‘Seismic shift’: Insights on the 2021 macro outlook with Perennial fund manager Dan Bosscher
Link copied to
The post-COVID macro environment has become a topical theme for investors this year.
Inflation chatter is back in the mix for the first time in a while, as data points to an emerging V-shaped recovery in developed economies.
And it’s all happening in the wake of what Perennial’s Dan Bosscher calls a “seismic shift” in central bank thinking as part of the COVID-19 policy response.
Speaking with Stockhead this week, Bosscher provided some insights on the macro outlook as investors weigh up a number of competing forces.
As the head of Perennial’s Solutions Group, Bosscher runs a concentrated portfolio of around 20 ASX stocks where “top-down” (macro) analysis forms a key part of his process.
“I need to set the framework for the portfolio with respect to where we are in the economic cycle, before I figure out which stocks hit my thesis. So it’s really a focus for me,” he said.
And along with the top-down view, he told Stockhead how he’s allocating capital in what could be a rising inflation environment.
With economic growth snapping back while monetary and fiscal policy makers keep the stimulus taps on, inflation expectations have begun to rise.
But for Bosscher, the discussion about whether inflation is coming or not “kind of misses the point”.
“If you look at five-year break-even (inflation) rate, that’s been rising for quite a while. And as we know markets are forward-looking,” Bosscher said.
“So just because we haven’t had 2 per cent inflation yet, it doesn’t mean markets aren’t well aware of it coming — and they are.”
When it comes to forward-looking predictors, Bosscher shares the view of other experienced investors that it’s often the bond market which moves first (before equities).
So far this year, the rise in bond yields has been a key talking point.
And going back to the 2008 financial crisis, Bosscher recalled that the rates on credit default swaps “blew out well before the equity market thought there was a problem”
“So forward expectations set by bond market securities is helpful. And the fact that inflation expectations having already rallied is important,” he said.
In terms of the inflation outlook, another development to be aware of is a key change in strategy by the US Fed last year, which was adopted by other central banks (including the RBA).
Instead of basing interest rates policy on what they think CPI growth will be in the future, the Fed said it will wait to see average inflation rise above 2 per cent – and stay there – before putting a rate rise in play.
That marks a “fairly seismic shift in the narrative”, Bosscher said.
“Over the 20-odd years I’ve been looking at this stuff, it’s pretty rare to see something so significant.”
“More importantly, the big elephant in the room is that the overall level of debt in the system is so significant that raising rates is almost untenable,” he said.
Therefore, even a small move in rates is going to have a “significant impact, because of the debt load that central banks govts and corporations have.”
“So it’s a really difficult spot for (central banks) to be in. Which makes me think they’re probably going to be true to their word and let it run, rather than tapping the breaks.”
Right now, the view of both the US Fed and the RBA is that inflation will indeed rise above the target two per cent level this year.
However, a sustained climb above that is unlikely given that annualised June data will incorporate low base effects from the previous year.
But once actual inflation does clear that target, Bosscher said the spotlight on that narrative will inevitably become brighter.
“It’s either going to be ‘OMG we’re here and it’s faster than we thought’, or ‘that’s just base effects, don’t worry about it’,” he said.
“So the next thing we want to see is how the narrative changes when that base effect creates higher (CPI) prints.”
For now, Bosscher shares the view of RBA governor Phillip Lowe that a sustained rise in wage growth will be needed to consolidate inflation at or above the 2-3 per cent target range.
“We haven’t got that yet but that’s kind of how I see it playing out over the next 12 months,” he said.
So with an increasingly complex top-down picture, how is Bosscher allocating capital for the year ahead?
He noted the rotation into ‘value’ stocks such as banks and companies tied to cyclical economic recovery, at the expense of high-growth tech valuations which have come off since bond yields started to climb.
Looking ahead, he said that rotation “could still have quite a long way to go”. And along with energy, gold and bank stocks, Bosscher’s portfolio is also overweight commodities.
“One of my favourites charts is the ratio of the S&P commodities index divided by the S&P500 itself,” he said.
What it shows is a “significant” underperformance over the medium term. And “this move over the past few months is really only a small blip on that chart”, he said.
“It’s potentially got a lot longer to go, so we’ve definitely got exposure to hard assets like commodities.”
The fund also increased its exposure to Aussie banks at the start of this year.
“We think a significant amount of negative press has passed through that sector now in the wake of the Royal Commission. And the steepening yield curve prompted us to increase that overweight,” Bosscher said.
The fund also holds multiple positions in more “idiosyncratic” sectors such as gaming and telecommunications – stocks with operations that aren’t so tied to the economic cycle.
“We pick investments that we think will offer stable performance in any kind of environment, and kind of wrap that around our macro thesis,” he said.
“So I’d describe the portfolio as fairly diverse, but strongly pointed to the inflation theme.”