Economic Update and Q&A, November 2023

Coming up is our highly anticipated guest speaker, Russell Chase, the head of investments and capital markets from the NAC.

He'll be presenting an economic update, a look back at 2023 and an outlook into 2024 to review opportunities for investors.

Venec is one of the world's largest issuers of ETFs, with over US$75 billion funds under management.

In Australia, Venec is the fastest-growing ETF provider and a leader in smart beta investment strategies.

They have over 35 EDFs on the ASX that focuses on performance and assets to asset classes typically unavailable to Australian investors.

Russell is an actuary with over 25 years experience in financial services.

He is responsible for managing Venec's passive solutions.

Prior to Venec, he worked at Sunstone Partners, Wealth Management, Perpetual, Grange Securities, Alexander Forbes, and Liberty Life.

Russell's presentation will be followed with a Q&A session with me.

Welcome to the presentation, Russell.

Thank you.

Thanks, Angelina.

Thank you for your kind words and having me on today.

So what I'm presenting today, just as a reminder, is general in nature, and it's not personal advice.

We do recommend that we speak to your advisor before making any investment decisions.

Now, Angelina has given you some background on VanEck, but I thought I'd just start off with a very short introduction.

As Angelina mentioned, we've been around since 1955 and have assets over 80 billion US dollars.

In Australia, we now have 35 ETFs listed on the ASX and 13 billion in assets.

Many of our ETFs have received multiple awards and are highly regarded within the financial advisor, institutional and investor community.

Our key focus is a bit different from other ETF providers.

We provide beyond the usual approaches to established investment strategies, and we provide opportunities to asset classes often underrepresented in portfolios.

I'm going to start off my presentation today with a quick look at performance this year, provide you with my views on the world in Australian economy, including the possibility of a recession, and end off with some investment ideas in the current market.

So let's start off looking at global performance.

And what I what I thought I'd do is just start off with a

a quote by Warren Buffett.

And what he said is the future is never clear.

You pay a very high price in the stock market for a cheery consensus.

There really is never a right, I guess a right, a perfect time to invest at the end of the day.

So if we take a look back

at performance year to date.

I think if you look at the equity markets, they've really been a roller coaster from the beginning of the year.

We saw the markets go up initially.

Then we had the regional banking crisis in the US.

We saw Credit Suisse go under as well.

And then what we saw happening further into the year, we saw, you know, a lot of, I guess, more cheery consensus.

We saw strong results coming out of many companies in the U S and the market moved up.

And then now since October or so into September, we've seen the markets come off again.

And if you do look at the chart, what you can, what you can see there in terms of performance.

And if you look at if you look at if you look at Australia, for example, we're barely positive emerging markets are down.

If you have a look globally, yes, it's up significantly.

It is up quite a bit.

But a lot of that is due to performance of what everybody's calling now the magnificent seven, or very much those large tech companies.

So from an asset class side of things, strongest performance, as I said, from the US equities driven by tech stocks, Australian equities have generally been quite flat.

And then unfortunately, on the bond side, we've seen another negative year coming through on those fixed rate bonds or in that fixed rate market.

And just speaking a little bit more about bonds,

We've seen quite a move since July.

We've seen significant shift in the yield curve, both in the US and in Australia.

You know, we saw the 10-year yields getting close to 5%.

They have come off a bit now, but it's really a far cry from the near zero rates a few years ago.

So for investors, and I've headed the slide farewell secular stagnation, but really from our perspective for investors,

it feels like an episode of the twilight zone.

What's happening really doesn't reflect reality.

Equity markets have been quite optimistic, they might have come down a bit now, but they've gone up again as well.

And really, you know, I think investors are expecting, I mean, we saw last week, the Fed didn't raise rates, investors are already expecting the Fed to drop, even though the Fed is saying it's quite firm in its fight against inflation.

What's clear from our perspective is that we're going to see higher rates for longer.

So let's take a look at some of the key economic indicators coming out of the US.

This is called the economic surprise index, and it shows how economic data compares with consensus analysis expectations.

What we are seeing now is that the economy, the US economy is actually performing better than analysts expected.

And what we've also seen, we've seen an improvement in the manufacturing PMI, which has turned around in the last few months.

If you look at the graph, you can see at the end there, that red arrow pointing upwards.

So we are seeing more manufacturing.

And then if we take a look at existing borrowers, and here we're really talking about consumers who are borrowing on their houses for mortgages.

And what's really interesting,

about the US, which I'm sure many of you are aware of US rates, when you take out a mortgage, you can fix your mortgage for 30 years.

So even though if you look at new mortgage rates, new mortgage rates have shot up, but on average, people are still paying very low interest on their mortgages.

So they're still in a pretty good position from a financial perspective.

Now, what I find quite interesting is you've got the Fed increasing rates, they keep increasing rates.

But at the same time, they've almost been weakening, or they've been adding liquidity into the market.

Firstly, we saw in March, when the regional banks started collapsing, what did they do?

They went in, added liquidity into the market to support those banks.

We've also seen a lot of spending coming through in the Inflation Reduction Act.

And

on the previous slide showing what's actually happening on the mortgage side.

At the same time, what we're seeing in terms of we're seeing wage growth and services inflation continue to remain high.

So there's continued high inflation in the economy, something which the Fed really wants to fight against.

They're coming off

But if you look at it with everything in place, the US economy is still very strong.

The chart on the left just shows the low level of US jobless claims.

It shows that really low unemployment rate.

Now, I came across the next chart or the chart on screen some time ago, and I think it's quite interesting.

And I'm seeing there's been a lot written about it in the press, actually.

We've seen a lot of economists have made comparisons of the current inflation environment with that in the 1970s.

So if you take a look at the blue line on the chart, it's really showing what happened in inflation from 1966 to 1982.

Now you can see what's happened now.

If you look at the yellow line from 2013 to 2023, we've followed a very similar pattern.

Now, the Fed certainly won't want to make the mistake that was made in the 70s.

What happened in the 70s?

Inflation came down and rates started getting cut.

But what happened is inflation took off again.

And if you look at the chart, you can see there it took from 78 to 82 to bring inflation back down again.

So we don't see the Fed cutting rates anytime soon.

In fact, with such low unemployment and relative and you know, services inflation, I think it's quite possible we could see another rate rise coming through into next year.

Now that's what's happening in the US.

But let's now take a look at Australia.

So in Australia, we've had unemployment remaining at historical lows around

3.5, 3.6 level unemployment.

Wage inflation has increased, but certainly not to the same level as the US.

I do expect inflation or unemployment here to go up, especially with the high immigration coming through, but it is taking time to feed through into the market.

In fact,

To date, we haven't seen a huge amount of change, particularly in those areas where there are shortages.

And where we're seeing that is in construction, retail, as well as hospitality.

Now on the right-hand side of the chart, you can see there we've got seek job ads.

Now you can see over there, job ads have fallen.

But I think what's really interesting is even at the current level, they're still 17% higher

than they were in late 2019 before COVID hit.

So that was at a time when the economy was really going well.

If we look at consumer sentiment, if you look at the graph on consumer sentiment, we'll see that that is actually weak.

But on the flip side, business confidence has been consistently resilient over the last few months.

Now I think if we look at inflation in Australia, what we can see, Australian inflation has been falling.

It's falling, but still high at 5.4%.

So still well out of that two, 3% range where the RBA wants to get inflation.

We've seen oil prices spark and come up a bit, they've come up a little bit now, but still relatively high with the war in the Middle East.

And you know, when you go and fill up your car, it's certainly costing more.

And at the end of the day, the price of oil, price of petrol pushes the price of everything up as well.

So I don't believe, I think it's unlikely you're going to see inflation come down a hell of a lot in the short term.

It's not just petrol.

Look at what's happened to electricity, the cost of electricity in July, electricity went up quite significantly.

The other interesting number or statistic is that retail sales have proved quite robust.

Retail sales were falling, but in September they went up by 0.9%.

That was on the month.

And in fact, they're up 2% over the year.

So not extremely strong, but they're still up.

And then I think the one thing that's really keeping things going well in Australia is that there's a high level of savings.

Level of savings has come off, but it is still relatively high.

Now we saw the RBA lift the cash rate to 4.35% just last week.

Now what I think the RBA has said in this statement, I've been saying it for a couple of months, they're now just really watching data releases very carefully.

So the next RBA meetings in February, so by then they should have the quarter end inflation to December, they'll also have new unemployment numbers.

They're certainly based on where we are at the moment, there certainly could be an increase early next year.

And I would expect that to probably be the last I would, I'd expect it to go up to 4.6 and stay there.

Now,

One of the big questions on everybody's mind is, is there going to be a recession in the US?

Well, let's look at a number of different factors of why there could be a recession.

And then I'll take a look at the flip side as well.

We've seen central banks have been flooding cheap money into the financial system since the GFC.

It was unconventional, so much, so large, making the system awash with money.

What the graph shows how M2 money suppliers grown, and this includes all cash people having their bank accounts, savings accounts, and short term savings instruments.

Over the same period, what we've seen is a massive increase in debt.

If we look at that increase in debt, certainly as a percentage of GDP, if you look at the government debt, that's the one in black on screen.

You can see it's virtually off the charts.

Corporate debt as a percentage of GPP is historically high as well.

What rising interest rates do, it brings higher debt servicing costs.

Debt service is set to become the largest budget item over defence and social security in the US.

We've seen US headline inflation is falling, but it still remains high.

and services inflation is still up there.

Combine this with the high debt with rising interest rates and something has to break.

We've seen inflation last seen at levels that it was back in 1980s.

And we've seen the sharpest increase in the Fed fund rate in the last 40 years.

The Fed fund rate has risen by 5.25% since it's low.

And like I said earlier, I think it could still rise.

Maybe we'll get another rise or maybe two out of it in the future.

So let's look at what the past can tell us.

Let's look at what's happened in the past when the Federal Reserve has increased rates.

What we can see is that the blue line on the graph represents the Fed fund rate.

Now 75% of the time, as indicated in grey, since 1955, an increase in rates has resulted in recession.

More importantly, not directly reflected on the graph though, a recession has followed the last five times when inflation has peaked about 5%.

US inflation hit 9.1% in June last year and is still at 3.7%.

Now in this slide, I have a graph of an index that I really like the name of.

It's called the anxious index, quite a clever name.

And it is real, it is an actual index.

And it's calculated by the Federal Reserve Bank of Philadelphia.

It's done by carrying out various surveys.

And what it is showing is that there's a heightened risk of recession.

So you can see that's the blue line when those blue lines peak, that's when you tend to get recessions.

And you've got the grey lines there, the grey block showing the recessions.

Now, to me, those are quite strong reasons for recession.

But, you know, things aren't always the same.

And if you look at this time around, there are some reasons why we may not move into recession.

If we look at the cycle, it was very different.

You know, we had COVID.

So that resulted in an unprecedented swing in the mix of consumer spending.

Locked up consumers, they were splurging on goods.

They weren't splurging on services because they couldn't go out.

But what happened when we saw the reopening is we saw a big catch up surge in service sector demand.

And you can see that on the graph there on the left, how the two were sort of really pulling apart.

Now, normally goods, the goods sector starts recessions.

But this time around is quite different, so not necessarily the case.

And what we've also seen in the US, which is actually quite, which I find quite interesting,

is that we've seen wages growth come off a bit, even though the employment market remains strong.

So if we look at the solid red dot, that graph on the right hand side, that represents the latest reading.

And you can see how far away it is from the recent, those recent dots, which are the ones in yellow and red right there above it.

So, you know, if we take everything together, what does all this mean?

No one could predict everything, you know, that there's going to be a recession with any level of certainty.

But if we take a look at Bloomberg, they do a survey every month and they had the probability of a recession in the US at 65% earlier this year.

That's actually fallen to 55%.

But certainly from my perspective, my view is that with so much debt, public and private,

And we're also starting to see some increases in bankruptcies.

I'm of the view that there is a greater chance that the US will have a recession rather than a soft landing.

Now, what about Australia?

So, you know, if we look at Australia, it is quite different.

I think if we look at it from the RBA's perspective, they are quite concerned of those downside risks.

Now, if you take a look from Australia's perspective, I think the outlook does remain a little bit more murky.

I do believe we will have more of a softer landing.

Resource prices have been resilient to date, they have stayed up.

So that's a big driver of our economy.

We've also seen we haven't hit the same levels of wage growth.

But at the end of the day, if the US goes into recession, and has a particularly deep recession, well, that could affect Australia.

As the saying goes, when the US catches a cold, the rest of the world catches the flu.

So now I'm going to move on and just talk briefly about the Australian dollar.

So if we take a look at the Australian dollar, we saw it ending October around about 63 cents.

Then we saw we've seen a little bit of weakening come through in the USD.

Australian dollar also improved a bit with the expectation that the RBA was going to increase rates and went through the 65% level, but just for a very short time.

Certainly from our perspective, if we take a look at the AUD, I think short term,

there's possibly a little bit of upside.

But long term, I think there's a lot of risks in the system, which could skew things to the downside.

What we're seeing is if the US has a recession, and that's what's shown on the graph, then the Australian dollar performs poorly, so it'll come off.

And also, if the weakness in China continues, it will suppress our exports and our demand.

And that could have an effect on the Australian dollar as well.

So just summarising the views that we've gone through now, if we take a look at the US economy, and my view, our house view is very much that we, you know, at the end of the day, there is still a chance of a further rate rise.

We think that the very much that the Fed will be trying to avoid what happened in the 1970s, they do not want

inflation to take up again, we do not want to have that scenario.

I think our preference is for companies which really do have strong balance sheets and are more quality type companies.

In terms of Australia, really, there's still a lot of inflationary pressures.

So it'll be interesting to see what this next

rate increase, what effect it actually has watching that data.

But certainly there could be another rate rise.

I do think though, the risk of a full blown recession is less likely in Australia and we are likely to have more of a soft landing.

And then as I just mentioned, AUD short term, short term upside, but maybe skewed to the downside in the long term.

So

Now with the current economic background in place, I'm going to share with you some of our best investment ideas.

And really the overall focus here in terms of looking at markets is being defensive and really looking for those pockets of opportunity for your portfolio in these market conditions.

So the first one I want to talk about is quality and particularly quality global large cap stocks.

So quality stocks tend to be quite defensive.

and quality stocks tend to outperform in terms of volatility.

So if you have a look at the chart, we've got the VIX index, and that's there in dark blue, and that's just a measure of volatility, typically measured in against the S&P 500 in the US.

And then the tier line, what that is showing, it's the ratio of the MSCR World X Australia quality index.

So it's a quality index versus the benchmark MSCR World X Australia index.

So when that tier line is upward sloping, quality is outperforming.

And what you can see in all those grey periods where there was that extreme volatility, quality tends to outperform.

I'm not saying it's not going to go down, but it tends to do better than the rest of the market.

And it did that again in the banking crisis earlier this year as well.

If you look at the economic conditions at the moment, they're very much the right conditions for quality stocks to outperform.

If we take a look at the US ISM manufacturing index, it's just ticked upwards moving into that recovery.

You can see there those blue dots moving up into that recovery period.

And what you can see in the table below with each of the recovery expansion, slow down contraction relating to the dots above, what you can see there is that quality outperforms in contracting environment, which we were just in.

And that's over a long period of time outperformed by 7.93% per annum and in recovery periods by 5.82%.

So that's why we believe

You know, with the defensive, if you're looking for a defensive portfolio, generally outperforms the market, but also outperforms in these market conditions.

Now, leading on from, from quality, I want to talk about, I want to talk about small caps as well as maybe tilting that towards quality.

Now global small caps.

in the past have performed better than large caps in a general recovery.

And small caps have been really hit hard over the last couple of months.

So if we look on the, you know, if we look on the chart here, what we can see, the black lines heading upwards, those represent the small cap performance.

And then you've got and then you've got the teal line representing large caps.

And what you can see is that they do tend to outperform in that recovery, in the recovery period.

But what's also quite interesting is if we compare small caps to large caps, so here we're looking over the last 12 years, and if you look at the PE ratio, giving an idea of the valuation of stocks, that teal line, you can just see what's happened to it.

It's come down so far.

the valuations have come off, they've performed poorly.

The blue line is showing the large caps is showing the S&P 500.

And the black line is showing that differential.

So the differential between large caps and small caps is significant.

And we all know with most things, there's some form of mean reversion.

So certainly global small caps are looking relatively cheap at the moment.

And then if we overlay quality, they're even looking cheaper.

So we've got the quality in dark blue, and you can see the PE ratio on the quality stocks is actually even lower than that on this general small cap universe.

So those ideas really on global equities.

Let's take a look now at Australian equities.

So when it really, when it comes to Australian equities, to me, diversification is the key to help protect your portfolio, particularly in these economic conditions.

What the graph on the left is showing the graph in till, so if you look at the till, it shows the weight, there are very thin lines there, which you might not be able to see properly.

It shows the weight of each stock in the ASX 200.

And what you can see there is that BHP, for example,

makes up over 10% of the index.

So if you buy a fund that tracks the ASX200, 10% of your money is going into BHP.

Also, if you take a look at it from a sector point of view, you can see that financials make up 30% of the index.

So from my perspective, to better diversify an Australian equity portfolio, investors should consider down weighting the mega caps

those very large stocks, up weighting may be large and mid caps as well.

Investors could even move to a portfolio which tends to equal weight different stocks.

Now in terms of our views on the overall sectors, we're generally neutral on banks.

I think what we're seeing with banks at the moment, we're seeing their net interest margins

remain more or less level, maybe with this next increase, they make up a little bit, but there are risks there.

And the risks being really default mortgage defaults, call loan defaults, credit call defaults coming through there.

REITs, we're actually quite positive on and that's really

more to do with from a valuation perspective as REITs have really been hit hard and at the moment particularly offers shopping centre REITs do look like they present good value.

From a resources sector point of view with resources remaining resilient again there we're neutral to overweight.

Now the last two sectors almost complement each other.

We've got consumer discretionary and really

Consumer discretion is held up incredibly well, but with another rate increase, we do think that consumer discretionary will probably get hit in that consumers won't be able to buy those bigger items, but will more concentrate on purchasing consumer staples, which they need basically just to live from day to day.

So that's really on our views on Australian equities.

Now changing tech completely to gold.

Now gold is well known as being a defensive asset.

And when it when it comes to gold, there are different ways of investing gold, there are really two key ways.

You can invest directly, you can buy a gold bar, or alternatively, you can buy gold mining stocks.

Now what we've seen with gold, gold's been range trading for much of this year.

started the year 1824.

It's gone a little bit above 2000, but not really not really going anywhere.

And you know, if you go back even to 2011, gold was still 1850.

So gold hasn't done a lot for a long time.

Now this could very well be the year for gold.

And we have seen geopolitical risks increase.

Gold did respond, not that significantly, but it has responded.

But we are seeing long term rates starting to increase, and certainly could see a move, very much a move in the gold price into next year.

I think what's also

what's also another positive or what could certainly push gold, is that we've seen central banks buying significant amounts of gold.

Last year, central banks purchased more gold or purchased similar amounts, hasn't been at this level since 1967.

And this trend's carried on into this year.

If we look at year-over-year purchases,

176% at the end of the first quarter and 62% up relative to the 10-year quarterly average.

What's also quite interesting, we've seen on Bloomberg that gold in Dubai, Istanbul and Shanghai is trading at a premium to London because gold takes time to move, takes London vaults to elsewhere in the world.

And this physical demand for gold should certainly help create a floor for the gold price.

And I think that floor is probably around the 1600 level.

So from that perspective, you've got a floor and you've got upside coming through above that.

So there's certainly more believe, I believe there's more upside to gold than downside.

If we take a look at, if we take a look now at gold miners and what I've done in this chart, I'm comparing gold miners to the price of gold.

And that's in that blue line.

And you can see there, over the long term, that has fallen significantly, that relationship between gold and gold miners.

Now, over the years, we've seen gold miners, there's been a lot of mergers and acquisitions, we've seen recently Newmont and Newcrest merged together, we've also seen a lot of cost savings come through.

So certainly,

I believe that we could see loss of gold miners relative to gold recover as well.

And at the end of the day, when you're investing in a gold miner, you are getting a leveraged exposure to gold, so that if gold does go up significantly, the miners will go up by even more.

So we've covered global equities, Australian equities.

I'm now going to talk about fixed income.

This may be the time to add duration to your portfolio.

It may be the time to add in a little bit of longer term fixed interest into your portfolio.

We've seen that yield curve move up, I showed you earlier.

You know, it's got to the point, you know,

or one and a half percent or 10 year yield.

And to me, what that's actually saying is that inflation is going to be high for a long time.

It's going to be, you know, on average over the next 10 years with a four or five percent handle there, you're looking at inflation above that two to three percent target of the RBA.

I don't think that that's going to happen.

I think the RBA is going to get it back into that two to three percent range.

It might take another year or another two years.

But certainly, those rates are looking really high.

And with fixed income, if the rates come down, then your fixed income portfolio goes up at the end of the day.

And really, for me, if we take a look at it, the Goldilocks, or people like to talk about the Goldilocks scenario, would be what we call a bull flattened scenario.

And this could possibly be in the cards.

And this is really placing investors in a really good position.

So if you look at what happens in a bull flatten, we have all the rates moving down, but the long end tends to move down more than the short end.

And if we take a look at what's happened in the past for that, if you take a look what's happened in the past in this graph, the bottom shows that long term bonds

And those at the bottom there are represented by bonds that have a maturity of 10 to 20 years.

So those are quite long.

And what you can see there is that they've outperformed other fixed income instruments over all the periods.

And they've also outperformed equities in all but one of those periods.

So I think fixed income is actually really interesting to look at.

Yes, we've had almost three years of negative returns.

but this could be the year going forward for fixed income to perform.

Thank you very much for your time listening to my presentation.

I'm now going to hand back to Angelina.

Thank you, Russell, for the presentation.

That was very thorough and interesting.

Now we have some questions for you.

Interest rate expectations.

Yeah, you mentioned that interest rate expectations a few times, but it has been driven market sentiment for some time now.

Do you think the market's current shorts and long-term interest rate expectations are about right, or do you think markets have more surprises coming?

Well, you know, if you look at the market, they kept assuming that the Fed and RBA are done.

If you look a couple of months ago, everybody's saying the RBA is done.

No more rate prices are coming through, even though inflation still remained high.

So, you know, I don't think the market got that right.

Even now, a lot of people are saying they're done.

I don't think they're necessarily done.

And there's still a reasonable chance that the RBA will need to increase rates again.

The same goes, the same saying really goes for the Fed.

So when it comes to, I guess,

those short term rates, I don't think the market's factoring in, factoring in everything.

But interestingly enough, when you look at the long term rates, if you look at say the 10 year rate, as I said a little bit earlier in my presentation, it does seem to be a little bit overdone.

long term rates hitting 5% over 10 years, that's really showing, really saying at the end of the day, that we're not going to see inflation fall back into that two to 3% level over a 10 year period.

So I do think that they've gone, you know, the market as such has gone maybe a little bit over on that side.

And that certainly presents opportunities for investors.

Hmm.

Interesting.

And how does unemployment rate factor into the RBA's next interest rate decisions, given that they just raised 25 basis points on Melbourne Cup Day?

And does the current low unemployment rate still give them a lot of potential rate rising firepower?

So if you look at

the RBA statements of late, they say they're watching data, and clearly the unemployment rate is one which I'll be watching very closely.

They'll want to see that rate increase.

Otherwise, they might need to raise rates again.

If we look at it, it remains at historical lows.

But I think they will look at some other pieces of information, important inflation,

Inflation to the end of December, that comes out end of January.

So they'll certainly take that into account when they make their decision in February.

The other piece of data they will consider is retail sales.

It's going to be really interesting to see what happens to retail sales coming this Christmas period.

And if retail sales are strong, again, that will give the OBI an indicator to possibly increase rates.

Now, if you look at that unemployment rate, it really surprised me.

I thought it would come down this year.

We've seen a lot of immigration, a lot of migration into Australia.

For the year ended 31 March, there was about 450,000 immigrants coming into Australia.

Yet we've still got labour shortages in construction, retail, hospitality.

But if this immigration continues at current levels,

we will see unemployment start to increase.

And that will reduce the need for the RBA to increase rates.

And it really depends on the pace of what happens.

So it's really a matter for watching the data as that data comes out.

And I think it'll become a little bit clearer well into January.

It sure will release the pressure on the RBA to raise rates.

As you quite clearly pointed out, it's the unemployment rate.

Now, do you believe central banks are in control of inflation?

Or will the continuation of what's called the excused inflation in the corporate world ensure inflation remains higher for the longer?

Well, I think everyone would agree

that developed economies waited far too long to start raising interest rates.

And, you know, I think people are generally, I feel often, are making excuses for raising prices.

But I do think they've got it under control.

But because you've got this inflation started to get a little bit entrenched, it's going to take a long time for it to fall back into the target range.

I don't believe we're going to see cuts here or in the US until probably at least the third quarter of next year, if that.

And if you look at the developed market central banks, they need to be careful that they do not start cutting too soon.

I alluded to this in my presentation that I want to repeat what happened in the 1970s.

That would be an absolute disaster, cutting and then having inflation rebound back.

But what I find really interesting, though, is in this cycle, what we've seen is emerging markets seem to have got it right.

They actually were watching what was going on.

When inflation started picking up, they started raising rates.

And now many emerging market economies are either on hold or have actually started to cut rates.

So I think the developed markets have a lot to learn from the emerging markets at this point in time.

Yeah.

And what are the implications of your interest rate inflation view from an asset allocation perspective?

For example, with most Aussie investors like myself, overweight equities and underweight bonds, do you see potential for floating and or fixed rate bonds to outperform looking forward?

Well, I think looking forward, I think we've seen this negative returns on fixed rate bonds for the last three years.

And if you look at last year, if you look at 2022, equities performed poorly, and bonds are supposed to be defensive when equities perform.

So it didn't provide that usual defensive nature.

So if investors were following a, you know, the more traditional sort of 60-40 growth allocation, it didn't really work well.

And I think what we started to see, what we started to hear more about is re-looking at that 60-40 allocation, re-looking particularly at the defensive assets, maybe looking more towards uncorrelated assets, for example, like gold, and maybe infrastructure.

I guess when it comes to bonds, if you look now,

at fixed rate bonds, certainly with the rates being offered at the moment, they certainly do look like good value.

You know, in this situation, even if the long rates do increase a bit more, yes, you might lose some capital, but you still have a reasonable amount of income to offset your losses, you're earning four and a half percent.

Whereas, you know, if you look back,

couple of years ago, you were earning virtually no interest at the end of the day.

Yeah, true.

And how should investors be viewing bond duration right now?

You touched on that a few times in your presentation.

Do you think as a friend or foe, what are the implications for the outlook of floating rate versus fixed rate bonds?

So I think I think I think duration now can be your friend, because at the end of the day, you know, as I was as I was saying, you know, with with rates being high, if you take on duration, you're going to get the benefit coming through from capital gains, from making you know, the value of those bonds going up, as interest rates as interest rates drop.

So I think that's that's positive, but you're obviously still taking on some risk.

So you know, if investors don't want to take on duration risk,

then floating rate notes come into play.

And if an investor, for example, is happy to take on maybe a little bit of a higher risk, they might want to consider investing in subordinated debt or tier two debt.

Much of this tier two debt is issued by the major banks.

Yes, it's a little bit further down in the capital structure.

It still sits above hybrids.

And if you look at many of these instruments, they're yielding well into the sixes, maybe six and a half, 6.7% per annum.

So there certainly are opportunities out there in the floating rate space as well.

Interesting.

And looking forward to 2024, do you believe Australian and global economic risks are to the upside or downside?

What are the key issues likely to be at play?

So overall, I think risks are to the downside, in my view.

I think the biggest risk, as I mentioned, I think the risk of recession in the US, if the US goes into deep recession, it could certainly push Australia into a recession as well.

Secondly, we've got geopolitical risks, which have certainly been intensifying.

And you've got now the war in the Middle East.

And at the same time, the Ukraine Russia war, it's not looking like it's going to end anytime soon.

I'm really surprised it's gone on for so long.

And lastly, there's also the risk that inflation will become entrenched, and it won't move back into that into that target range.

And are there any particular sectors of Australian economy which are positioned to influence the economic narrative next year?

Well, I think what's, what's going to be very interesting is, is what happens to consumer discretionary companies.

That's something I'm watching really closely.

We've seen a few like Adares have poor results, but those have been due to specific companies.

Others have been quite resilient.

And for me, the stock to watch really is JB half art.

JB high five is a very strong operator consistently being able to perform when their sales and profits start to fall.

It'll be a good well weather for the rest of the sector.

So that's, you know, that's what I was saying before.

We have an underweight on consumer discretionary as that's really where we expect consumers to cut back.

Banks is the other interesting sector.

It's always a good guard to the condition of the economy.

We don't see banks' NIMs expanding, even though rates are going up.

I think the key things to look for next year will be default rates, not just across mortgages, but looking at credit cards and motor as well.

And we have seen credit card debt increasing, which is a sign of a stressed consumer.

And the other sector certainly is REITs.

That's a really interesting sector where we've seen offers and shopping centre REITs trading at a deep discount to the net asset value.

They've really been out of favour and so I think it's a really interesting sector to look at and see how that pans out over the next year.

Yeah.

And are there any standard risks that most investors aren't paying enough attention to at this junction?

And are there any standard opportunities on the other hand they may be ignoring?

So I think if you look at it from an investor point of view,

Like I said, I don't think the market's taking into account necessarily the stickiness of inflation, not necessarily taking into account that those short term rates will continue to be cut really soon.

And I think the other area to watch for is something which has grown quite rapidly over the past few years, and that's really private credit.

And it's an area where not many investors are paying attention to.

They probably are paying too much attention in that there's a lot of money flowing into private credit.

And the amount of private credit really globally has grown from around about 870 billion in 2020 to 1.4 trillion at the start of this year.

And that private credit really falls out of the traditional banking system.

And really, it wasn't around before.

So nobody really knows what's going to happen with these rising interest rates if they default in their private credit sector.

You know, it's easy to say it's private credit, it's separate from the banking sector, but we all know everything's quite tied together in the economy.

And it could certainly have a poor effect on markets as well as banks.

Thank you, Russell.

It's wonderful to have you.

Great to see you.

We look forward to seeing you next time.

Take care.

Thanks, Angelina.

Thanks very much for having me on today.

I appreciate it.