Spoiling the ending
An avid reader, Yetsenga commenced his presentation, titled ‘Uncomfortable Resilience’ by jumping straight to the point, starting with monetary policy; “rather than play the Agatha Christie story, where you have to wait until the end to find out who did it, I want to tell you where we’re going…we think the Fed is going to take rates to five per cent next year.” This, Yetsenga explained, is part of a synchronised global tightening cycle, the velocity and magnitude of which has not been seen in decades. Similar trajectories are expected for the Bank of England and the European Central Bank, with recessions forecast for each of the US, UK and eurozone next year.
It’s a necessary requirement according to Yetsenga, given the current resilience being displayed by the global economy; and, as he noted, “there’s some things we should be welcoming both globally and domestically…” with the forecast recessions likely to be typified by negative GDP prints rather than deep, long-lasting, and damaging impacts to the global economy.
Gifts from aliens and busting myths
Yetsenga then shifted to the other talking point of 2022 – inflation. Popular opinion throughout the pandemic has been that inflationary pressures have been caused by supply chain problems. Yetsenga believes this is false. He pointed to global import volumes that are greater than 10 per cent above pre-pandemic levels, semi-conductor sales that are more than 20 per cent higher over the same period; and global shipping rates that have been falling since last year as evidence that supply issues are not the main driver of inflation.
Rather, he highlighted the stimulus provided throughout the pandemic as a key catalyst. Fiscal stimulus – more than six times of that provided during the GFC – combined with ultra-loose monetary policy, has seen corporates and individuals rebuild balance sheets without needing to liquidate assets. Put simply, he thinks demand is too strong.
Yetsenga explained, however, this is only part of the issue – the consumer’s mindset is now vastly different to that post-GFC: “we finished the GFC with this sense of dread risk; I’ve had a near-death financial experience.” This led consumers to hold onto their liquidity. Conversely, Covid was treated as “something of a gift from the aliens,” he noted, with consumers and businesses desperate to revert to normality; subsequently spending up rather than hording cash. The challenge for central banks is to raise rates to a level where this dynamic changes.
Landing the fighter jet
For all the negativities being bandied about in popular press, Yetsenga pointed to the rude health of household balance sheets in the US and Australia as one reason the downturn is unlikely to be nasty.
Key to this he noted is the labour market. A lack of spare capacity is fuelling wage growth and allowing households to continue spending despite the rising cost of money. In the US, there are roughly two job openings for every unemployed person and in Australia almost one job for every person looking for work. With neither economy having ever operated at this level of labour demand; according to Yetsenga, central banks will need these levels to drop markedly before the hiking cycle can take a sustained breather.
Not to underestimate the challenge facing policy makers, Yetsenga made a comparison to landing a “fighter jet, on the aircraft carrier, in the middle of the typhoon”. However, he considers the RBA can achieve this and envisages a softish landing with hope that, “the downturn is not too bumpy.” Should this occur, he has no desire for Australia to return to the economic conditions experienced in the decade that preceded the pandemic – 10-year growth in real GDP per-capita was the lowest since the 1950s, real household income per-capita hadn’t risen from a decade earlier and underlying business expenditure was the lowest since 1994. Conditions, Yetsenga eloquently described as “much lower than we should aspire to.”
With higher inflation, lower unemployment, and capacity utilisation now at levels high enough to support productivity growth for the first time in 15 years, Yetsenga sees potential for a better macroeconomic environment moving forward. In his opinion, this should provide a greater opportunity for successful policy reform across numerous areas including climate transition, training and skills, and energy policy. Where many are seeing doom and gloom, Yetsenga is focussed on the potential silver linings from this pandemic.
A risk-based approach
Not wanting to be the bearer of bad news, Anantakrishnan, who followed Yetsenga’s presentation, was quick to acknowledge the relatively upbeat take on the global economy from ANZ’s Chief Economist, but noted he comes from a slightly different perspective – managing multi-asset portfolios on behalf of clients. It’s this responsibility for client capital, that sees him apply a risk-based approach to managing money. Put simply, he is focused foremost on protecting the downside. Anantakrishnan explained that he is “not as concerned about keeping up with the market when things are doing really well, that tends to play itself out…what you really need to be concerned about in terms of growing wealth is avoiding big losses.”
Anantakrishnan went on to discuss the cyclical and structural reasons behind the market volatility, noting the volatility index had remained above its long-term average for an extended period. Indeed, since the pandemic began, it has risen above 30, roughly 20 times. For context, it reached that same level only 5 times between 2012 and the onset of the pandemic. A major cause of the volatility has been the persistent inflationary pressures, and according to Anantakrishnan this is something investors will need to get used to, as among other things, structural shifts including changing demographics, deglobalisation, the availability of labour, energy supply constraints and perhaps most interestingly the scarcity of trust – something which according to Anantakrishnan can increase the cost of doing business – are likely to remain for some time.
We didn’t start the fire
Touching on Yetsenga’s comments about the state of the macroeconomic environment following the GFC, Anantakrishnan pointed out that equity markets rallied several hundred per cent over the period despite these fundamentals. In large part, thanks to the support of central banks and other policy makers. As a portfolio manager, he pays as much attention to the reaction function of central banks as he does market fundamentals. Now that the low volatility, low interest rate environment that led up to the pandemic has begun to be unwound, Anantakrishnan noted that it has “start(ed) to show some cracks.” When thinking about risks in financial markets, Anantakrishnan separates this into three sections – conditions, catalysts, and consequences. According to Anantakrishnan, conditions are usually set in the period prior and in this case, it was the low volatility and cost of funding that led to significant leverage and asset price inflation.
Anantakrishnan explained how investors often look at single events or catalysts and think they are the cause. In his opinion, dislocations are more often the function of vulnerable market conditions that have built up over time; likening it to bushfires – he is more worried about the amount of dry wood or risks in the financial system than the eventual spark that could start the fire. He pointed to the recent meltdown in the UK gilt market as a classic case. What started as an isolated issue in the UK quickly unravelled and spread to the Australian bond market as UK pension funds tried to liquidate assets to meet margin calls.
It’s against this backdrop of rising risks and sustained volatility that Anantakrishnan started to position portfolios more defensively earlier this year. This has included increases to bonds at the expense of equities in recent months as yields reached more attractive levels, risks became more pronounced globally and the growth outlook deteriorated further.
Everything old is new again
Despite the significant drawdowns this year, by historical standards, Anantakrishnan noted they weren’t that unusual. In fact, as he explained, there are similarities between the current period and that of the mid-1960s to 1980s when a “supply-side energy issue…the Iran-Iraq war and geopolitical risks” were prevalent. He pointed to the performance of the S&P 500 over the period, which saw no less than five upswings of greater than 50 per cent and an equal number of peak-to-trough falls of 20 per cent or more. As he explained, this is what tends to play out in these more volatile environments. For Anantakrishnan, this environment provides a great opportunity to create wealth but equally, for those who are not cognisant of the prevailing conditions, and don’t have a disciplined investment strategy, the potential to destroy it.
On the best way he sees to approach the current scenario, perhaps surprisingly, Anantakrishnan wasn’t suggesting any radical changes for investors, “it’s not different to what you’d normally do, but its revisiting some of those things you may have done in a low risk, low volatile environment.” According to Anantakrishnan, it’s a case of the basics being more important than ever – specifically the right risk profile, remaining invested over the long-term without the need to liquidate during extended drawdowns and ensuring your core portfolio has adequate liquidity to be able to take advantage of opportunities when the time is right.
Anantakrishnan remains positioned defensively across his portfolios, mindful of the increasing risks in financial markets. However, like Yetsenga, who is focussing on the silver linings from the pandemic, Anantakrishnan is keeping one eye firmly on the potential opportunities on the other side of this cycle.
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