Peter Warnes and the 2021 Forecast

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Lex Hall: 2020 has been a year of records. It's been a year of despair and also euphoria. What will 2021 look like? With us to discuss his forecast is Peter Warnes.

Peter, welcome to the end of a tumultuous year.

Peter Warnes: Yeah, thanks, Lex. It certainly has been tumultuous and hopefully, it's past us, but we'll see what happens.

Hall: We're back to square one as you were telling me beforehand. Is there any upside next year? Can people find any opportunities?

Warnes: Yeah, well, I think there will be. As you said, we're back to square one basically exactly as of close yesterday. And I think the momentum that's there in the markets at the moment will push this market higher, Australian market and global markets. But 2021 won't be a repeat of 2020 hopefully, but it will be one where you have to be very, very aware and you have to be aware of what's the likelihood of another problem in terms of the Biden administration, are they going to get an easy ride, I don't think so, and what happens economically in terms of the recovery and the sustainability of it when things start normalizing. So, 2021 is going to be a very interesting year, but I do think in the first quarter at least, you'll probably see these markets continue to move not spectacularly higher but higher.

Hall: Okay. We'll get onto the Biden administration a little later and some other macro themes if you don't mind. Let's talk about the local equity market first of all. In the forecast, which is out today, you talk about some of the sectors that you see as overvalued and some that are undervalued. Just give us an idea of what you see there.

Warnes: Yeah, well, the teams have worked hard on trying to get their forecast right for 2021, but also longer term and see how these things, again, will normalize because 2020 there was a lot of pull-forward demand and there were abnormal forces out there that actually drove these markets, firstly, down and then certainly, the recovery very, very strong. So, we have to be aware of those. It's very, very dangerous to extrapolate from either low points or high points ever. You don't want to do that.

So, our guys are saying, well, in terms of retail and in metals and mining, those things do look, on a long-term basis, look overvalued. One, because of what's happened with retail sales, we know why, but it's not sustainable. Those growth rates aren't sustainable. And so, we normalize those and look longer term.

Hall: On that speaking of retail, I did a screen the other day on our 11 wide moat stocks and top of the list was Wesfarmers which returned 23% which was streets ahead of all the others.

Warnes: Yes.

Hall: Which tells the story I suppose.

Warnes: Well, don't forget, I mean, it's a Bunnings story and came out that's quite well. But the smaller areas of Wesfarmers that are retail exposed, Officeworks, those three have done very, very well in a COVID environment.

Hall: Yeah.

Warnes: Bunnings, I believe, will continue to do very, very well going forward in the DIY space which they basically own and but it really is a very, very fragmented market. I mean, they would probably have close to 30% of that market and they are the dominant stakeholder, which tells you it's fragmented. And I believe – because I think the economic recovery is not going to be as robust or sustainable at rates we've just seen for a little while, there will be some business failures, particularly in the small end of the hardware market, and they will pick up that market share and continue to grow market share in my opinion. And so, that's the driving force in Wesfarmers.

Hall: Okay. You've been telling us all year to sort of squirrel away a bit of cash. Where should people be deploying it do you think?

Warnes: Well, I think you've got to wait for the opportunities. I wouldn't be putting more money into the market right now. If you've got cash, and I certainly have got cash, you look for the opportunities when kind of a March reemerges. I'm not saying March like we've got a bear market in '20, it drops 20% in a month. What I'm saying is, you buy the market when the market is on the back foot not on the front foot. And so, you got to take that opportunity and the cash gives you the optionality to do that. If you haven't got cash, you can't take advantage of it. You have to do something else to raise the cash. And the time – the window of opportunity can be very, very narrow and short. And so, you have to have that to be able to push the button straight away, and that's in my opinion.

So, I think the thematics that I like, that I – looking for the long-term tailwinds, it won't disturb now. The government every three years, no matter which government in, is always fiddling with superannuation and they will continue to fiddle because it's a big cash pool they can't keep their hands off. But the regulations are going to change to look at the retirement phase of superannuation, not so much the accumulation phase, the retirement phase because that's where more and more of our population is going at a faster rate than most of the demographic within the population age group. We're aging quicker, right? That's a silly statement to make. We're aging – there's more people aging than there are being born, if you like. The fertility rate is very, very low.

So, the government now is saying, hang on a second, we've got to start looking at people in the retirement phase. Well, we don't want them on the government (team). If we can keep them off the government (team) or partially on the (team), then that's as a country we're better off. So, the regulations are going to tighten up is that what advisors have got to do and what trustees have got to do to look after people in retirement, to make sure that the income is sustainable, and the income stream is all is reliable. And that, to me, sends me into the annuity space and in the annuity space there's one company there that stands out in my opinion. And I've declared an interest, but I've had an interest there for a while, and I've been telling our subscribers, I think, basically all year to be in Challenger after March. And so, they've been there, have a 3 in front of them, now pushing towards 6. Our fair value has got a 7 in front of it. There's still room for it to go back to, in my opinion to fair value and then probably move higher ultimately. But the next few years they're going to be in the right space. So, retirement is a tailwind for the companies that are going to service that space.

Elsewhere, I think, again, because of fiscal stimulus we are going to build a lot more infrastructure. I would just wish we could build it quicker. Badgerys Creek is taking 10 years to build. I think I mentioned to you before. China has built 15 international airports in 10 years and we're going to take 10 years to build one. But still and all the companies exposed to those – I mean, the CIMIC we still like, is in the 4-Star range. Again, I've declared an interest and we have been recommending this to subscribers for a little while as well when they were kind of near 20.

The insurance sector is coming up as slightly undervalued because of things that happened with IAG and what have you. But I'd be a little bit careful there. Again, you could probably dribble some money in there, but I don't think there's a big tailwind there. Yes, premiums are going to go up. But does that mean that people won't insure? And if premiums go up who's the winner? Initially the insurance companies will, but what will happen is that if their rates of return go up, then more capital comes into the industry and the picnic will be a one loaf picnic rather than a 10-loaf picnic. And so, I think you've got to be at least be a little cautious, because one is insurance, it's insuring risk and you want to be trying to – you want to de-risk your choices, if you like. It's undervalued, but again, it's the price at which you buy these shares at.

Hall: Okay. And selling, what should we be trimming do you think?

Warnes: Well, because of the macros, I think that the – even though I've been positive on China and what have you, and even though we haven't been able to – our longer-term forecast for the iron ore prices is low, and so we've missed the – basically missed that that move, I do think that going forward, not next year, but maybe later next year that China will start backing off on infrastructure.

Hall: Yeah.

Warnes: And so, I think these gains, you should be taking a bit of money off the table in the markets.

Hall: I might just promote a question that I had on that because you talk about Australia's overreliance on China. Is there an answer to that?

Warnes: Well, in the short term, there's not. And you saw what the CEO of Fortescue said the other day. 87% of Australia's iron ore went to China. Over 50% of our total country's exports go to China of which obviously iron ore dominates. We are overexposed to China. And so, how you de-emphasize that or get – that concentration risk has to be addressed by companies, by individuals and by governments. How you do it is not an easy solution. And don't forget China is trying to become more and more self-sufficient because they probably can. Politically they can basically, if you don't agree with them, well, you probably won't be found for a while. But the thing is that we have a democratic society and we can't. I mean, given what's happened with wine and barley and cotton and what have you, we can just say, okay, we're not sending any iron to China. Well, we can't do that. We've put BHP, Rio, Fortescue and all their workers out of business. So, we can't do that. They can. We can't.

Hall: Right. So, it's not a matter of just finding other customers in the region?

Warnes: Well, how do you find other customers for 87% of your iron ore output? You can't. And story is you can't.

Hall: Yeah, okay. Let's talk about central banks because that's been such a dominant theme. Do you think central banks will continue to keep rates very low even as growth recovers?

Warnes: Well, they've indicated they will. But never say never.

Hall: Because there's a nice line you say, cut interest rates and throw money at it has been the prescription despite the different ailments. Will that…

Warnes: Well, that's right. I mean, all we've done since 2010 basically, the GFC, is that they have thrown money at a problem, right? They've either printed it, number one, then through QE, asset purchase programs and then, obviously, driving interest rates down. So, they create the liquidity and then drive the price of that liquidity down. They want to make – the liquidity is there so the financial system can operate efficiently and effectively. If there's no – but we haven't had a credit squeeze since I don't know when, right? And so, there's a surplus of money out there and they've created it. And what they've also created is, it's been – that liquidity has been misdirected. It hasn't gone to the areas that they would want it to go.

Business has not invested for 10 years basically. Yes, in Australia the resources and energy space have. But generally speaking, if you look at how much business has invested in hard assets, it's basically been pretty ordinary. And in the U.S. similarly, those companies went and used these debt markets and the liquidity and the price of that liquidity to buy back shares, to keep dividends higher, all this type of stuff. But the third pot, if you like, the free cash flow pot, of growth CapEx has not increased dramatically, which is what the central banks wanted. Now, that liquidity is also being used to push up risk assets and mostly equity markets. But in the U.S. in particular, and here as well, it also has funded and being responsible for a widening of the gap between the income and wealth across the demographic. The have nots and the haves, the gap is getting wider. In the U.S., particularly given the division there, that is going to be a major problem and the central banks have been responsible for it.

Hall: Let's turn to the U.S. because I know you've got some strong thoughts on that. 2020 was marked by COVID-19. It was also marked by the Democrats coming into power, we presume on January 21 our time. What does a Biden presidency mean for global markets do you think and more broadly, geopolitically?

Warnes: Well, I mean, geopolitically, you would expect the tension in China and U.S. to come off the boil a little bit. I mean, it couldn't get – it's over 100 degrees already and so it will come back for sure. That's a positive. But don't forget it's not going to be an easy – look, the Republicans are at control of Senate. And it's not going to be an easy free kick for the Biden administration. They can go and bring policies into place and what have you. But they've got a – it's going to be more bipartisanship. If you want that economy and that country to grow and grow as it should, you need cohesion and you need solidarity. You haven't got either at the moment from the man in the street corporately or in Washington. There is no cohesion and there's no solidarity. So, until you get that this is not a walk in the park. His administration and his West Wing will be asked a lot of questions over the next four years and I don't think they will have the answers or most of the answers.

Hall: And the employment situation in the U.S.

Warnes: Well, I think the biggest problem all developed economies will face and even China is employment or unemployment coming out of COVID. In the U.S., we've still got 10.7 million people out of work. What you've seen over the last few months is that jobs created falling on a monthly basis because there's still COVID out there and it's rampant and jobless claims obviously are still going higher. But there's 10 million. They lost 22 million. They've still got 10.7 million to get back. We lost just over a million. We have to get back another 650,000. Yes, Victoria reopening will help or whatever. But I think it's not – again, it's not a walk in the park. Getting those people back and re-hired is going to be very, very difficult and it will not happen in 2021. We'll make some inroads, but there will be still a lot of people unemployed this time next year. And that's the major problem. You can see all the fiscal policy being thrown and money being thrown at it. This is fiscal policy, not the central banks. The governments throwing money is to get jobs and create jobs.

Hall: Okay. Well, on that note, thank you very much for all your analysis and tips this year. It's been great.

Warnes: Pleasure, Lex. And I just like to wish all our subscribers a happy and a safe Christmas and a healthy and hopefully, not so anxious 2021.

Hall: Here's to that. I'm Lex Hall for Morningstar. Thanks for watching and all the best.

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

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