Paul O'Connor:

Good morning all and welcome to the first Netwealth Portfolio Construction Podcast for Netwealth. My name is Paul O'Connor and I'm the head of strategy and development for the investment options offered by Netwealth. Joining us for today's podcast is David Bassanese, who is the chief Economist at Betashares and based in Sydney. Good morning David and I trust 2024 has started well for you and the business.

David Bassanese:

Good morning. Great to be with you. Yeah, it's been I guess a good start to the year. The markets are looking nice at the moment. Things are looking encouraging. Looking forward to the year ahead.

Paul O'Connor:

A busy year, no doubt for all of us. Given David's role and background, today's podcast discussion will focus on a market and economic outlook for the year ahead. I hope David, you brought your crystal ball with you for all of us. David's responsible for developing economic insights and portfolio construction strategies for advisors and retail clients of Betashares. He was previously an economic columnist for the Australian Financial Review and spent several years as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank. David also held roles at the Commonwealth Treasury and OECD in Paris. Betashares is a specialist provider of ETFs with approximately $30 billion in funds under management across 83 exchange traded products as at September 23 and these cover both passive and active ETFs. Betashares Holdings was established in 2009 as a specialist provider of ETFs and is currently owned by TA Associates and the Betashares management team.

The Netwealth Superannuation and IDPS investment menus include all Betashares ETFs that cover almost all asset classes. After a disappointing 2022, 2023 was a good year for investors with equity markets generating strong double-digit returns, fixed interest providing positive returns and cash returning in excess of 4%. So, "Can these strong returns continue in 2024?" Is the main question on most investors' minds. From a global macro viewpoint, central banks seem to be winning the battle against high inflation courtesy of restrictive monetary policy settings. However, they need to be careful that they do not overshoot the mark and impact on GDP growth, pushing economies into recession. So, all eyes will be on whether central banks can navigate a soft landing and avoid a recession. Inflation certainly does appear to be moderating, which should allow some scope for the central banks to reduce rates. So, I expect both cash rates and bond yields to reduce modestly over the year, but obviously I'll be interested in the expert David's views.

The International Monetary Fund or IMF's predicting global GDP growth to be around 2.9% this year, with developed economies growing at about 1.4% and emerging economies at 4%. 2.9% still well below the 6% GDP growth enjoyed by the world in 2021 post-COVID, but if the 2.9% growth is achieved this year, this should mean that a recession is avoided in most countries. Australia's GDP growth is expected to be around 1.2%, which again is well below the 2.2% growth enjoyed in 2021, but still positive.

The AUD finished last year against the U.S. dollar at 66 cents. So I'll also be interested in understanding the thematics behind the AUD in 2024 and will commodity prices continue to generate a tailwind for the AUD? So, maybe for starters, David, you've had a varied career as an economist working for organisations such as the Commonwealth Treasury and OSCD as I mentioned earlier. So, can you provide the listeners with a few insights about how you arrived at Betashares?

David Bassanese:

I was working at the AFR. I went to give a presentation on the Australian economy to an international investment forum in the U.S. and there were a lot of investment products available, various groups offering investment products and I discovered ETFs at this conference and being index funds that you can trade on the market. When I got back to Australia, I got quite interested in the ETF market. I actually started to do some research on them. I actually tried to create a newsletter at one point on ETFs, but it was a bit very early in the day, but through that process I did meet the guys at Betashares and we agreed to sort of jump on board. So, I moved from the AFR to my current role as chief economist at Betashares. Look, I guess I like ETFs and the future that potential they had here.

A, because the passive type of investing, there was obviously a trend toward that, but also from a, you can still do active investing, it's just not at the security level, it's at the more of the asset class at the regional or the sector level, sort of more top down type of investing and as a macroeconomist, it allowed me to sort of get into investment markets and do investing without being a security analyst. But many active managers look at focus on company level detail, whereas with ETFs you do focus at the global macro picture. So, that's how I came to be part of Betashares, yeah.

Paul O'Connor:

It's been a good journey for you and good timing given how ETFs have been embraced over the last decade in Australia and I think you sum it up well there that most of the return out of a portfolio is typically generated from asset allocation and ETFs give you those building blocks to be able to express your views both efficiently and fairly quickly and at a reasonable price as well. I can certainly understand the growth of Betashares and the broader industry over that period. A good journey for you, but let's get into the real stuff now anyway, talking about the economy. So, can you provide a brief summary of where the economy stands today, including any perceived misconceptions about the current situation?

David Bassanese:

We've been going through a slowdown in growth. We were fearing a recession in Australia as we've been fearing globally on the back of very aggressive central bank interest rate increases. But I guess the economy has slowed, but it's been more resilient than the worst case fears. So, we are going through I guess like a soft patch of growth, modestly below trend growth. The unemployment rate has been drifting up very gradually, albeit it's still at a very low level. So, I think it bottomed at 3.4 early last year, it's now around 3.8, 3.9. So, a very gentle uplift in the unemployment rate. As you pointed out in the introduction, inflation, the good news is that growth has been resilient. We have not tipped into recession, but it's not come at the cost of inflation staying stubbornly high. Inflation is still high, but it's been coming down, it's been coming down more or less in line with the central bank hopes.

I think we're pretty well-placed. I think we are going through continued soft patch of growth for a while on the back of the rate rises on the back of the high inflation which have hurt real incomes, but later this year I think things will start to gradually improve. But I think the trend for inflation will continue to come down and allow central banks and our bank to start cutting rates and starting to focus on supporting growth more than worrying about the high inflation.

In terms of misconceptions, I mean the story of the past year has been that history suggests that you need a recession to get inflation down once it gets as high as it's got, particularly in countries like the United States, it's turned out that at this stage it looks as if we don't need a recession to get inflation down. The inflation that we have been going through was due to supply-demand imbalances, caused by the COVID upheaval, but that's been sorting itself out and inflation, we've one-off level adjustment in prices, which for a period of one to two years did cause high inflation, but as prices level off again and in some cases come back down again, inflation is moderating.

Paul O'Connor:

Yeah, well I guess 12 months ago the general consensus was that many developed countries, including the U.S. would have a recession this year or later this year, but seems that we are heading on that soft landing trajectory. So, take your hat off to the central banks. They've done a great job despite governments and their extreme fiscal expenditure that I tend to think the U.S. Fed Reserve and the Australian RBA have done a good job.

David Bassanese:

Yeah, no, I think that's right. I mean certainly the history will show that at this stage they've avoided the need for a recession. Not to be too critical to central banks, but I think a luck is a little bit involved here. I think central banks themselves probably thought in late '22 that their policies would cause a recession. I think the Fed themselves were at one point forecasting a recession and a candid interview Fed chair Geraint Powell basically said we think we are going to have to cause some pain in the economy to get inflation down. So, what's happened though is that the economy has been more resilient than central banks expected, but at the same time inflation has come down. So, it looks as if they've done a great job, but I think it's a little bit lucky in that it turns out they didn't need to cause the recession that they were going to cause, a win's a win and we go forward.

Paul O'Connor:

So, how does today compare with past inflationary environments?

David Bassanese:

Again, the example we economists like myself have been looking at and central banks have been referring to it. If you go back to the 1970s when inflation was running 8, 9% and we had two really big bouts of inflation through the early '70s and late '70s essentially at the time driven by oil price shocks, but inflation stayed high and it got embedded into the economy through a lift in inflation expectations. And the fear of central banks was that we don't want to repeat the mistakes in the 1970s where we let inflation become entrenched. I think that the big difference between now and then, well there's a few key differences, but firstly the inflationary shocks of the '70s were what economists call negative supply shocks. When oil prices jack up to the extent they did, it hurts demand, because real incomes get hurt, but it also pushes up inflation.

You get a period of rising unemployment and rising inflation, whereas the shock that we've had post-COVID was actually essentially a positive demand shock. So, inflation did go up, but unemployment went down not up, so that's the big difference in the '70s. So, in a way the economy has been more resilient to the inflation, because we didn't have the negative consequences of the oil price going up. So, it's been a different type of shock and that's hence why economies have been more resilient. And the other factor is that competition is stronger, worker bargaining power is not what it was in the '70s and so the increase inflation we got hasn't become as entrenched in the way that it did become in the '70s.

And also inflation credibility, central banks would argue that inflation expectations are better anchored these days and so people seriously didn't think, they were more prepared to believe that the inflation that we got would be temporary and as a result it didn't get factored into wage and price spiral. So, those are two key differences. The nature of the shock and the fact that the economy has been better able to avoid inflation becoming entrenched would be how I would characterise things.

Paul O'Connor:

Interesting there David. And I guess in my mind as you were talking then I'm thinking, "Well, that really explains why stagflation has been avoided." Where there was even a little bit of talk of that potentially probably 12 months ago. Given the fact that inflation has been more demand-driven over the last couple of years, courtesy of COVID. What are your expectations for interest rates and inflation over the course of 2024 and into even 2025?

David Bassanese:

I think central banks are done in terms of raising interest rates. Now the debate is when will they cut interest rates and how deeply will they cut interest rates? So, I do anticipate the Fed in the U.S. The markets at the moment are pricing in the Fed cutting rates by 1.2, almost five rate cuts expected in the U.S. I don't think they'll cut rates that much simply because I think the economy itself will hold up better than... I think you need a weaker economy to justify rate cuts to that extent. But that still means that bond yields can fall, because the markets will still be pricing in further rate cuts in '25, even if the Fed only cuts rates by three times this year, but the markets price in more rate cuts for '25, bond yields can still fall.

I've got the RBA also cutting rates by around about 50, maybe even 75 points as well and so bond yields here falling. The bonds had a terrible '22, they had an okay-ish '23 and I think '24 will be a better year for fixed income returns as bond yields continue to decline. Importantly behind that of course is that inflation will continue to trend lower. So, I've got inflation in Australia actually getting into the RBA target band just under 3% by year-end, basically a year earlier than the RBA currently is forecasting and inflation in the U.S. continuing to trend down as well. And really what we'll see I think is the moderation of inflation in the goods sector increasingly flow through into the services sector.

Paul O'Connor:

What's your outlook for the Australian dollar and Australian equity markets?

David Bassanese:

The driver of the Aussie dollar globally is the trend in the U.S. dollar. The broad trend in the U.S. dollar is the main factor there, and the Fed aggressively raised rates more aggressively than other central banks when they were going up and I think now they'll be able to cut rates more aggressively on the way down. That will be a negative for the U.S. dollar, but also just the risk. The U.S. dollar to some extent is also treated as a safe haven type asset and I think as risk of recession continues to moderate, investors become more confident in terms of the outlook, then, that the safe haven bid for the U.S. dollar will also ease. And the combination of those things will help push up the Aussie dollar. It's seen as a global growth type of currency and so when people become optimistic about the global economy tends to be supportive of the Aussie.

So, I actually think it can break up to mid-70s by year-end and possibly even 80 cents by mid-25 at the moment. So, I think the trend for the Aussies should be up. Our share market, look, it's not that expensive. I mean it's trading at a reasonable price to earnings ratio at the market, even with bond yields where they are. So, bond yields fall that should support valuations at least staying where they are maybe going a bit higher and meanwhile we've got corporate earnings which have been soft over the past year due to weak consumer spending and also a pullback in commodity prices will start to recover. And so the earnings outlook for '24 and '25 are more optimistic. And as we start to focus on those earnings, the measure of earnings, it's a concept called forward earnings, will start to rise after having fallen over the past year.

So, I see earnings recovering and I see valuations at least staying where they are, maybe going a bit higher. So, the overall outlook I think is also quite encouraging for the equity market. Whether it outperforms global markets is a more nuanced question, because we've got globally the big tech companies are so dominant and they're continuing to do relatively well compared to everything else. And if that remains the case, it may be our market does well, but maybe not as well as the U.S. market for example. But it will depend on the course of the big tech companies.

Paul O'Connor:

A fairly positive, then, outlook, which I think I'd concur with you there, David, for the year ahead, ignoring any geopolitical risks or what have you, but we won't get into that at the moment anyway.

Paul O'Connor:

Can you explain what you consider to be the most likely scenario for the economy and markets over 2024?

David Bassanese:

I mean, I think the scenario here is continued moderate growth. Below trend is growth for the first half of the year, consumer spending still remaining under pressure. So, really in the economy at the moment, growth is soft, but it's really driven by consumers, because real incomes for households has been quite weak. Elsewhere, business investment has been good, public infrastructure spending is roaring ahead, exports are recovering on the back of the reopening of the Chinese economy and the continued good growth in the U.S. economy. So, there are mixed forces, but overall moderate growth, but the downward pressure on consumer spending easing by the second half of the year, so growth starting to recover. Again, as I was saying earlier, I think it's a good outlook for both bonds and equity markets this year. With inflation moderating central banks are able to cut interest rates and growth starting to recover certainly by the second half of the year.

Paul O'Connor:

What would lead to this outcome, this outlook that you have?

David Bassanese:

A critical in all of this is continued moderation and inflation. If we don't get inflation continuing to come down back toward the central bank target zone, then central banks will not only not be able to cut rates, they'll probably raise rates more. So, the central banks have basically said, "We are not going to repeat the mistakes the 1970s." So, if it takes a recession to get inflation down because we don't want to allow inflation to become entrenched, then we will create a recession if that's what it takes. But looking as if that's not what it takes, we don't need a recession. So, as a result, central banks won't engineer one. And why will inflation moderate without a recession? Because we are seeing demand at the margin moderate a bit. Some of that reopening demand for goods and then services is moderated, taking pressure off inflation, but also supply chains being Asian factories being able to reopen and start providing the goods that people wanted, moderated inflation, the goods sector.

And we've had labour supply recover, labour force participation recover, immigration rates recover. So, the excess demand for workers that led to higher wages and higher services inflation also moderating as well. So, they are the underlying forces here, bringing back inflation and provided that remains the case, then the outlook will remain encouraging.

Paul O'Connor:

What is the key data points you watch to give you a bit of a guide, a signal as to how the economy is performing?

David Bassanese:

First and foremost, I mean it's a bit of a lagging indicator, but it's the absolute critical number will be the inflation numbers. So, in the U.S. the inflation numbers are continuing to come down in a nice way. We only recently got more evidence of continued disinflation in the U.S. We get the CPI that comes out regularly in Australia will be critical. We need to see continued declines in annual inflation in the CPI, but then we got to look at the labour market. Is wages growth moderating or is it remaining at very high levels? Because that's going to underpin service sector inflation, but we are seeing wage growth moderate in both the U.S. and Australia with at this stage only a very gentle increase in the unemployment rate and it's ticked up a little bit in both the U.S. and Australia, but it's been enough to keep a lid on wages.

The course of consumer spending in terms of recessionary risk, we've been worried that consumers would really clamp down on spending, but it has slowed, but it hasn't really fallen in a hole. We want to see that continue, so these are the things, it's inflation, it's the labour market and wages growth and it's the resilience of consumer spending I think are the key drivers of the outlook for this year.

Paul O'Connor:

You've articulated your thoughts on the outlook for the economy, so what are the investment implications attached to your outlook?

David Bassanese:

At the moment, it's a good outlook for both fixed income markets and for equity markets. So, being invested, certainly it's not a time for being defensive and hunkering down too much. I think the fears that we had over '22 and to an extent '23 are sort of dissipating, put your cash to work. I think the outlook is looking well in that regard. The other issue then is if you look at the global equity market, there is really a divide, as I said earlier, between the Magnificent Seven as it's been called now, the big tech companies of the U.S, the Googles, the Amazons, the Facebooks, those versus everything else. They have been doing very well.

They're looking relatively expensive compared to other parts of the global equity market. And the question is will they continue to outperform or will there be a catch-up by things like small caps, emerging markets, Europe, even Australia to an extent? Will the relatively cheaper valuations in those areas cause investors to move into that area? I don't have a strong conviction at the moment on that, because on the one hand the Magnificent Seven look relatively expensive, but they've looked relatively expensive for a while, but their businesses are just so strong it's hard to see a catalyst for a rotation out of that at the moment.

Paul O'Connor:

They've looked relatively expensive I think for the last couple of decades almost now, David. But to the points you've made, the earnings growth, really growth does catch up at times. So yeah, it can appreciate. So, what are the key risks to your outlook? What are the sort of issues at the back of the mind? I mentioned geopolitical earlier.

David Bassanese:

Obviously you've got tensions in the Middle East, more than tensions, you've got war in Europe. The great fear had been that the Russia-Ukraine conflict would cause a disruption to energy supply and to some extent that did happen in Europe, but Russia was still able to sell its oil to other countries. And so that didn't cause a big sustained increase in oil prices, but that is a risk and if there's any disruption there or a disruption to Iranian oil supply as well in the Middle East. That's ultimately what markets care about in the Middle East, is that will there be any disruption to supply from Iran? But just on that, but countering that is that non-OPEC oil supply, particularly in the United States has been very strong. So, there is a risk on the energy front. There is actually even a risk that oil prices fall a lot this year rather than go up a lot.

If OPEC give up trying to restrain production and actually flood the markets with oil again and try to wash out the shale oil producers in the United States, which at the moment are doing very well. So, that's one risk just on the energy sector and geopolitical. The other one, you've got a lot of elections this year, particularly the U.S. election under Donald Trump. I think markets are more comfortable with Donald Trump in the sense that he is pro-business and he likes to keep taxes low. The one concern is that he doesn't seem to care about the budget deficit, nobody in the U.S. cares about the budget deficit anymore.

Paul O'Connor:

No, no. It's a forgotten thing now, isn't it?

David Bassanese:

It's just a question at one point, will the bond vigilantes, will there be a sell-off in the bond market due to fears of the U.S. budget deficit? Now, it's not happened yet, but that's another risk that if bond yields went up because of that, even with inflation coming down at central banks' cutting rates, then that could be a negative for obviously the economy and for equity markets, so that's another risk. On the other side of course, is that would there be a sudden more substantial slowing in consumer spending due to the lagged impact of the policy tightening we've seen today. So, that's a negative on the real economy side of things, but again, I think we haven't seen that yet, and I think with central banks moving to cut interest rates, I don't see that as a huge risk on the downside.

Paul O'Connor:

It's going to be an interesting year ahead. I think I saw the statistics, 60 countries have got elections this year and it covers almost half the world's population. We could see a little bit going on politically, globally there, but no, I can certainly appreciate your comments around energy and geopolitical, but let's hope things continue to moderate and particularly in the Middle East, things start to settle. Distilling all your thoughts, you're sitting there running a diversified portfolio, how are you thinking about asset allocation then? What would you think more about your underweights and your overweights and I guess a couple of comments I've picked up already would be potentially a hedged international equities exposure if the A dollar starts to drift up. But chair, how would you be thinking about tactically managing a portfolio?

David Bassanese:

Again, at a very high level, I think at the moment you want to be at least at sort of benchmark weight if you like, to the equity market. So, we're not underweight equity. So, at the moment we're not overweight equities either. We'd rather go overweight if we got a pullback in the markets for some reason. Where we are overweight is in fixed rate bonds relative to say cash, because we do see bond yields declining this year. So, from a very broad asset allocation point of view, we are fully invested in the equity market, overweight bonds are relative to cash. As you point out with the Aussie dollar potentially rising here, hedged global equities will do better than unhedged global equities. So, you maybe want to think about hedging some of your exposures. In terms of equities, do you stay in things like NASDAQ for example, we have the NASDAQ ETF that's been doing so well for so long, but there's some value exposures out there.

Japanese equities, we like. Japanese people about the Japan, they think about a sluggish economy, but corporate earnings in Japan have been doing very well and that's seeing the Japanese market, one of the few areas of global markets outside big tech in the U.S. has actually been outperforming, but we think that can continue. So, it's really that question of what are the areas that could do... Well, maybe small caps as well, because they really underperformed last year, but as people take on more risks this year, they may look to go into the small cap area as well.

Paul O'Connor:

Any thought around emerging markets, given they've been a real laggard compared to developed markets over the last couple of years?

David Bassanese:

The big, I guess, challenge in emerging markets has been China now is a big weight in emerging markets and I think pessimism around China is probably reaching probably extreme levels at the moment. The market has underperformed for a while. It's looking very cheap. China has disappointed some investors by not launching a big stimulus package this year. There's a lot of concerns around the property sector still, but the economy itself has been ticking over still quite nicely. It's still running 5% over the course of last year, certainly not growing at double digits anymore, but structurally Chinese growth is slowing down anyway. I mean, I think China may well turn around this year just due to the degree of pessimism that's already priced into that market. And if things settle down on the property sector, people may gravitate back into China.

India is also... The economy is doing well, the share market runs hot and cold and that's been an area that's been doing very well as well. So, I certainly like Indian economy and hence the share market as well. Emerging markets are certainly cheap relative to, again, within global markets, but as that point I was saying, everything looks cheap relative to the U.S. tech companies at the moment. We're just waiting for a catalyst to drive the turnaround.

Paul O'Connor:

I guess an interesting trade, but I've noted more and more diversified strategies are taking an exposure to India over China. So yeah, it sort of sits with me your comment there that is negativity towards China, putting capital into China, getting close to peak at the moment, but I guess it'll play out over the next 12 months how the China's economy performs, the property market unwinds and where the capital starts to flow back in.

David Bassanese:

Yes.

Paul O'Connor:

Any other themes, factors or strategies you think tactically could be well-placed?

David Bassanese:

Yeah, I mean one area that's been doing well from a factor, if you look at investing from a factor point of view, global quality is a factor alongside growth and value and small caps. So, quality has been doing very well for a while. And so what is quality? These are companies with typically above average return on equity without too much debt. That's what a lot of active managers screen for. But you can run a quantitative screen across companies and just pick the top companies with high return on equity and they're then defined as quality companies. We have an ETF, for example, that does do exactly that, and it's a global quality ETF, it's been outperforming. That's an area that will continue to do relatively well. I mean it stands to reason companies with above average return on equity tend to generate above average earnings growth. And companies with above average earnings growth will tend to do relatively better than other companies.

So, that's one we like at the factor level. As I said regionally, the Japanese market certainly has been doing relatively well and I think continue to do well. And I think that some of the tactical tilts within the global equity market, and of course if people still love the big tech companies, you've got the NASDAQ still charging ahead, easy exposure to that now through an ETF as well.

Paul O'Connor:

David, I think it's drawing to a close now the podcast. So, I'd just firstly like to thank you very much for joining us today on the Netwealth Portfolio Construction Podcast. Certainly your comments, insights I've found very interesting and certainly then the implications for investment and a diversified portfolio over the year ahead. I'd just like to thank you very much for your time and your input this morning.

David Bassanese:

No worries. Great to be with you. Best to everyone for the year ahead.

Paul O'Connor:

Yes, yes, you echo my sentiment there. I just wanted to thank the listeners again for joining us on the podcast series. I'm sure you got a lot of value out of today's comments there and how you can think about how it would reflect on your own portfolio, and I wish you all the best for a safe, successful, and prosperous 2024. Thanks all for joining us.