Market update with Shaw and Partners, May 2022

Shaw and Partners Chief Investment Officer Martin Crabb discusses the paradox of rising valuations in a looming bear market.

For those listeners and viewers who’ve seen me talk before, we have been quite cautious on markets and defensively positioned, really. And that’s our view about global growth slowing down and financial conditions tightening and central banks, obviously, shifting course from being accommodative to restrictive in terms of interest rates and monetary policies. So, those three things are conspiring along with the geopolitical issues, you know, particularly with the war in Ukraine, to create a pretty tough environment for equities.

The difficult thing to contemplate as part of this is, when you talk to companies and when you listen to the companies talking today, conditions are pretty good. I mean, people have got a lot of cash. There’s something $300 billion of excess household savings in Australia. Everyone’s feeling pretty chipper about their house price, if they own a house. That $300 billion is about 15 per cent of GDP, so that’s sitting in people’s banking accounts, you know, waiting to be spent. And so conditions for a lot of industries are pretty good. They’re seeing a recovery in spending activity, a recovery in mobility. So, people coming to the office and starting to travel again. So, on the ground, it feels like things are reasonably good, but obviously the markets are taking a totally different view.

And that’s really driven by one thing and that’s inflation. So, you’ve obviously heard a lot about inflation. We haven’t really had much of it. I’m in my 50s. I actually remember inflation. Most of my colleagues are younger than me and they don’t really know what inflation looks like. And now we’re sort of seeing a taste of that. So, inflation in Australia is predicted to grow to sort of 5 to 6 per cent by the end of this year. It’s already running at 9 per cent in the UK. Double digits in continental Europe and 8, 8.5 per cent in the US. And wages, of course, aren’t keeping pace with that. So, we have declining real income.

So that’s keeping people pretty nervous and pretty pessimistic despite the fact that we’ve all got lots of cash, well, not, we all, but as an economy, we’ve got a lot of cash sitting on the sidelines. So, we have this situation where earnings are actually being revised up, companies that are in the commodities and energy space, certainly seeing higher prices. We had an agricultural company we were talking to this morning, very strong conditions there. So, you know, in Australia anyway earnings have being revised up and a lot of companies are seeing conditions improve, not deteriorate, and yet share prices are going south.

So, what we’re seeing is PE compression, so the price that investors are willing to pay for a current or full-year earnings, has come back down to below average. So, for most of the last couple of years, the PE ratio of the market’s been, you know, up as high as sort of 20 times, which is a pretty punchy number. And now it’s sort of closer to 12 or 13 times. So, we have seen significant PE compression of the market, and that’s obviously pushed some markets into bear territory.

So, you know, technically, what is a bear market? It’s basically, if it falls 20 per cent from its high, it’s considered a bear market. We’re not quite in one in Australia yet, but obviously we get exposed to the NASDAQ every morning. That’s clearly in a bear market, and I think the S&P 500, you know, the biggest share market in the world. The US comprises about 72 per cent of the MSCI All Country World Index, so it is by far the biggest market and it’s sort of headed into bear territory. So, we have this sort of slight paradox of, as I said, rising earnings and falling share prices and companies just getting cheaper.

So, from an investment perspective, while those conditions continue to persist, ie global growth is slowing… We’ve just seen a couple of PMI data out this morning from Australian and Japan, Australian manufacturing continuing to slow down. Obviously with China in various forms of lockdown, that economy is slowing. US consumer sentiment is at one of the lowest periods we’ve ever seen. So, that economy is probably slowing. So, we don’t really see a change in the short term to a slowing global economy. Financial conditions are continuing to tighten. We’re seeing mortgage interest rates rise. We’re seeing central banks increasing interest rates. So, we don’t see a change to that. And obviously, as I said, you know, central banks are continuing to tighten monetary policy, so we’ll see more interest rate rises this year.

So, while those conditions persist, it’s hard to get too super bullish about equities, but countering that is that valuations for the first time in a long time are becoming quite attractive. So, there’s lots of companies paying, you know, strong fully franked dividend yields that are sustainable. Debt levels aren’t too high. You know, corporate profits are being upgraded. So, there is some sign of optimism, but I think it does become a stock picker’s market. The overall trend is still probably quite tricky. But I think if we can focus on good companies, good management, good products that are expanding and growing, and obviously emerging companies such as those presenting today are a good place to start.

So, with that as a sort of big-picture, macro overview, I’ll hand back to you, Tim, and thanks again.