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Is value starting to emerge now?

Alan Kohler speaks with Dermot Ryan, the Australian Equities Portfolio Manager at AMP Capital for his thoughts on the market after the ASX experienced its biggest fall since 1987.

Alan Kohler speaks with Dermot Ryan, the Australian Equities Portfolio Manager at AMP Capital for his thoughts on the market after the ASX experienced its biggest fall since 1987.

Alan: Dermot, I wanted to talk to you because I read a note you put out last Thursday which I thought was terrific and I really thought I need to talk to this bloke. But Thursday was an eon ago; it was years ago now! So much has been happening since then and what you said then was markets have been behind the curve, one of the things you said in that note. Do you think that today markets began to get in front of the curve, or not?

Dermot: Not really, I think this has been a really difficult pandemic to stay ahead of the curve on, mainly because it moves so quickly. And so we’ve seen the kind of spread and a lot of people are looking at the infection numbers first and then the death rates and the whole thing has been the number of new clusters and how it seems to move so quickly across borders and across countries and how difficult it is to stop so far.

Markets have been complacent, you know we came into this a month ago with record asset pricing across a number of asset classes and it’s been incredible the downdrafts, and how quickly it has come. I think, again this morning we saw an emergency cut from the Fed of 1.25 per cent to zero and a 75 basis point cut from the RBNZ, so people here are starting to think that the RBA will cut as well. What we’re seeing is that the institutions are trying to react to the panic, the market is seeing the conditions on the ground are getting more difficult. The difficult thing about this is it’s been both a demand and a supply issue in the short term that are affecting markets. You have a lot of panic and some people kind of really struggling with confusion and where to go next.

Alan: So at the end of today, it’s 10 per cent down today, that’s a big fall. The market is down 30 per cent now, from top to bottom.

Dermot: Yes.

Alan: Does it feel like there’s starting to be value there or is it just impossible to tell?

Dermot: No, we think there is value starting to emerge now. A 10 per cent fall today and what was interesting was the acceleration at the close where it kind of drops another 2 per cent in the last 15-20 minutes after what was a pretty tough day already. There seems to be just indiscriminate selling. We had seen that last Thursday, I wrote that note that you got I think it was before market because we were just expecting that that was the day that we’d been quite defensively positioned and we started to see some really aggravated selling. So we were starting to step into the market and sell our defences and get rid of the remainder of our cash and step into more cyclical plays. But that’s something we saw again on Friday morning where we saw more selling. We saw a rally Friday afternoon and more selling again today.

So you’re starting to see a point where that selling should certainly exhaust itself soon. In fact, the drop we’ve seen so far has been even faster than during the depths of the GFC. At a certain point, we think already, the sellers are selling assets at cheaper prices than they should be and we think that this depth and speed of sell-off won’t be able to be sustained. Because ultimately this will be a period of weeks and months where there will be these shutdowns, but post that economic activity will resume and there will be, of course, the demand pick up on the other side. We think what you’ve got to do is probably not worry too much about profits this year and look at maybe what a mid-cycle, what a company’s going to earn on a three year basis.

If you can, and you’ve already positioned there, you’ve got really focus on balance sheets, so the assets, the companies can manage their debts and working capital so they can trade through a couple of tough weeks and months and then also picking the kind of companies that are going to be around in five years’ time and will be back into a normal demand situation and can look to do well then.

Alan: To what extent do you think this depends on the depth of the recession that we see? Have you got in your mind what sort of GDP contraction you’re expecting to see and does that have an impact on how you invest?

As I said, I think the issue we have in Australia is that GDP growth has been pretty weak already because we’re just coming across from bushfires on the east coast and we had the flood issues and then we got hit with this virus. It’s essentially GDP numbers for this quarter and at least the next one, if not a good part of the rest of the year are going to be tough. It’s hard to say exactly where the numbers are going to fall out at this point. Our major exports in resources are still going to do well but other major sectors like tourism and education are going to be hit pretty hard. And how long the shutdown continues for, and particularly things like travel bans where you’ve got to have 14 days self-isolation is going to be difficult for tourism. Obviously, universities closing is going to be difficult for the education sector.

Without having a better line of sight for when those shutdowns will finish, it’s really hard to say at the moment. But again, what I would say is people are really just focussing on the issues right now and forgetting that these companies are going to be around for a very long time and really there’s a lot of good opportunities in the market at the moment. You’ve got to keep your calm and I think good decisions made now will reap great rewards in the future.

Alan: It was noticeable in the ASX200 there were only three stocks that went up. We’ll go through them, Telstra was one of them and you mentioned telcos in your note last Thursday. You said ‘Telcos will benefit from people working from home’, and that’s obviously starting to show up in the buying today, which was quite interesting.

Dermot: Yes, we think that one of the areas where there is going to be more demand is that work from home segment. So we think essentially people will be upgrading their broadband packages, they’ll be spending more time on their phones and so we think that’s an area where demand will increase. We were already seeing average revenue per user, which is a kind of industry metric, increasing and we think that trend will continue. We think there’s some very good cashflows coming through across that whole sector, across Telstra, Optus and now TPG Vodafone.

Alan: But the best stock in the ASX200 was Fisher & Paykel Healthcare because they make respirators. But more broadly, do you think there are some defensive investments to be made in the healthcare sector now?

Dermot: Yeah, we think there’s some very good opportunities but also some risks. Some of the larger healthcare names are on very high valuations and we think the risk of disruption due to elective surgeries or maybe disruptions with part of their supply chains is actually higher than the market appreciates relative to where the rest of the market valuations are at. Where we see opportunities are in creating surge capacity for the healthcare system here and abroad and so particular aged care stocks have a large amount of beds. And what we can see from other countries where they’re a couple of weeks further down the track to us is that building that surge capacity in hospitals and through your whole system in aged care is going to be very important.

We think that this may be part of the second round of stimulus response that we’ll see from Canberra tomorrow. The other part as well, of course, is private hospitals. Private hospitals may have to scale back elective surgeries which will be a short term profit hit, but there are excess beds there now which will be needed to potentially combat some of the issues that you have with the surge in infection rates as they come.

I just wanted to talk about banks, if that’s okay, you mentioned them in your note. Obviously they sold off even more today, there were some incredible falls among the banks today. Crikey, look at NAB, it’s down 12 per cent, CBA 10 per cent, Westpac 12 per cent. This is happening because of further rate cuts coming which are going to squeeze their margins, right, and also credit quality is going to decrease?

Yeah, I guess the banks are being hit on a number of fronts. Obviously the rate cuts coming through and the fact that we’ve gone to zero now, so far this week we’ve seen the Fed and the RBNZ go to zero, means that the yield curve is going to be pushed down and what that does then is it reduces the ability for a bank to earn a spread between long term lending and short term borrowing or term deposits. The net interest margin on banks is going to be coming down. The question as well, of course, is the housing market. We had seen the housing market recover back towards its peaks on the east coast, but residential housing is at record highs almost again, and indeed record low yields. So valuation support is not really there for residential housing and also I guess of course with the shutdowns that we may face for these unknown times, I’d say a couple of weeks, may have impacts on small businesses and too indeed, casual workers’ earnings etc.

And so it’s how much support do they get from the government and others, how much payments have to be delayed potentially on mortgages etc. If it’s a short period, they should be able to work through but if it goes on for an extended amount of time then credit quality will eventually start to be questioned. It’s been a very tough time for banks but what I would say is that it’s not going to be a liquidity and solvency issue. If you look at how, I guess all central banks, regulators and the authorities, in general, have kind of learnt from what the GFC was and this won’t be an issue of liquidity to the banking system. You see credit lines opened up on Friday through repo markets, in many ways we think that the banks may be where some stimulus is actually pushed through.

We think the central banks have lost effectiveness with rate cuts. In many ways they’ve been kind of – they had a hammer and everything was a nail, they kept cutting rates and what we’ve seen over the last couple of weeks is that rate cuts haven’t been enough to stimulate markets and that’s been really because this has got to be a fiscal stimulus problem. Companies, particularly small and medium enterprises are going to need working capital to get through this. Also households, particularly, I guess with casual workers and the more exposed are going to need assistance to try and get through this period. That will mean some issues in the short term. But I think these are the kind of times where it’s not just the governments it’s also the corporations that need to lift and work together to try and get through these difficult times.

Alan: I really appreciate you giving me some time, Dermot. It’s been a big day and you’re obviously tired, so thanks very much.

Dermot: No problem, thanks Alan.

Alan: That was Dermot Ryan, Australian Equities Portfolio Manager for AMP Capital.


Alan Kohler is the founder and Editor-in-Chief of Eureka Report. For more financial insights, start a 15-day free trial.