The transition from hope to growth

-- | 15/02/2021

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Lex Hall: Low rates, rising investor confidence and fear of missing out, it's a pretty heady mix and one that's helped fuel a spectacular rally since COVID first hit. With me to discuss that today and a few other things is Hamish Tadgell. He oversees a couple of portfolios at Australian equities manager, SG Hiscock.

Hamish, welcome to Morningstar.

Hamish Tadgell: Thanks, Lex. Nice to be here.

Hall: I thought I'd tackle you first up on a comment, which has sort of drawn a bit of attention and that was made a few weeks ago in The Australian. You said, you hinted that there might be a 10 per cent pullback in equities by year end. I was just wondering do you still have that conviction, and can I ask you to be a little bit more specific perhaps on when that might occur?

Tadgell: Yeah. Thanks, Lex. It's headlines like that always seem to grab a bit of attention. Look, the context of really that we were saying that is that we've had a spectacular run clearly from the COVID lows in March. And it's not unusual for things not to move in straight lines, and we think there is the possibility that just given where markets have run to, but also the fact that a lot of good news has been priced in, and there clearly are still some risks out there that there is the possibility that we could get a pullback sometime over the next sort of six months.

Our overall view though is that policy remains very easy and really provides what we call policy put, that is that if markets falter or if the economy starts to stumble, governments through fiscal policy and central banks through monetary policy really indicated that they will continue to support the economy. And we think that that fiscal or policy put provides a support and should continue to support the recovery in economies. And I think just the RBA yesterday came out and highlighted that the economy is recovering faster than I think they expected. So, from the course of this year we think we're still in this period which we call this sort of the transition from hope to growth.

I might just spend a moment just talking about that. Really, what we've seen—if you—we do look at market cycles and we do think that cycles are important in terms of positioning, particularly in the types of stocks that we want to be in. But we've been through a period of despair, if you like, back when COVID struck. We think it was very much an event-driven crisis which distinguishes it from some other crisis that we've been through. But since March-April, we've really been in this recovery or hope phase as we call it, where there's the expectation of recovery on things getting better or lockdowns easing, economies opening up, vaccine news, et cetera. And through that hope phase we've seen really valuations expand as earnings have continued to be downgraded. And those are classic signs of a hope phase. We think we're moving or moved perhaps since the early phases of the growth recovery and really the growth phase of the market recovery we think probably kicked in about sort of October-November. And that's when for the first time really in 12 months earnings started to turn, revisions started to turn positive across the market at a market level. But more importantly, I think what we need to see is this continued transition from hope to growth. And reporting season will be very important in underwriting and underscoring that in confirming what earnings is—where earnings are, I guess, for companies.

The real distinguishing factor between hope and growth phases is that the growth is really characterized by earnings growth, not multiple expansion. So, companies need to—or the economy needs to grow into, continue to show recovery and companies need to grow into, I guess, those multiple expansions that we've seen. And as I said, there's risks around that, and it's not always—doesn't always go in a straight line and we might see market come back a little bit before it continues to go forward. And that's really the context of our comment. Sorry, long answer, but it's important to provide a context to it.

Hall: Well, I should also point out that you're not the only one who's talked about a pullback. I mean, people like Jeremy Grantham have talked about that too. Let me just give you a quick overview of the SGH20 fund that you oversee. It's a benchmark unaware large cap strategy with the ability to invest up to 25 per cent of fund in small cap companies too. It was conceived in October 2004. It's returned more than 10 per cent since then, and it's outpaced the S&P/ASX 300 Accumulation index by more than 2 per cent. What are the top five heavy lifters if I can put it like that, Hamish?

Tadgell: Look, I think as we are positioned today, over the last 12 months, I think stocks that have done very well for us have been things like James Hardie, NEXTDC, Saracen Minerals would be sort of the top three. As we sit here today, the top five active positions in the portfolio are Woodside Petroleum, National Australia Bank, James Hardie still, Uniti Group and Lendlease.

Hall: Okay.

Tadgell: We have shifted the portfolio a little bit in the last probably three or four months. And that really is a reflection of the shift from hope to growth as we've been saying.

Hall: And you're optimistic about banks, too, Hamish, if I'm not wrong?

Tadgell: Look, yes, we've become more positive on banks. So, we've been—we've still got an underweight position in the portfolio to banks, but it's the most—at least underweight I should say that we've had for probably 10 years and we are more constructive because if the economy is recovering, we think that that is positive for GDP and again, banks ultimately are probably one of the biggest proxies of GDP growth in the economy.

I think the other thing is that today the scarring from COVID has been less than what people would have expected. And therefore, mortgage defaults, foreclosures, all those business failures have been less and a lot of that is due to the fiscal support that's been provided by government.

Hall: Yeah.

Tadgell: I think the other thing is that the banks have really used COVID as an opportunity to help reset their social license. Clearly, there have been a lot of scrutiny, and rightly rightfully so, around the banks in the last sort of—or post-GFC really, and the Royal Commission and so forth has done a lot of reputational damage to the banks. They've had to pay out a lot in terms of penalties. And we think that that's easing. Those headwinds are easing. In fact, we're starting to see a few tailwinds.

The other big clearly headwind for the banks has been lower rates. And margin income has been impacted dramatically and that's made it tougher. And we're not of the view that rates are going to race away, but we do think that probably hit the lower bounds of where rates will go. And there is a risk over the next probably 12 to 24 months that we start to see a bit more inflation in the system and therefore, the pressure on interest margin should (ease) if not get any worse. And with that if the economy recovers, we think that you could see—we'll see some pickup in lending growth and loan growth.

This report appeared on 2021 Morningstar Australasia Pty Limited

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