In an excerpt from a recent interview with Livewire Markets’ Glenn Freeman, Tyndall AM’s Brad Potter (Head of Australian Equities) joins Fidelity’s Lukasz de Pourbaix to discuss why Inflation remains the main game, and shares other key insights.
We regularly take the temperature of the macro and market landscape by quizzing some of the nation’s biggest asset managers about their views. We did this at the end of last year, when we collated outlook statements from more than 20 different groups.
Now we’re just past the mid-point of calendar 2024, we’ve gone back to gauge how things have progressed since last December. But more importantly, we also asked them what their expectations are from here.
Fidelity’s Global Cross-Asset Specialist Lukasz de Pourbaix revisited some of his team’s statements from the end of last year.
We also checked in on Tyndall Asset Management’s Head of Australian Equities Brad Potter, for his views on several sectors.
Luke de Pourbaix: Fidelity
De Pourbaix says the market environment has “evolved materially since late 2023.”
“Of note has been the resilience of the global economy, despite multiple rate hikes.
“In particular, the US market has continued to grow, which is exemplified by the strong labour market, consumer confidence and positive economic data such as the PMI surveys, which have continued to hold up.”
De Pourbaix says this has reduced the risk of a cyclical recession to 5% “based on our scenario-based macroeconomic framework.”
“The likelihood of a soft-landing scenario, which is characterised by a disinflationary environment with rates heading back to neutral and slightly below trend economic growth, currently stands at around a 40% probability.”
But he emphasises that Fidelity is closely monitoring the trajectory of inflation data, “as stickier inflation data has also increased the likelihood of a no landing scenario to around 30%, whereby rates remain higher for longer.”
Fidelity’s Lukasz de Pourbaix and Tyndall’s Brad Potter
What Fidelity is watching now
In the second half of calendar 2024, de Pourbaix’s team remains focused on inflation – more specifically, they’re watching the different components of inflation.
“While overall inflation has moderated, inflation hasn’t moderated equally across all segments of the economy,” he says.
“Notably services inflation has proven to be sticky relative to other segments such as goods and energy, which have fallen materially. Central banks such as the US Fed and the RBA have explicitly noted that they want to see services inflation trend down before the consider any potential future rate cuts.”
He also emphasises the labour market as a key focal point, especially in Australia and the US, where near-full-employment has contributed to stickier services inflation as labour costs have remained elevated.
“The strong labour market has also contributed to resilient demand,” de Pourbaix says.
“However, the longer rates remain higher, our expectation will be that the consumer will begin to show signs of weakness and you may begin to see some softness in the labour market, which is what central banks would like to see before pulling the trigger on rate cuts.”
Which sectors are tipped to perform best in FY25?
“If we see the soft-landing scenario playing out we would expect sectors such as consumer discretionary, industrials and materials holding up relatively well,” de Pourbaix says.
Though he notes economic growth is moderating, he believes it will remain positive and says potential rate cuts be positive for the consumer.
“However, if rates remain higher for longer, the consumer will increasingly feel the pinch and we would likely see a fall in consumer confidence and sectors that have held up to date such as consumer discretionary stocks may feel some pressure,” de Pourbaix says.
Brad Potter, Tyndall Asset Management
“Tyndall’s view on both inflation and rates is largely unchanged from our outlook statement at the end of 2023. Inflation will be higher for longer as tradeable inflation rolls off, replaced by stickier labour and cost inflation,” says Tyndall’s Brad Potter.
“The recent inflation print has spooked the market a little, leading some market commentators to predict a rate hike in August and pushing out the timing of Australia’s first interest rate cuts to mid-2025.
“The government’s stage-three tax cuts will provide some relief for consumers, but will also potentially incentivise the RBA to raise the cash rate in the second half of 2024.
“The era of low inflation and interest rates that followed the GFC seems unlikely to return in the foreseeable future. Deglobalisation and decarbonisation are inflationary forces that will remain for some time,” Potter says.
Renewables roadblocks
Potter explains that regulatory, heritage and environmental approvals are “just as difficult to achieve for a renewable project as they are for mining-related ones”.
“The land usage is arguably much greater for renewables and is often allocated in prime agricultural land,” he says.
Potter notes that project approvals are a worldwide challenge and the ambitious targets set by the government are virtually impossible to meet.
“Other factors, such as sourcing the labour and materials, are also problematic. Australia has not constructed enough high transmission lines over the last few decades, making the ability to complete such projects on time and within budget highly unlikely.”
Building materials
In this industry, which was called out by Tyndall at the end of last year, Potter compared its views on two category leaders: James Hardie (ASX: JHX) and Reliance (ASX: RWC).
“Both James Hardie and Reliance face macro challenges, particularly in the USA, as interest rates remain elevated and repair and remodel volumes drift back towards trend from their COVID-inflated peaks,” Potter says.
“The single biggest driver for both stocks is falling rates, leading to increased building activity. While both are high-quality companies, Reliance is more skewed towards the less volatile repair segment and offers better value than James Hardie at this time. Our conviction and positioning in Reliance remains unchanged.”
What about Aussie banks?
Potter points out that Australian banks have substantially outperformed the market over the past nine months and over the past quarter.
“The major bank P/E multiple has increased to approximately 16.9 times and is 100 basis points higher than it was at the beginning of the tightening cycle. Commonwealth Bank (ASX: CBA) remains arguably the most expensive commercial bank in the world and is now trading at a 58% premium to peers and a few standard deviations above its long-term average multiple,” he says.
“ANZ Group (ASX: ANZ) and Westpac (ASX: WBC) remain around fair value based on our models, while National Australia Bank (ASX: NAB) is expensive.”
“The current investment case on the banks is predicated around reasonable earnings certainty compared to market, with net interest margins stabilising and material bad debts unlikely without a recession. However, the price being paid for this is excessive and should de-rate over time.”
“Peak productivity is behind us”
On Consumer Staples, Potter refers to several headwinds that have faced the sector, including government and competition inquiries and moderating food inflation.
Looking ahead in the second half, he believes steadier food pricing could lift volumes “as struggling consumers choose to cook more at home.”
“We believe the peak negativity surrounding these issues is now behind us,” he says.
“We are overweight consumer staples given its defensive earnings profile in an economy that may weaken further.”
Healthcare v Insurers v Energy v Materials
Potter says the “stark underperformance of resources compared to banks warrants careful observation, given the underlying drivers.”
“It is difficult to envisage the banks re-rating further given the recent share price performance with little growth in earnings. Resources have been adversely affected by poor macro conditions stemming from China, where its government is actively attempting to stimulate the economy. If successful, this could lead to a sharp reversal in the resources-banks trade, especially given the resource sector is currently trading at very low multiples.”
On the insurance industry, he notes strong margins continued due to rising premiums and the uplift of investment income amid elevated interest rates. But these effects have been moderating.
“While we remain overweight the sector, we have been selectively taking profits,” Potter says.
On Energy, the “risk premium” on oil and gas prices continues amid geopolitical uncertainty in the Middle East and Ukraine.
“Demand is supported by the glacial rollout of renewable power generation and slower-than-expected adoption of electric vehicles,” Potter says.
“Australia’s oil and gas sector is skewed to gas, which is vital for transitioning to net zero. The Australian government has finally recognised this inconvenient truth and appears constructive in developing and exploring for gas. As a result, The Tyndall Australian Share Wholesale fund is overweight energy.”
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