Crystal Wealth Newsroom
Holding pattern: recovery uncertainty fuels investment waiting game
“I think we’d all be delighted if the market performed as well as it has done over the coming months, but in reality, we’d be very fortunate if it did,” says Tim Wedd, Executive Director at Crystal Wealth Partners.
Three of the critical factors that will determine how the market performs over the coming months are:
- The extent of ongoing financial support provided (given COVID impacts to economic expansion and rolling lockdowns);
- The extent to which central banks start to reduce financial liquidity; and
- The likelihood and future level of inflation (and hence expectations).
“There’s a reasonable case to be made that the bulk of government spending has already happened or is happening at the moment in terms of its effect flowing through the economy,” he says.
“You would expect potentially in 12 months time that the growth figures wouldn’t be as strong unless, of course, we get through COVID quickly, vaccination rates are high, and the private sector picks up the slack as governments withdraw their current support.
“As an example, in the government bond market rates have reversed in the last month (dropping), which tells us that either the bond market isn’t as convinced in the future economic recovery being as strong and as persistent as we may have thought, or rates are just going to stay low for a more extended period of time.
“There are a lot of risk factors clearly still to play out.”
The inflation outlook
The core view over the coming months is that inflation is likely to be more transient than permanent – however, ‘transient’ is open to interpretation. What does it actually mean? Is it months, or is it longer than that? There is no pandemic handbook so the reality is no one knows. On the balance of probabilities, we expect current higher inflation prints to moderate as the year unfolds. This is more consistent with growth continuing but at a lower rate and inflation remaining under control as supply bottlenecks clear.
“Higher inflation numbers are coming through, particularly offshore, but the central banks haven’t moved as yet,” says Tim. “Although the central banks haven’t moved their actual policy positions, discussions have started and you need to watch when they start to roll back some of their quantitative easing programs because how and when that happens will provide a forward indication of likely future rate adjustments.”
While support is still there for markets (and with solid balance sheets), valuations are on the high side, making standout buying opportunities difficult to find. However, a typical defensive strategy isn’t being rewarded either in this type of environment (plus it carries an inflation risk given low starting yields).
“This means it pays to be patient and maintain some liquidity and flexibility in portfolios to respond to opportunities as they present,” says Tim. “While company earnings have been good to date, we expect volatility given the uncertainty about where to from here with the pandemic recovery.”
If and when there is a shock to the system, then there could be opportunities to capitalise. However, Tim warns, it won’t be a free-for-all at any price. Having a position in commodities, energy, floating rate securities and higher yielding corporate debt as well currently can be used to support risk adjusted returns with some core fixed income as ballast. This includes within the mix having exposure to some assets that can reset their ongoing cash flows to any unexpected inflation outbreak – where costs can be passed on to consumers (e.g. property, rents, some infrastructure assets, businesses with strong franchises and customer support). In other words, still look for future growth but hedge your portfolio outcomes.
“When you look at some of the current takeover activity emerging in the market – for example, Sydney Airports and Spark Infrastructure – these assets were seen as having attractive long-term income flows before the pandemic. They’ve recovered somewhat, but they’re not back to full value, which is why you’re seeing somewhat opportunistic takeover bids coming through – a sign of money looking for undervalued assets with good future cash flow potential.”
Tactically speaking
From an investment perspective, the important thing is to not be overweight in a particular sector of the market at present – and within that, being mindful of the type of exposure you’re getting.
“Coming from a higher valuation starting point, we expect returns in future to be constrained and lower but with a positive equity risk premium still over traditional fixed income and cash. It’s not a trading game at the moment,” says Tim. “It’s important not to chase returns and be mindful of the embedded risks.”
“The winners of one week may suddenly be the losers of next week based on news flow – as illustrated by the inflation debate and view of either a too strong or too weak economic recovery.”
Security of cash flow and revenue are essential attributes of potential investments, rather than just the growth story – and it’s important to approach the coming months with a long term view, rather than seeking short term wins.
“We expect the market environment to stay very fluid,” says Tim.
“Tactically, you’re in a slight holding pattern presently. Make sure you’ve got the assets you want to hold on to, look for opportunities if something gets mispriced, but understand there’s a lot going on behind the scenes that can also lead to a period of market consolidation at the moment through the northern summer months.
“Accordingly, we feel diversification is still the key: have a mix of domestic, international shares and property assets to underpin growth returns offset by some more defensive positions, given the difficulty with trying to ‘market time’. If something looks too cheap, there’s probably a good reason for that.”