working capital.
For us, the uncertainty is not about the direction of income for each company but about the extent of the deceleration.
– Robert almeida
The result, according to Almeida, has been an era of secular stagnation with below-average growth, low productivity, stagnant real wages – but historic enrichment of capital owners, who have benefited from resources dedicated to improving yields.
The pandemic and political responses briefly removed these secular stagnant forces, but they did not go away. Corporate debt increased, not decreased, during the pandemic. Digitization, which lowers barriers to entry and creates competition, has intensified. And the demographic challenges that particularly affect work have worsened.
Almeida further argues that the post GFC feedback loop has now reversed, with supply shocks pushing up the costs of inputs such as energy, labor and goods.
In the past 12 months, almost every business in the United States has been successful in raising their prices as consumers have been cashed in on government stimulus payments. This has resulted in strong revenue growth, but Almeida says it will wear off as the sugar stimulus wears off.
“The market, which is like the smartest person in the room, already knows that. For us, the uncertainty is not about the direction of income for each company but about the extent of the deceleration. “
Almeida says he can’t predict what a Minsky moment might look like, or when and if it might happen. Thus, he remains focused on the one thing that ultimately matters to him – the company’s five-year cash flow path, and warns investors to prepare for a return on capital that is less than what. they are now waiting or what they have seen from GFC, partly because of the pressure on earnings and partly because of a normalization of interest rates, which will result in a lower multiple on those lower cash flows.
If there is one bright spot to be taken from all of this, surely it is the opportunity for investors to successfully manage these risks and find companies that can get through this difficult time.
Almeida says stocks with real pricing power that can meet expectations may well be a scarce commodity.
Hershan is hunting companies that can come out of the pandemic on better terms than they used to be; he enjoys the telecommunications and airline industries and miners focused on copper, nickel and aluminum.