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Finding opportunities in difficult conditions

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20 Mar 2016
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Chad Padowitz, chief investment officer at global equities manager Wingate Asset Management, said while there are a lot of negative headlines surrounding the global economy, the underlying facts point to a more positive outlook.

“Markets always watch oil as an indicator of global economic growth, and there is no doubt that commodity markets need to stabilise for markets overall to recover,” said Chad. “However, in a more upbeat sign for markets, corporate health is positive with the US and Europe growing. Our view is that markets are rebalancing to a lower growth world. While volatility will continue to be the new normal, attractive investment opportunities remain.”

A similar story is playing out domestically, said Don Williams, chief investment officer at Australian equities manager Platypus Asset Management.

“The performance of the industrials suggests the economy is not as bad as some pundits suggest, and decent returns can be achieved—which was also the case last calendar year,” Don noted. “Industrial earnings have held up reasonably well despite the subdued economic conditions, whereas natural resources companies’ earnings have been decimated. Natural resource names remain a ‘no go’ zone in our opinion; while they are unambiguously cheap, the majority of commodities remain in an oversupplied position. Investors can expect commodities to track sideways for at least two years.”

 

Chad also said there are significant pockets of stocks that imply extreme fear, and these could be sources of opportunity for investors.

 

“Current valuations in some sectors can’t all be borne out. Safe haven stocks are defying gravity while financial stocks are implying GFC-type scenarios. This valuation mismatch can’t be sustained.”

Banks – Australia vs the world

One area where there is a stark contrast in views, however, is the outlook for banks. While Chad is upbeat on the opportunities that exist in global banking markets, Don’s expectations for the Australian banking sector are more subdued.

 

“Global banks are increasingly presenting a significant investment opportunity,” said Chad. “Traditionally, global banks are a proxy for pessimism, as historically they are the stocks most affected by recession—and as you would expect, ongoing volatility in global markets has seen investors exit global banks and flock to consumer staples. However, the banks today are very different animals to those pre-GFC, and we believe the recent selling has been overdone.

 

“Globally, banks have recapitalised their balance sheets and sorted their bad debts and non-performing loans. US banks in particular are looking like good value. They are buying back their own shares at a discount to book value in the maximum quantities permitted by regulators. This is highly beneficial to shareholders as it’s akin to buying one dollar of assets for only 80 cents. Two of the currently compelling global banks are both US-based—Bank of America and Citigroup.”

 

But Don said Australian banks, in contrast to their global and US counterparts, are looking somewhat less attractive in 2016. Although Platypus holds positions in all the major banks in its portfolio, it holds them in a large underweight position with the exception of ANZ.

“We have been reviewing our position on Australian banks over a period of time now, as the love affair with yield from Australian banks is waning. In fact, earnings per share growth has dissipated dramatically over the past 18 months. There was a time when EPS growth was sitting at 5-8 percent. But no more. The new normal in this economic environment seems to be just 1-4 percent growth,” said Don. 

Stimulus leaves bond investors exposed

Moving away from global equities and commenting on global fixed income, Bill Bovingdon, chief investment officer at fixed income manager Altius Asset Management, said that as the central banks wind down their stimulus programs this will leave bond investors exposed.

 

“The expectation is for three rate rises in the US during 2016, raising rates to between 0.75 and 1 percent,” said Bill. “Clearly, however, if we had a financial crisis of some kind we could expect a response from the US Federal Reserve where they delay tightening. A hard landing in China would cause the Fed to pause, but otherwise it has set its course and we think the global economy will handle the rises quite comfortably.

 

“Changes in US interest rates should have little effect on the Australian cash rate. If anything, we will be looking at potential rate cuts still being at least considered by the market. However, long bond rates in Australia will come under pressure from US bond rates, and we expect to see the yield curve steepen in Australia.”

 

Overall, Bill is expecting 2016 will be a reasonable year for the Australian economy.

“We are expecting GDP growth in Australia of 2.75 percent this year—much of that from infrastructure spending and the pick up in housing construction as well as stronger exports due to the weak Australian dollar. Conditions will be relatively positive for the consumer. Jobs growth is quite good and a lot of costs are reducing with lower oil prices and lower energy prices, which will boost disposable income.

“Our base case is that we are expecting no change in the cash rate from the Reserve Bank of Australia. Clearly the RBA will act on market conditions and how the economy pans out over the year, but the hurdle is quite high and the RBA will see little benefit in reducing rates further unless they can influence the currency. Much will depend on China, and it accounts for one third of our exports. But our expectation is that the Australian cash rate will still be two percent at the end of the year unless the global economy takes a horrible turn.” 

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Chad Padowitz

Wingate Asset Management - Chief Investment Officer

cpadowitz@wingategroup.com.au