Paradigm shift is coming, says Warnes

-- | 14/11/2019

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Glenn Freeman: I'm here at the Morningstar Individual Investor Conference. And I'm speaking here to Morningstar's Peter Warnes.

Peter, thanks for your time today.

Peter Warnes: Pleasure, Glenn.

Freeman: Paradigm shift was the theme of your session. There's a paradigm shift coming. So, you're talking about the market. In a nutshell, what is this paradigm shift that you're talking about? What's happening?

Warnes: Well, Glenn, paradigm shift or a pattern shift is what I'm talking about. And don't forget, over the last 10 or 12 years, we have had a pattern or a paradigm that's gone all one way. It's been central bank driven. It's low interest rates, stimulus monetary policy and printing money. They've printed US$18 trillion. And interest rates are at zero. It hasn't worked. The expansion that's now 12 years long and the longest duration in history, has delivered the lowest GDP growth also since 1950s in the U.S. expansion. So, it hasn't worked. I'm suggesting that the patent change or the paradigm shift will be that that unsustainable and – those unsustainable forces that have pushed the risk asset prices to where they are, will change. Valuations are being driven by low discount rates which are being driven by record low interest rates. That will change.

Freeman: And you drew the distinction here between potentially what's coming – it's not happening right now or not happening next year or the year after perhaps, but comparisons between the 1930s and the current situation.

Warnes: Well, if you go back and have a look at history, and history is a very, very good teacher. If you go back to 1930s and have a look at what happened there, in the first three or four years of the 1930s, I think we came out of the crash of 1929. We had stimulus packages and what have you. And that drove market very, very strongly higher, because the Fed pulled interest rates to zero, stimulated with fiscal policy from the governments, all the things that are happening today, until it changed. And that was between 1932 and 1937. In 1937, they changed, and they tightened and what have you, and the result was a wipeout. All the things that are happening today in terms of wealth gap, the haves and have nots from widening, globalism, nationalism, all those things were prevalent back in those days and basically created the Second World War. Those things were fertile. I'm not saying that's going to happen again, but financial markets are going to get involved in all this unprecedented and unsustainable force called central bank.

Freeman: And on the local front, you're looking at the stimulus that the Reserve Bank of Australia is attempting is just simply not having the effect that consumer spending is not picking up because there just isn't the confidence there.

Warnes: The thing is that consumers aren't spending because they're nervous. The NAB Anxiety Index, which was only just published two days ago, is showing that anxiety is elevated and elevated because they saying – they said in the question now, why is the Reserve Bank doing what it's doing? They're cutting. So, that's good news. And out we go and buy risk assets. They're questioning now, why are they doing it. Well, are we in trouble? And so, they're getting very, very cautious now and cutting back. And that to me is symptomatic of the lack of confidence and too much money out there but it's not circulating. The wealth is being created with fixed asset prices – sorry – risk asset prices going north whether they be equities or some property or what have you, that's wealth. If you don't spend wealth, you spend income. 80% of our people out there are living from pay packet to pay packet, as they are in the U.S. The disposable income is flatlining. So, you can't spend. No matter what Philip Lowe wants you to do, businesses aren't spending, because there's high uncertainty and households aren't spinning because equally, they're uncertain.

And so, I'd be very, very wary in that REIT space, particularly REITs that are selling at premiums to NTA because the NTA through valuations – or revaluations are being driven by low interest rates, i.e., low discount rates. And that's pushing asset prices or asset valuations higher. It may will be that the bargains are in the retail space, which no one wants at the moment. So, retail REITs, because I'm sure the only way you can get this economy moving, come hell or high water is by stimulating the consumer, putting income in his pocket through substantial income tax cuts. It's the only way it can happen. And then, that confidence – consumption drives investment, investment doesn't drive consumption. So, if you drive – if you get consumption growing, you get business investing. That's the combination you want. They are the two major drivers of GDP growth.

Freeman: Sure. And just finally, so in terms – are investors damned if they do, damned if they don't. You can't leave it in cash because you're earning nothing and increasingly less as the rates go down, but at the same time, equity markets are hot.

Warnes: In the racing vernacular, what the equity markets are asking you to do as investor right now in my opinion, is to back a horse trained by Jay Powell and to be ridden by D. Trump. I don't want to be there.

This report appeared on www.morningstar.com.au 2020 Morningstar Australasia Pty Limited

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