Market update with Shaw and Partners, June 2020


by Clive Tompkins

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Shaw and Partners' Chief Investment Officer Martin Crabb analyses volatility in EOFY market conditions, discussing liquidity, dividend income & investment into gold. 

Martin Crabb: 
Welcome to everyone to today's call. Thanks for taking time out of your busy days to listen to some exciting companies. Time's moving pretty quickly at the moment. I was giving one of these not that long ago, and the sharemarket was on its knees and everything looked cheap, and the expected return from the market was 40 or 50%. So where we are today, I just ran the numbers before this call, in terms of looking at where share prices are trading relative to what analysts think is the 12-month fair value. And we're almost on top of that.

 So the expected return from buying the market today, and this is the top 100 stocks and holding them to these target prices in a year's time and taking the dividends along the way, is just above 5%, which is not a particularly attractive rate of return when you consider how much risk there is out there at the moment. So of that 5% return, I think it's 5.4%, about three and a half percent of that is dividends. So the dividend yield of the market's absolutely collapsed. And it's not just because of the rally that we've had in the market recently, it's also the significant cut in dividend income, particularly amongst the banking sector, but also a lot of other companies that are under pressure to shore up their balance sheets, and a quick way to do that's to suspend dividends and deemed to be prudent to do so.

So really, the market's moving to a phase now where it's gone from being very undervalued to very, very overvalued in a relatively short period of time, and a combination of both lower earnings and dividend estimates, but also sharply appreciating prices.

Now, underpinning all this, of course, is the abundant amount of liquidity that's been injected into the financial system by not just the US Federal Reserve, but our own Reserve Bank, the European Central Bank, the Bank of Japan, the People's Bank of China. Name a central bank and they are printing money. They are literally printing money out of... creating money out of nothing. As the Governor of Reserve Bank explained to Parliament the other day, we create money out of nothing.

So with all that sort of liquidity, and we're talking trillions and trillions of dollars that are being put into the financial system, it's not surprising to see asset prices moving higher. And it's just all that money finding a home. So there is a lot of that money going to the bond market, but also a lot of it's finding its way into people's savings accounts. Banks themselves are holding records amounts of liquidity with the Fed, et cetera. So there is just a lot of money looking for a home, and that's obviously pushing asset prices.

So that does create a little bit of a dilemma for investors. Clearly, you're not going to get any return in the bank. If you're lucky, you might have a high-yield savings account that's paying you reasonable amount of interest, but for large institutional investors, it's harder and harder to find return. So they've bid up the prices on government bonds to points where they're hardly yielding anything at all. So US 10-year Treasury's yielding 65 basis points, Aussie 10-year Treasuries, 90 basis points. These are hardly attractive long-term returns, and they're certainly not going to hedge against inflation and other liabilities that you have out there. So that money's moved into the market. So what it's done is created, particularly at the top end of town, an expensive, risky market. And we tend to suggest that investors avoid expensive, risky markets.

 The other thing you can do in this scenario, obviously, is look for value. So look for companies that are maybe not in the spotlight of the institutional investors, and I'm sure some of the presenters today will probably fit into that category, in that they're using FNN's fantastic service to showcase their story. Because it is difficult for companies to get in front of the bigger end of town. So I think doing your research, coming to events like this are a really good idea, because you can uncover opportunities that are not caught up in the madness of the large cap market, where we're seeing relatively boring companies trading at sort of 30 times earnings, just because they're considered to be safe.

 So there's a couple of other things that we are advising clients to do. Probably the most important thing is just to hedge the tails. The last time I was on here, I spoke about tail risks. So if you've got a 5% expected return, yet it's a 25% volatility, there's a reasonable chance you can lose money if things don't go well.

So apart from being out of the market, which is not much of a strategy given where cash rates are, can you be in the market and be hedged somewhat? So it's difficult to do that with derivatives. It's very expensive to do it with derivatives. You might want to think about stocks that do well when the broader market's under pressure.

So a clear candidate here is gold. So the price of gold is inversely correlated to negative interest rates. So when interest rates are negative in real terms, so below inflation, gold tends to perform quite well, just because the holding cost of gold is negative when real interest rates are negative. So we have a situation now where, in most major countries around the world, the cash rate's below the level of inflation, so we've got negative rates. So that environment's very good for gold. Add to that, the concern about the coronavirus. So if there is a secondary wave of infections like's happening in Iran, it looks like it could be happening in many Latin American countries, and we go into a secondary lockdown, that's going to be horrible for markets and economies, but it is going to be quite positive for gold.

So having some gold in your portfolio, whether that's physical gold or a gold producer, or even at the riskier end, gold explorer, someone who might be finding gold, that's certainly got a place in portfolios. So they're just some ideas, I think, that we think investors should be looking at. The market as itself is not particularly attractive, but there are opportunities in the small, mid-cap, and also in the gold sector. So there's just some ideas for investors.