In this episode, David Bassanese, Chief Economist at BetaShares joins us to discuss the potential impact of the US election on global markets, how China's trade restrictions might impact the Australian economy, the opportunities for investors in value investing and an outlook for Australian equities.

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Transcript

Paul O'Connor (POC): Welcome to the Netwealth Investment Podcast series. My name is Paul O'Connor and I'm the head of investment management and research. Today, we have David Bassanese from BetaShares, who is BetaShares' chief economist. BetaShares is a specialist provider of ETFs with approximately 13 billion in funds under management across 65 exchange-traded products as of August this year. This includes both active and passive ETFs. With over 60 products available, BetaShares offer the broadest range of exchange-traded products in the market, and all are listed on the ASX. The ETF's cover Australian and global equities, cash and fixed income, currencies, commodities, and active and alternative strategies. BetaShares is owned and managed by the Australian management team along with the strategic shareholding from Mirae Asset Global Investment Group, who was one of Asia's largest asset management businesses.

David is responsible for developing economic insights and portfolio construction strategies for advisors and retail clients. Prior to BetaShares, David was an economic columnist for the Australian Financial Review for over a decade. Prior to the IFR, David spent several years in financial markets as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank. He started his career as a commonwealth treasury official. After which, he spent three years as a research economist at the organisation for economic cooperation and development in Paris.

He graduated with a first class honours from the University of Adelaide and a master in public policy from the JF Kennedy School of Government at Harvard University. Given David's extensive educational and I guess, work background, I thought we'd focus today's podcast on the global and Australian economies and the implications for markets. Good morning, David, and thank you for joining us on the podcast today.

David Bassanese (DB): Great to be with you, Paul.

POC: In 2020, we've seen the largest economic slowdown, since the depression due to COVID-19, which has resulted in extraordinary monetary and fiscal policy responses. So I'll certainly be interested in hearing David's view on these policies. However, whilst markets sold off heavily in Q1 2020 as expected, they staged a remarkable recovery in Q2, which really is at odds, given the severe economic turndown. So, many in the market question where the equities valuations can be sustained. So to start with David, how have you coped with the changing nature of the workplace over the last six months? I assume you spent a fair bit of time working from home.

DB: Yes, yes. Like many. I mean, we did go through a period where our office was basically completely remote. We're working from home for several months, but I mean with the power of technology these days, using things like Zoom and all the various video conferencing facilities, we actually managed to... You know. We're in a fortunate position where the nature of our business wasn't severely disrupted. So we're still able to conduct meetings and talk to clients and not travel around the country as we typically might do. And so that was one change, but yeah, it was good seeing a bit more of the wife and kids than what I would otherwise need, but yeah, so we managed it okay.

POC: Yeah. It's interesting, I guess, the way we as humans have embraced a lot of the technology that's been available to us, but I guess we haven't been using it to the degree that COVID has enforced that changing behaviour, and particularly in the workplace there. Moving on to the questions today, the main focus of markets in recent weeks has been the US election. Can you provide some insights perhaps into the market behaviour before and after the election, noting that markets seem to shrug off any concerns about a constitutional challenge to the vote counting by president Trump and the Republicans?

DB: Yeah, well, I think going into the election, the biggest risk for the markets was what we are actually seeing you would think was this idea of a contested election whereby it will be a close result, and there'd be a lot of court challenges over the postal votes. Now it turns out we are getting those. I mean, Donald Trump is talking about having court cases, but the markets, I think, are looking through that and seeing that in all likelihood, these court cases aren't going to be sustained. I think the markets have decided that Biden is likely to be the winner. And that's a bit different from, again, if you go back 20 odd years ago, where we did have this in 2000, Bush versus Gore, and it was important.

At that time, it was really one state that was in question, Florida, and the vote was really, really close, a lot closer than it is today. Whereas this time around, Biden has won in a number of states. And so the court cases would need to succeed across a number of states. So the probability of that is quite low. That's the key difference that the markets are convinced that we have had a decisive win by Biden, and we won't have this lingering uncertainty for several months. And also then they've been able to focus on the reality that whoever won the election was going to provide another dose of fiscal stimulus. And so the markets, I think, is starting to focus on the idea of a fiscal stimulus package at least by the new year.

POC: Yeah, it certainly was interesting over the last few days, the fact that I guess the US news networks had made the decision that Trump didn't have a lot of strength in his court challenge case there, and basically declared Biden as the next president. So it was certainly has been a very interesting week. Is a Democrat win with Biden as president elect a positive or a negative for markets? What are the risks on the sector level, and what opportunities do you see assuming Biden has won?

Look, I guess it's mixed for markets. I would say on balance, it's a positive, I mean, the negatives of the Biden win for the markets are that the Democrats are talking about increasing corporate taxes, greater regulatory scrutiny of some parts of the markets, such as big tech, for example. And so they are the negatives, but the positives are the fact that he's likely to be a lot more... You know, you're going to get less erratic behaviour as we've got from Trump. So the international relations may be somewhat more settled. What we're also seeing is that it's also important to know who wins the Senate. So at the moment, there are more runoffs to go in Georgia and depending on how they go, there's a chance that the Democrats get control of the Senate.

But again, most pollsters are suggesting that's unlikely. So what we may well find is that to the extent that Democrats under Biden did want to increase corporate taxes or increase regulation, they're probably going to be checked by the Republicans in the Senate. So we'll get back to what we used to talk about, gridlock in Washington, where not a lot of what they want to get done can't... Well, they can get some things done, but it'd be heavily compromised. So in a way that's probably a net positive for the markets in that you've got a more less erratic president, but one that's still going to be fairly moderate in terms of policy impacting on the market. So it's actually probably a fairly good scenario from a market point of view.

POC: So if the Republicans do hold the Senate, does that mean the Democrats won't be able to get any of their key policies through such as the increased taxes you've just mentioned?

DB: Look, I think that's right. Again, one of the issues in the US political system is that every member of the Senate and the lower house is subject to primaries, and so the risk is that... Basically other people competing for their job come the next election. So the risk is that if you compromise with the Democrats, that you could open yourself up to a challenge from a more right-wing person come the next election or the next primaries. And so that's going to check the ability of the Republicans to compromise. So again, Biden is talking about a lot of compromise, but my concern is that you may find on the Republican side at least that they will be very, very reluctant to compromise because Donald Trump may well be a force after the election.

DB: We can't rule out him actually running again at the next presidential election, heaven forbid, but that may well check their... Again, just going back to what I said, the risk of even more extreme right-wing Republican Party members challenging you in the next primary will temper the ability of them to compromise in the Senate.

POC: Yeah. It's interesting. There appears to be a fair bit of pressure mounting on the Republicans in what they will stand for going forward, and whether they will be more of the Trumpism type of policies we've seen over the last four years, or whether they will just change tact a bit. But I guess that remains to be seen and something for the party that it will need to work out.

Turning our attention to Australia, the RBA reduced the cash rate to 10 BPS on Melbourne Cup Day, last week, and also announced direct quantitative easing through a hundred billion dollar bond buying programme over the next six months. Is more monetary easing likely or in fact necessary in your view? Do you think the government will announce any sort of significant fiscal stimulus policy to further support the accommodated monetary policy?

DB: Look, I don't think more stimulus either from a fiscal policy or monetary policy at the moment is needed. I mean, the economy broadly is recovering now. We are in recovery mode. I mean, Australia has handled coronavirus better than most Western democracies. I mean, we've been able to... you know. The case count in most states is very, very low. Melbourne was a special case, but they had some problems in their tracing system and whatnot there, but now they've seem to have got on top of the problem. So for first and foremost, the key thing for the economy was controlling COVID rather than the stimulus. And given without being able to do that, I don't think we do need a lot more at this point, but if we did, I mean, it definitely would be forthcoming.

What we're seeing is that inflation and interest rates around the world are very, very low for largely structural reasons, globalisation technology, and that's giving central banks and governments almost a blank check to provide stimulus because they're not... You know, the cost of raising funds is quite low, and central banks can provide a lot of stimulus also because inflation is not proving to be a problem. So bottom line, I don't think anything is needed now, but if the economy were to falter, I don't think either the central bank or the government would hesitate in providing more stimulus.

POC: Yeah, no, I think potentially there is more potential for fiscal stimulus, but I think you're right, but given that it also appears a gen ed pay increase solidly in the September quarter, they'll probably hold off on announcing any further stimulus. So do you actually think Australia is no longer in recession at the moment?

DB: I actually think we are out of risk. I mean, when you think about recession, I mean, there's two aspects to it. One is the contraction period of the economy. So, if you think of the economy as operating at say full potential, like it's at full unemployment, let's say, then you get a shock to the system where the economy starts contracting. Therefore, unemployment goes up higher than would otherwise be, but then you get a point where it stops contracting, but you're still left with a situation where the economy is operating below its full employment level. Australia is at that point, we actually have stopped contracting as the economy. In fact, growth is starting to recover. I mean, as you put it out, the September quarter numbers are likely to show a nice bounce back in economic growth. So if you define recession as a period of contraction in the economy, that's clearly over. That's clearly over.

If you define it as a high level of unemployment or higher than we would like, then it's not over. I think in terms of the strict definition of recession, it's the contractionary period that is more relevant. I think in that sense, yes, we are out of recession, and that's quite different. Again, if you go back to recessions historically, they typically take a year or so to play out. So the period of contraction in the economy can take up to a year or so to play out. Whereas this time, given the nature of the shock to the economy was basically economic lockdowns to limit the spread of COVID, it was really a short, sharp period of contraction that went for only a couple of months. And as soon as those restrictions started to be lifted, we've been able to start to recover. So it's been quite different in terms of recession compared to what we've seen in the past.

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In this episode, Rhett Kessler, Fund Manager of Pengana's Australian Equities Fund joins us to discuss the recent performance of Australian equities, provide a macro update on the Australian economy, share his key takeaways from reporting season, and share where investors might look for stock opportunities in the current environment.

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POC: Yeah, it certainly has been. I guess, back to the earlier comment, the way that the market's certainly bounced, even during the times of the economic downturn there, it's been quite an incredible period there. So if we're out of recession, when do you believe that interest rates could potentially rise? Do you think this will be driven by rising inflation? And certainly we haven't seen inflation of any significant nature across the developed world for probably a decade plus now.

DB: Yeah. Well, again, that's a very interesting question now, because again, when interest rates rise, that gets back to the idea that yes, the contraction period of the economy is over, but we're still left with an unemployment rate higher than we would like. That means that any pressure, upward pressure on wages and inflation is not likely for a long time. So we've got the reserve bank basically saying we're not going to raise rates until we see inflation. Not only just expecting inflation arise, but actually see inflation within their two to 3% band. And so the RBA at the moment is saying they don't see a case based on their forecast to raise rates for up to three years. So it could be quite a long time before the RBA does raise rates.

We're seeing that also around the world. I mean, other central banks had said the same thing. So in a way, central banks they're in almost this race to the bottom where we can't raise our rates too much if other central banks aren't because if we did, it would cause the Aussie dollar to go up more than we would like, which hurts our export potential. So all central banks are sort of looking at each other, not wanting to be the one to raise rates and face a stronger currency that they would like. That's a quite a different situation. And again, historically, the banks would be a lot quicker in raising interest rates. If you thought the economy had bottomed and it is starting to recover, would you say, well, interest rates this low are not sustainable, we should gradually start lifting them back up to normal. But there's been a major change in central bank thinking on that front.

In fact, what I fear is that it won't be inflation that causes the banks to lift rates. It may will be a potential asset bubble like equity prices going up too far, too fast over the next few years given basically zero interest rates around the world, which could force the central banks' hand that they actually have to pay greater heed to asset price concerns than inflation concerns. But certainly no sign of that at the moment.

POC: No, that's for sure. As I say, despite the fact we've seen extraordinary loose monetary policy across the developed world, we just haven't been able to see inflation anywhere. I guess it's probably a question for another podcast there, David, to talk about why those the basis of that is. But yeah, it's certainly an interesting conundrum that the central bankers around the world currently have.

What's the outlook, or what's your outlook for the Australian economy? I guess I'm specifically interested in your thoughts on the risks around China. And particularly again, in the last week, we've seen China appears to have a policy to just slowly broaden the bans on Australian imports. So where do you think this will end?

DB: Yeah. Look, the issues with China are certainly worrying. You can't dismiss that they could get tougher in terms of our trade situation. But look, I think the government seems to be calling... In a way, the government is trying to call China's bluff. Like, will China continue to tighten up, tighten the screws, so to speak and impose more restrictions or more exports from Australia. But look, ultimately, I think ultimately at the end of the day, we've got to remember China is a member of the World Trade Organisation, and a lot of its prosperity in the past two decades has been because it's been able to trade with relatively low barriers to trade around the world because of its membership with the WTO.

Membership with the WTO means you can't unilaterally impose restrictions on country's exports, simply because you don't like what they're saying in the media and those sorts of issues. So ultimately, I think China will be checked. It will know it can't go too far down that path because it will open itself up to being challenged in the WTO and face harsher restrictions, not only from Australia, but even the US and Europe and lose favour globally. So I think that's going to check China.

I think what it's trying to do in the short run is basically see if our government will buckle to some extent and rein in some of the rhetoric. But I think we're calling their bluff, and not without getting too political, I think it's the right way to go because China ultimately can't just willy-nilly impose restrictions because it is supposedly a member of a free trading organisation.

POC: Yeah. I tend to think that particularly our views on the South China Sea have impacted and very much hit at the heart of the Chinese and the rulers in China there. What about the broader Australian economy moving off China? What's your thinking there around potential growth opportunities in the economy?

DB: Yeah, well, obviously for the moment, things like international tourism, international education are off the table, so that what was always a decent source of growth for our economy is not there for the moment. But at the same token, I mean, it is true that we're losing international tourism, but a lot of Australians will be forced to holiday at home as well. So the net tourism may actually still be a reasonable contributor to growth, but it will be more domestic tourism offsetting the loss of international tourism. Meanwhile, you've got the housing sector won't benefit from the immigration because that's been cut over the next couple of years. So that's again, a bit of a handicap. I don't see our economy surging ahead, booming ahead, but areas that can do well will be, I think, consumer spending.

Households are certainly cashed up. They've had a lot of stimulus thrown their way and the savings rate amongst households is quite high. As, again, social distancing restrictions are eased and our borders hopefully, internal borders are lowered, we'll see a lot more consumer spending, a lot more internal tourism. Areas of business investment, you look at that and you think, well, that's going to be pretty subdued given the international outlook for the moment. And then you've got as government stimulus through infrastructure, which is great, but it does take a while to come through certainly new projects. So all up, it's a pretty mixed picture. Ultimately, I mean, what we're hoping for is a vaccine will be developed, one or several vaccines, in 2021 such that the global economy more broadly can start to recover and we can participate in that.

It's a mixed picture for the economy to be honest, but we're starting from a position where households are cashed up. We have a lot of spare capacity that we can use. In the sense of the unemployment rate in Australia these days, it's probably around 9%, and we can get as low as say three or 4% before we would ever need to worry about wage inflation picking up. So that's a lot of runway for growth that we can rely on if we can get the drivers going.

POC: Yeah. Well, I mean, certainly on the COVID vaccine, there appeared to be some positive news from Pfizer overnight that the Americans have accepted this. So yeah, hopefully by next year, we can have some clarity on a vaccine for COVID and some sort of return to normality of the global economy.

We've seen a lot of commentary on the underperformance of value investing compared to growth investing over the last 10 years or so. And with a quantitative easing, the incredibly low cash rates or even potentially productivity gains through the IT revolution have driven growth stocks valuations. Do you believe we will ever see the return of value investing outperforming growth investing? I guess I must admit, I recall as a young guy, when I started in the industry, I remember people saying, "Oh, growth investing, I think had underperformed for about eight or nine years value," and there was a debate about why anyone wouldn't need a growth stall manager. So I feel like it's the same debate now. What's your views on whether the value investing can outperform growth?

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DB: Look, the way I think about the va- I mean, basically, why does value deliver? Let's go back to ba- Basically value delivers because we think that... And what is value? Value is basically companies trading at a below average P/E ratio, below the market average. We basically think of this over time because typically the markets oversell companies, so they're unfairly sold down. So typically, they are cheap and so cheap stocks will tend to outperform. That's the case for value. The problem that we've seen in the past decade or so is that stocks can also be cheap for a reason. So when you get major structural changes in the economy, such that companies lose market share, particularly the big, the technology sector as you've mentioned, then those P/E ratios are actually starting to indicate a change in fundamentals. I think that's what we're seeing at the moment.

The traditional companies, which are looking cheap, basically are facing relatively weak earnings going forward because of these structural changes. Another way to think about the value versus growth is that typically, value companies are things like energy and financials. And both of those from a macro point of view are constrained because the financial sector globally is constrained by very low bond yields as you point out. So that tends to reduce their net interest margins, because they have a swathe of deposits that don't earn interest. So when interest rates decline, the ability to borrow, or sorry, the ability to lend... You know, all their lending rates lower relative to their deposit rates. So, that squeezes their margins.

Then the energy sector, of course, is facing both structural changes with the move away from fossil fuels. Plus the reality that the oil sector is pretty well supplied, and OPEC would like to produce more if they can. So with the US shale oil producers. So even as demand recovers, I think you'll find all prices pretty well constrained. If you look at the typical value parts of the market, they face a lot of headwinds. Meanwhile, the major growth part of the market is obviously technology and not just... When people talk of technology, they talk of the FANG stocks, the Google, the Amazons and Facebooks of America, but it's true across the board.

Globally, anything with a tech flavour is doing well because of the structural changes in the economy. That's robotics, artificial intelligence, cybersecurity, the Asian technology companies doing core. And even in Australia, if you look at the tech sector within Australia, albeit it's a very small part of our market, is handily outperforming most of the rest of the economy at the moment, or rest of the market. So I still tend to favour the growth over value, and in large part, because it does, I think, reflect an ongoing structural change that's going on in the economy.

POC: Yeah. I think a very pertinent point you made there, David, around it, sometimes a company is cheap for a rational reason and not the fact that the market has oversold it. I'm with you. I think that given some of the structural changes going on in the economy, that some of the older business models, as you mentioned, energy, for example, are certainly coming under pressure, and their earnings are increasingly coming under pressure as a result. Traditional higher dividend paying stocks on the ASX have been... well, appear to have been particularly impacted by the economic downturn and have naturally reduced their dividends as a result. Some have also experienced falls in their share prices.

POC: Where do you think income-seeking investors can find a reliable yield going forward and noting that the cash rate at 10 BPS isn't going to offer you anything either. So it does feel like investors are being cornered to a degree to continue to pile into equities, but where do you think you can find a reliable yield?

DB: Yeah, look, that's a great question. People are sort of searching for yield everywhere at the moment. Look, let me break it down. I mean, in terms of the equity market, I mean, the areas with... The two key typical income areas are financials. Obviously, the banking sector and areas like listed property infrastructure that offer a relatively, typically a relatively cyclically insensitive income stream, because you're talking about toll roads and airports and these sort of things.

Now, the banking sector, I think is basically X growth now. So our banking sector is going to continue to produce relatively reliable income streams. I mean, the banks are an oligopoly. They're a big part of them. They have a huge market share and I think a pretty strong defendable market share. So, I think you're going to see banks continue to punch at reasonable dividends over time, but they won't give you much growth because they already dominate our market and they can't grow internationally easily, and other sources of growth are being constrained.

The infrastructure area, that was really heavily hurt this year because of the economic lockdowns. I think that's maybe a value opportunity for the market as we come out of COVID and people start flying again, start driving their cars. And so the infrastructure parts of the market, to the extent they were hit by COVID, I think they offer both income and a value opportunity heading into 2021. Now outside of equities, I mean, things like... You know, you don't have to rely on cash. I mean, obviously you can buy longer duration bonds. And again, just a quick little plug there with ETFs, as you mentioned, the beauty of ETFs now is you can invest in bonds and even hybrids are using an exchange-traded fund. So you can buy fixed income bonds and hybrids on the ASX. Before the advent of ETFs, that was a lot harder.

So they do offer you a decent income pickup over cash without the equity risks. So, bonds typically are much less volatile in terms of their price return, and so are hybrids to a degree relative to the equity market. So, depending on your risk preference, things like longer duration, longer term government or corporate bonds hybrids, and then obviously the banks and the infrastructure stocks in terms of the equity market.

POC: Finally, David, Australian equities have underperformed global equities over the last five years or even considerably longer now. Do you think this trend will change any time soon, or ultimately, should we hold a significant overweight to global equities in our portfolios? I have noted that more and more diversified managers are over-weighting global equities over the last two, three years. So, yeah. Do you think Aussie equities can ever bounce back to that golden period where we had probably 20 years of being one of the best performing markets in the world?

Yeah. Look, I think it's unlikely in the short run, and again, it goes back to this sector story that I was mentioning before. I mean, a way to look at relative country performance these days is to look at what sectors are the local markets most exposed to, and if those sectors globally aren't likely to do well, then your market isn't likely to do well. Australia had a period of outperformance for two reasons. (a) We had a major leveraging up of the consumer sector. So in household debt basically tripling relative to household income, which really underpinned the banking sector for a long time. Also, we had a commodity boom, of course. When China entered the WTO a couple of decades ago, we had a rising commodity prices for a long time.

But over the last few years, certainly since the GFC, we've seen the tech sector globally, as I've mentioned, continue to basically dominate and had major structural changes favouring technology. And Australia, again, we have a great technology sector, but it's a pretty small part of our market. So that's what's really been either growth in the tech sector globally, plus the basically trend decline in commodity prices since around 2013 and the relative underperformance of resources and financials has been why our market has tended to underperform. In terms of the trends, I mean, again, I still like technologies are thematic globally. I think our banks are going to struggle in terms of outperformance. So, in terms of growth from a relative country perspective, you'd still be favouring global markets.

POC: What about the miners? Have you got any thoughts on the outlook for our mining sector, mining and energy?

DB: Yeah. Look, they had a good [inaudible 00:34:34] iron ore... It's been interesting. With the COVID, we've had China basically do what it did during the GFC, basically flick the switch to a lot of stimulus and a lot of top down infrastructure-led stimulus and so demand for steel and as a result, demand for Australian iron ore remain quite high. So we did see a pretty strong rebound in iron ore prices through much of early part of this year. That's been supporting the resources sector, but I think iron ore prices have probably hit their peak and starting to come off. And our resources sector started to show signs of relative under-performance. So, I think our miners will do okay.

But will they outperform within the Australian market or will they outperform vis-a-vis global markets? I don't think so, because again, it comes back to your view on commodity prices. I think in a low inflation world and a world tending towards services and technology, it's hard to see commodity price boom. So again, I think in a bit like our banks, and a lot of them now will be quite dependable, or depending on iron ore prices offering relatively attractive dividends. I mean, a lot of our miners are now offering good dividends, but maybe their growth opportunities won't be as great as we had during the commodity boom a decade or so ago.

POC: David, thank you very much for joining us this morning on the Netwealth Investment Podcast series. Certainly your economic and market insights have been really valuable. I've certainly got a lot out of the discussion this morning, so thank you very much for your time and your input to the session. To the listeners, thank you very much for joining us again on the Netwealth Investment Podcast series. I look forward to joining you again on the next instalment of the series. Have a great week everyone, and we'll catch up soon. Thank you.