Bullish ASX investors may be underestimating rate risk

-- | 05/07/2019

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Glenn Freeman: I'm joined today by Brad Bugg from Morningstar Investment Management. Thanks for your time today, Brad.

Brad Bugg: Good to be here.

Freeman: Now, we're speaking to you at quite an interesting time in Australia's macro situation where we've got interest rates at the record lows at the moment. Now, how is this playing out in financial markets and in your portfolio positioning?

Bugg: Well, quite surprisingly, post the move we saw on Tuesday, markets haven't moved too much, particularly interest rate markets. We have sort of seen the equity market continue to push higher up to the highest that we saw in 2007. But we are now starting to worry that the market is sort of mispricing where we might go from here.

Freeman: So, the Australian stock market and also in the U.S. – I mean, U.S. is at record levels. All three major indexes overnight were again at a record high. How sustainable is that going forward?

Bugg: We don't believe it is sustainable going forward. We think the market is pricing in these very low interest rates out into the future, 10, 15 years and beyond. But we think eventually interest rates will normalize and go back to levels higher than what we see today. But for the time being, people seemingly price in the sort of 1% interest rate as a part of their discount rates and that's really what's pushing share markets higher at the moment. And when we do start to see things like lower growth, which are really driving these interest rates lower, that's going to have an impact on equity markets both here and in the U.S.

Freeman: And how does this flow through into the positioning that you take in some of the multi-asset portfolios within MIM?

Bugg: So, for the last couple of months or so, we've actually been pairing back our growth asset exposure. So, we've been pairing back Australian equities, U.S. equities. We already had sort of fairly low exposures to those markets and we've been reallocating that into cash. Normally, you might be allocating that back into bonds if you are concerned about where markets might go from here. But because bonds have such low yields on them at the moment, they are not going to give you those diversifying qualities that you might normally get. So, we're quite happy to be parked in cash for the time being, wait till those difficulties in markets come along and then redeploy into better opportunities.

Freeman: Sure. And are emerging markets part of where you are actually potentially be looking in the shorter-term?

Bugg: Emerging markets is an area which we think is better valued than Australia and the U.S. for the time being. But outside of emerging markets things like Japan, even the U.K., they have much better valuations on them at the moment. So, we're happy to be in those growth assets for the time being. But depending on what happens in terms of the volatility, we may well decide to go back into emerging markets again.

Freeman: Going back again to the interest moves here in Australia, I think you've said that there's positives and negatives. While it may affect one side quite badly, there are – and it's important to be on the right side of that, I guess, isn't it?

Bugg: Yeah, that's right. So, there are going to be people happy with what's happened, and in that camp, you'd probably put those invested in equities. Lower discount rates have pushed markets higher. Also, those in the housing market, you know, we think these lower interest rates are going to be a support to house prices going forward. But on the other hand, you are going to have those who are fully invested. They do have a lot of money in cash at the time being. And that means that they will be getting lower income looking forward and that's going to impact their ability to spend. And that will eventually flow through to GDP growth as well. And so, who knows where that takes us. So, as usual, there's always winners and losers from my experience.

Freeman: Sure. Thanks for your time today, Brad.

Bugg: Great to be here.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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