Weekly update on the impact of COVID-19 on the financial markets
Alex Cousley - Russell Investments - Tuesday 12 May 2020
Paul O'Connor (POC): Welcome to the Netwealth portfolio construction podcast series. My name is Paul O'Conner and I'm the head of investment management and research. The investment management and research team looks after both the investments we make available to you through our super and non-super investment platforms, but also the managed funds and managed accounts we issue. So spend a lot of time interacting with various fund managers. Today. We have Alex Cousley from Russell Investments, who was the Asia Pacific investment strategy analyst. Welcome Alex.
Alex Cousley: (AC): Thank you, Paul.
POC: Given your role covers the Asia Pacific region. I thought for today's discussion, we'd focus on the global impact of COVID-19 and subsequent economic slowdown, the rising geopolitical tensions and the ultimate impact on the Australian economy. Russell had many different managed funds that they offer through the Netwealth platform, including diversified funds and asset class specific funds, such as Australian and international liquidities, starting with Russell, how has your company handled the isolation policies and work from home rules given you've got staff located all around the world?
AC: Sure. Paul, firstly, thanks for having me. So how we managed or how he got through this? Our IT team had been doing a lot of work over the last couple of years, actually preparing us for something like this where everyone had to work from home. So it's actually been quite smooth. Personally, the transition to working from home again has been fairly smooth. I have started coming back into the office a couple of days a week, just for a bit of a change of scenery. It's really quiet in the office now, which is nice and you can get a lot of work done.
And I mean, in terms of how we're going globally. So, we have offices around the world and I did see an email from the IT team recently saying that there had been 22,000 Skype calls over the previous week. So it seems that everyone at Russell has really adapted to the online forms of communication quite well. And even on the social side, where do we kind of Friday night drinks over Zoom. We have Microsoft Teams, we use that product quite a lot. So it has been quite smooth.
POC: Ah, that's good to hear, I know certainly, in terms of Netwealth's experience all of the Netwealth staff and are experts in Microsoft Teams. So, I can appreciate the way all of our work behaviours and communications have been adapting and changing to the isolation policies.
POC: The spread of COVID-19 appears to still be increasing globally. So while Australia is starting to ease social isolation restrictions, other countries and regions do not appear to have reached peak infection rates. So where do you think we're at with the spread of the disease globally? And does Russell have a view on the duration of the outbreak until I guess we, as a planet start to manage COVID-19?
AC: So, I think there's right now, there's an interesting distinction between the developed markets and the emerging markets. Obviously it started in China, it kind of spread little bits of Asia and then move to developed markets who are largely now coming out of it. So if you look at the United States, if you're looking at Europe, we've been tracking the official announcements of when countries are expected to restart and go into this phase one of re-opening and it looks like all of the United States should be fully back on phase one sometime before mid June and Europe is a couple of weeks ahead of them.
The EM side of things so if you look at Asia, they were quite successful early on and it is starting to become a little bit more concerning. And I cover emerging markets as part of my job at Russell. And what I've been watching is particularly Brazil and India are still seeing rises in the number of new cases per day, which is quite concerning. In terms of the duration, I think the EM side is going to be a bit more difficult to manage given the weaker infrastructure on healthcare throughout many of those countries. But I think on the developed market side, I think we are through the worst of the outbreak. And we will start to see economy start to come back towards that phase one, as I said by the middle of June.
POC: So you don't have any fears that some of the more developed markets are starting to relax their selection policies potentially too early, which appears to be some of the debate in the media?
AC: It's certainly a risk we're worried about, the idea of a second wave. But one thing that we have been debating as a team globally has been that there is no real country that's going gung ho at trying to reopen fully. And so we think that if they do have these phased gradual restarts, that kind of contains the risk somewhat that you have these second outbreaks.
POC: And do you have any thoughts on the potential for a vaccine and any potential timeframe when one might be available?
AC: I mean, it's really hard to say what the timeline will look like. One thing that we have been spending some time talking about has been president Trump and the US government, this Operation Warp Speed. They are aiming to have 300 million doses of vaccines available in the US by January and by historical standards. That would be a very, very quick timeline. We haven't seen something that before.
But on the flip side, we have never really seen a programme given this many resources. There was an article in The Economist, just this week, knowing that since January, the number of publications about COVID-19 have been doubling every fortnight. So I think with everyone focused on it, it is hard to say what the timeline is like, but I wouldn't be ruling out the idea that this Operation Warp Speed could get us to a full vaccine sometime maybe by the middle of next year, but it really is quite difficult. And it's not something that we specialise in at Russell on vaccines.
POC: Yeah. I can appreciate the comments there, Alex given just how difficult it will be in terms of developing a vaccine given I'm not a hundred percent sure that we understand fully the spread and the way COVID-19 may certainly potentially morph and reappear in certain economies. From an economic perspective, we're all well aware of the damage being done to the global economy, but what's Russell's view on the depth of the economic contraction we're experiencing and is Russell of the view that we're currently in a global recession?
AC: Our view on the depth, we're going say Q2 numbers are very bad. So in the United States, perhaps 35, 40% down on an annualised quarterly basis. In terms of we are very likely in the middle of a global recession. But one thing that we are focusing on and it is our base case is that this is a very deep, but very short recession as economies start to come out of these lockdowns and we start to see a gradual return to economic activity.
POC: So are you of the view or is Russell of the view that we will experience... well, the base case being we will experience a V shape type of a recovery?
AC: I don't think there's a... We don't have in the V shape camp, potentially a U, but it could be a strange shape where you have a bit of a pickup as you go back to phase one, phase two, and then a bit of a slower return all the way back to stage four. So I don't think it's a V shape, but I don't think... We don't think it's going to be L either.
POC: And in terms of, I guess, the two largest economies and being the engines of global growth, being the US and Chinese economies, what's Russell's view on how both of these economies are fairing at the moment.
AC: So I might start with China, given that within my coverage, the Chinese recovery out of COVID-19 has been positive, but there are some mixed signals in there. So if you think about China, there's the manufacturing side of the economy, and there's the services side of the economy. The manufacturing side has come back reasonably well, if you look at a number of indicators, such as coal consumption congestion, of traffic congestion, we are seeing that improvement in the manufacturing side.
We are seeing that improvement in the manufacturing side. Where we are seeing lags and a more gradual return is on the services side. So things like retail, cinemas, people are not going out and spending money, they're not going to shopping malls. They're going to work and they're going straight home. That poses a question, an interesting question for more developed economies that are more consumption driven, about to what extent is this psychological change in consumer behaviour? I mean, right now given the amount of stimulus, and I think we're going to touch on this later, Paul, there is a lot of stimulus to households to bridge some of the hit to income. But we might see this is where that gradual return after phase one comes in as people slowly come back to spending money and going out and shopping and going to restaurants, et cetera.
In the U.S. I mean, I think you just need to look at the U.S. unemployment rate and the jobless claims that are coming through. 15% unemployment rate last Friday was announced where there again, we are focusing not just on the scale of job losses, which are off the charts, but in looking at how many of those jobs losses have been temporary and how many have been important. And they do a survey within the usual unemployment survey asking respondents whether their job loss was temporary or permanent, and only 12% are saying permanent. So they are in the midst of the downturn right now. It is quite bad, but we do think that as the restrictions start to ease, those people go back to their jobs and we do see this gradual recovery.
POC: So ultimately, where do you think Australia's at at the moment? And obviously given the importance of China as I think our largest trading partner now is the Australia now in a recession?
AC: I think we are similar to the world in a recession, a short but sharp recession. In terms of China, I mean it's kind of strange, everyone thinks about China as iron ore which the price of iron ore and the imports have been holding out reasonably well. They've been stockpiling for steel production.
The bigger question is around education and tourism, which are going to be hit. And it's going to take a bit longer to come back because of the border shutdowns. And so that is going to be a bit longer of a headwind to the Australian economy. And I think the other thing to really highlight here and personally, I'm a little bit more cautious on the recovery in Australia, because if you look at the household balance sheet going into this, we were already seeing a [inaudible 00:11:31] the cautious consumer, and with the RBA interest rate cuts last year, the Australian tax cuts, they didn't really boost household consumption of retail sales through the back half of last year. You know people were basically just putting their money onto mortgages. So I think we're a little bit more cautious on the economic recovery in Australia, given those headwinds.
POC: Mmm, yeah. And certainly interesting your comments around education because I know certainly Victoria has been one of the leaders in, I guess, attracting many overseas students and certainly the impact on the Victorian economy and the Australian economy will be significant at the moment as a result of the travel bans and the isolation policies in place. So, interesting comments there, Alex.
The human impact of COVID-19 has rightly grabbed the largest attention of the world. Maybe a bit extraordinary government and fiscal, monetary and fiscal policies announced has been nothing short of extraordinary and the global fiscal and monetary response in 2008 to the global financial crisis, certainly pales in comparison. What's you know, does Russell believe enough government and central bank actions been done? Or do you think more policy action and in particular fiscal policy such as large government funded infrastructure projects should should still be in the plans of governments?
AC: leading up to this, we'd been of the view that we're going see I guess, defensive easing. So they are providing stimulus, but they're not throwing the ... not shooting the bazooka, so to speak. I still think that's the right base case to be having here. And I think that one of the interesting thing that I think we'll see in China is they are moving towards a more consumption driven economy. That's been a long stated goal of the party, and they also have the interesting development that they have a goal to double GDP per capita. So essentially household income, by the end of 2020. They needed about 5.6% GDP growth to reach that, that's really difficult when Q1 GDP is extremely negative. I think what we will see, and we have the National People's Congress or the big annual get together of the party to discuss economic policy.
One thing I'm looking for is we see more incentives or stimulus around trying to boost consumption and take this as a chance to further drive that transformation of the economy away from capital led investment into more consumption. So I think we have seen vouchers and those sorts of things introduced by different provinces. I think what I'm looking for is whether we see a national level consumption boost, whether it's a tax cut or some sort of other incentive. But I wouldn't rule out more infrastructure spending. I think we are going to see some of that, whether it's the huge package that we saw in 2009 though, I think is still remains a question.
In this episode, Roy Maslen from AllianceBernstein joins us to discuss the impact of COVID-19 on the Australian economy, including the financial implications of the Government's isolation policies, what sectors are presenting investment opportunities for investors and his tips for navigating the current market uncertainty.
POC: Yeah. Well interesting comments there Alex, given I guess it's a natural progression for an emerging economy such as China to move to a more of a consumption based economy over time. So yeah, interesting. Your comments there around the focus of the Chinese government there and effectively trying to double household income to improve the contribution consumption makes their pay in their economy.
Globally we're certainly witnessing a rise of geopolitical tensions with both the U.S. and China as authorities using a lot of rhetoric against each other. So what's Russell's view on the heightened geopolitical risk and the potential fallout, I guess, as a result of this heightened risk?
AC: Yeah. So it is quite worrying to see these tensions flaring between the U.S. and China. in terms of fallouts, the most worrying and likely is a dropping of the phase one trade deal. I mean military action is obviously more worrying, but we don't think that's as likely. But even then, our view right now is that it's not a base case outcome that we do see a dropping of the phase one trade deal and... case outcome that we do see a dropping of the phase one trade deal and a return of tariffs. On the Chinese side, what has been notable when you look at the press, and you look at what officials are commenting on, is that they are avoiding aiming criticism directly at President Trump. When we had the last trade disputes and those negotiations, there was a much more direct criticism of President Trump. I think that's important.
AC: And then, on the US side, so late last week, the US and Chinese negotiation teams had a phone call and, basically very vaguely, said that, things are going all right. And then, Trump noted that he was in two minds about what to do. Obviously a restart of the trade war would pose a very significant headwind to the economic recovery for both countries.
And then most notably for the US, it would also pose a headwind to those trade exposed and manufacturing sectors, which happen to reside in the Rust Belt, which is where Trump is going to rule, or the areas that Trump is going to rely on in the upcoming election in November, 2020.
POC: Yeah. Well, I was actually going to ask you about your views on the US Federal election and whether Russell believes Trump's handling of COVID-19 will be a positive or negative impact on his chances of being reelected?
AC: So, I mean, conventional wisdom has always been that if the economy's in bad shape, that's really bad news for the incumbent. But this is not your typical downturn, given the pandemic and the health catalyst of this downturn. I was looking through some polls this morning on President Trump's approval ratings. His approval rating has ticked down a little bit, but if you break it out into the handling of the economy and the handling of the COVID outbreak, what you see is that his approval for the economy has pretty much not moved at all. And it's been the handling of the COVID outbreak that has been slipping.
So, I think overall, it probably creates a bit more of a hill for him to climb. If you look at polling of Biden versus Trump, Biden is winning, but it's not by any means a done deal. I think it is going to be quite a tight race.
POC: Yeah, I guess it'll be interesting, your comments there around the Rust Belt of America, and I guess their shrinking middle class and ultimately how they will perceive Trump has handled this in the end.
So, yeah, I guess, keeping on the geopolitical issues, Australia's been very vocal in calling for a global investigation into the outbreak and spread of COVID-19, which has really been to the displeasure of the Chinese government. And a fallout from this appears to be the threat of significant tariffs against our primary producers. Do you believe the Chinese threats are due to Australia stance for COVID-19 or are we guilty actually of dumping barley and even hard commodities such as aluminium into the Chinese market?
AC: I think it's probably a combination of both, but even on the COVID-19 investigation and China's disapproval or anger at that, it's not just that. You can think back to a couple of other policy decisions that the Chinese government were not happy about. The exclusion of Huawei from the 5G network. In terms of the dumping, the Chinese ministry of commerce have had a investigation into the dumping of barley since November, 2018. And it's actually due to report next week, the findings of that. So it could be that the COVID-19 investigation was the catalyst to remind people of that. But that investigation had been happening for some time.
As a interesting aside, if China do place tariffs on Australian barley, then the only legal avenue that we can go down to try and overrule that is through the appellate body at the WTO. And this is something that there was headlines last year, that because President Trump was not reinstating judges, it basically is not in operation. So the legal avenue to get around or to try and push down these tariffs is severely hampered.
POC: Economic recessions are regarded as almost necessary to cleanse an economy of weaker business and business models that have survived on, I guess, stronger economic growth. So what impact on Australia do you think the recession will have?
AC: So it's something I've been thinking about quite a lot. I mean, given all this stimulus, when you think about the typical cleanse that we have through cycles, companies with high levels of debt, or that are just not operationally efficient, do end up going bankrupt or clearing the slate. And we have more efficient companies coming through. One side effect of the stimulus could be that we actually don't see as much cleansing coming through because companies are provided lifelines to get through. We have extremely low interest rates.
It has seen a clearing of the labour market. We have seen that kind of clean out and it's still unclear how much of that, if there is a structural change there. But if you look at the US corporate debt levels, for example, they were already quite elevated. We aren't going to see much of that cleanse through. So you still have a clean runway as you come out of this, but there is still that headwind, that debt levels are very high. And I think it's similar for Australia, but it's the flip side where it's less corporate debt that's a worry and more household debt.
POC: Yeah. I think I saw an article in the Australian Financial Review over the weekend, talking about even the potential negative impact of the JobKeeper package. And is it further supporting what economists call a zombie company, effectively? Do you have any views there whether some of the monetary and fiscal response in Australia is actually working to a detriment to the cleansing of an economy in an economic downturn?
AC: In Australia, there could be a little bit of it. But I think politically and socially, it would be not a great idea to have not done what they've done. So the JobKeeper, and if there are companies that are not operationally efficient, I think that it would not be the right time to let them go bankrupt and have people unemployed.
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I mean, it could present a little bit of moral hazard as an interesting anecdote. You're seeing that in the US meat packing industry where people are not going to work because the unemployed benefit boost that they're getting with the $600 a week that the US government has instituted, has meant that they're better off not going to work and they aren't going to work. So there are some of those moral hazard questions coming up. But I think, in general, I think the governments and central authorities have made the right decision by trying as best as they can to help people get through this downturn.
POC: I think I'd fully agree with you there, Alex, given the human impact of COVID-19 and the impact on jobs and livelihoods of Australians, ultimately.
Equity markets appear to have shrugged off any concern of COVID-19. And are basically back to valuation levels, pre-crisis. From an asset allocation perspective, how's Russell positioning your portfolios. And I know many investors who withdrew from growth assets in March and early April have missed a huge upward surge in equity markets that subsequently followed.
AC: Yeah, it's been a very impressive rebound. At Russell, so when we're talking about tactical allocation, we kind of have a process around cycle evaluation and sentiment, and we really use the value and sentiment to start adding a little bit of risk through March. What we were seeing, were that there was signs that sentiment was showing clear signs of panic and was really flashing red.
And on valuation in the US, use the US as an example, we were seeing that it was just below fair value. So the US didn't get that attractive evaluation to us, but it got enough for us to start just gradually adding risk across the global portfolios.
So, we have kind of pulled back a bit of that desire to add risk, given the rebound and just that valuations now, as you know, they are kind of back to where we were in terms of valuation levels. The one thing that is really important to note for investors is that a lot of this is also coming from lower discount rates. So, we have a 10-year government bond in the US at 0.7%. What that does is that reduces your discount rate, that you value your future cash flows at and pushes your fair value up.
POC: In terms of, again, the economic impact of COVID-19, what sort of companies do Russell believe are best placed to withstand the economic slowdown?
AC: I mean, I think the most important thing, or the most obvious one is companies with strong balance sheets. The most important thing or the most obvious one is companies with strong balance sheets that can withstand a reduction in revenue to zero or to very low levels. In Australia I think companies that are tied to any recovery in China because they are ahead of us. And whilst there is some gradual signs of recovery and services, they're still going to be ahead of the Australian recovery. They're going to be ahead of the global recovery. I think that will be benefiting.
And then as I mentioned earlier, I think the real worries for Australian companies is those that are tied to tourism and education, particularly higher education, and rely on that inflow of people from overseas.
Given that borders are likely to be closed for some time outside of New Zealand, which is our second biggest tourism market, but in terms of education, it's very small.
POC: It's interesting there, but I think we're all of the view that we're not going to see global tourism pick up in the short term at all. And it could even be a couple of years before we see any return to normality in that sector there.
Have you got a view on the Australian banks given, I guess, they've been a core holding of most Australians in their equity portfolios and they've certainly enjoyed the strong dividends pay? But I guess that appears to be coming to an end with the forward earnings guidance that's starting to come out from the Australian banks.
AC: Yeah. So we saw an AB cut last week. We've seen deferments of dividends. I think, given the hit to income and the increase in loan loss reserves we are going to see a reduction in those dividends across the board for the banks. But I think importantly if you look at where the share prices are, NAB is trading at levels last in 2009.
So a lot of that stuff, a lot of the damage and a lot of the reduction in dividends, I think a lot of that is already in the price. One thing that we've been discussing here at Russell is whether there is upside to the banks as they come out of that. And whether that's something we want to be more exposed to. And it's still a discussion that we are having, that's ongoing, but I think a lot of the downside is already in the price.
POC: Yeah. Well, I guess the outlook for the banks is going to be heavily dependent on how residential property in Australia holds up. So does Russell have a view at the moment on the Aussie property market. I can appreciate you don't specifically follow the residential market, but you'd certainly have some views on the office and retail and commercial property markets.
AC: Yeah. So we don't heavily focus on residential. On the office side, I mean, you haven't seen the valuations of the unlisted companies really start to reflect the damage. And one thing that globally, we're talking about a lot. So I talk with the global rates guys quite a bit, is how much of a hit to office demand become structural, whether we do see companies start to reduce their real estate footprint.
I mean, Barclay's CEO over the last week was talking about office real estate. And noting he would be surprised if most corporates don't reduce by 50% as we come out of this. That seems quite aggressive. But I think there is an element of this structural shift in how office occupancy evolves. On the residential market, and this is more personal thoughts than a Russel view, but I think there are some pretty serious headwinds.
You think about unemployment, it's going to be elevated for some time. I mean, even the RBA who have always had a more glass half full look at the Australian economy, see the unemployment rate at above 7% by the end of next year. You're going to have slower migration because of the shutting of the borders.
And if you do see psychological change in consumer caution, and they become a bit more cautious in going out and buying large goods such as a house, that all seems to me that it's going to be pretty tough prices to keep rising from here.
POC: Yeah. Well, I guess anecdotally, I certainly picked up on comments and observations from people in the residential property game that both the Sydney and Melbourne markets have seen a significant downturn in the interest from the Chinese by there. So, to a degree, I think they have a lot of impact on pushing the prices up of residential property across both Sydney and Melbourne there.
So, yeah, it'll be interesting to see how that plays out over time. But I think I share your somewhat concerning or views on residential property. But ultimately we're not going to know, I think, until we watch it play out over the next 12 months or so.
Alex, we usually finish these podcasts with asking a guest for any personal investing tips that you might be able to share with our listeners. So have you got any words of advice perhaps of your own personal investment philosophy that you've applied since you were young? And any specific thoughts that could assist our listeners with navigating the current financial crisis and economic downturn we're experiencing?
AC: Yeah, definitely. So when I was younger, I read Warren Buffett quite religiously. The idea that you should only invest in things you understand. And then I chose to ignore that and made a couple of bad investments in [inaudible 00:32:28] that I didn't fully understand. So I think that is truly the most important thing is really understand the companies or the products that you're investing in.
I mean, as another aside for those listeners that might've followed, there's a oil ETF in the United States called USO that has had a huge amount of interest. And the investors didn't appreciate that when you buy oil futures contracts, you have to roll up and you basically have an automatic loss. And there was some really, really bad losses that were announced as a result of that. So I think that is probably my biggest takeaway is just always invest in things that you understand.
POC: Yeah, yeah. Easier said than done I guess there, Alex. And one of the reasons why in my view that most investors should be considering using a professional manager. Because it's very difficult to understand what you don't understand in terms of trying to understand quality. And we've all certainly made those mistakes of investing in opportunities that we thought we understood that subsequently we may have realised we didn't quite understand it to the length we thought we did.
So, no, I thank you. Well, Alex, thank you very much for joining us this morning. I've certainly enjoyed the discussion with you and understanding Russell's views on how you're navigating the current economic downturn to the listener. Thank you very much for joining us this morning. I hope you're safe and healthy with you and your families at home. And look forward to joining you on next week's podcast. Have a great day and all the best.