Should investors trust the bears or a new economic cycle?

Investors who look through bearish signals will find companies poised to benefit from economic strength.

ST Wong

Was it really just 18 months ago that the price of oil was negative? Oil producers had such a glut they were literally paying buyers to take barrels of oil off their hands. What has changed?

Commodities experienced a boom. Residential property, industrial property and shares boomed alongside. Was this just a trade in risk assets resulting from COVID-19, or the beginning of the next economic cycle?

Investors must navigate many mixed messages. Every economic or financial report refers to some form of slowing growth. Bearish market observers are raising the prospect of stagflation overhanging the US economy, and Evergrande’s debt problems in China.

Some near-term headwinds have emerged. Several CEOs said in the August corporate reporting period that global supply chain constraints, the stop-start approach to lockdowns and rising costs are key challenges.

Yet, the fundamental strength of the economic rebound remains intact. The impact of more effective vaccine distributions globally provides confidence, and other positives suggest we are indeed in a new economic cycle.

Some commentators have tried to draw parallels between this economic cycle to the period following the global financial crisis. But the contrasts are stark: consumers and corporates emerged from the global financial crisis in a position of weakness; both are now in a position of strength.

When recovering from the GFC, banks and households wanted to unsaddle heavy debt burdens brought on by years of excess. Governments were hemmed in by fiscal austerity measures. The consumer felt the cut resulting from declines in net wealth or net worth. Consequently, businesses were either reluctant or had little incentive to invest for future growth.

By contrast, current personal savings rates are at elevated levels as households socked away excess cash which would have been used for entertainment, holidays and other lifestyle pursuits. Banks are not in a de-gearing phase, as bad loans have not been an issue, while governments don’t seem likely to be in a fiscal tightening phase.

This strength is evident in the household, with additional cash balances significantly above pre-pandemic levels. Investment bank Jarden estimates that since March 2020, households have built up a buffer of $202 billion (10 per cent of GDP or 19 per cent of consumption), with $114 billion in additional bank deposits plus a further $88 billion in extra debt repayments.

Consumer potential

So, we are looking for opportunities with companies that benefit from a strong consumer. These include businesses related to housing and ancillary goods and services.

Sure, there are short-term risks investors should understand. For example, some businesses have benefited from a pull-forward of demand and will not sustain these high activity levels; and navigating Australia’s open-shut economy is somewhat more art than science for retailers as businesses grapple with supply chain issues (an inventory build-up ahead of Christmas could lead to losses if shopping is subdued).

It’s important to look through the short term to focus on companies with durable businesses – those with the ability to price their goods and services well, and with credible plans to grow their businesses. Auto parts retailer Bapcor and national baby goods chain Baby Bunting fit these criteria – both companies service a consumer segment with essential needs, have reasonably limited competition and room to expand.

The second big positive for the economy is the latent capacity sitting with corporates. Much like the consumer, corporates pulled in their appetite for investing and capital expenditure after the global financial crisis.

Investing for growth

Today Australian corporates are in a much better starting position. They have de-geared significantly while the demand outlook, from a consumer perspective, looks healthier. A key differentiator is that demand has been more concentrated in goods compared to services. Underpinned by a recovery outlook and strong balance sheets, conditions for investments and capital expenditures are positive.

Investors should consider companies that can benefit from rising business spending and are investing for growth. The media sector is often forgotten as lagged beneficiaries of consumer confidence and business spending. Radio broadcasters such as Southern Cross Media and HT&E should benefit from improvements in advertising budgets as the economy recovers.

Through the pandemic a number of companies have taken the opportunity to position themselves for growth. In the aviation sector, Alliance Aviation acquired a number of aircraft at depressed prices which will yield high incremental profits as activity recovers.

Perpetual, Pinnacle Investments and Macquarie Group have all made acquisitions in financial services firms, with a view to growing those businesses – in contrast to shrinking major banks.

While the bears can be relied on to appear when we hit some bumps along the way, the argument for a new, stronger economic cycle is compelling.

ST Wong is chief investment officer at Prime Value Asset Management.

Source: Australian Financial Review

Related Content

Market volatility does not change key drivers of the share market

5 October 2021

Market volatility does not change key drivers of the share market By ST Wong Recent market volatility will likely impact the Australian share market in the short-term, driven largely by volatility in the commodities market. The concerns over commodities can be traced back to problems with Chinese property company Evergrande, which is currently experiencing a […]

CONTINUE READING

Latest Mercer survey puts Prime Value Emerging Opportunities Fund in Top Ten

20 August 2021

Latest Mercer survey puts Prime Value Emerging Opportunities Fund in Top Ten The Prime Value Emerging Opportunities Fund has achieved another high ranking in the latest Mercer Australian Small Companies (ex-ASX100) survey, following its table-topping ranking in last year’s survey. The Fund, which is managed by Prime Value Asset Management Portfolio Manager, Richard Ivers, was […]

CONTINUE READING

Is News Corp a buy? Is Blue Bet a good punt? +3 big mistakes property buyers make! | SwitzerTV

12 July 2021

Is News Corp a buy? Is Blue Bet a good punt? +3 big mistakes property buyers make! | SwitzerTV Click here to watch ST Wong on Switzer TV  

CONTINUE READING
FIND OUT HOW TO INVEST WITH US

We'll get back to you within 24 hours.

CHAT WITH US