Financial Planning

Current Equity Market Trends Explained: Risks, Opportunities & Tips To Maximising Returns

By April 30, 2021 No Comments
Current Equity Market Trends Explained - Chat With Alexis Gray of Vanguard

Current Equity Market Trends Explained – Chat With Alexis Gray

Over the next few months we’ll be giving you an inside look at our discussions with investment experts and fund managers. We’ll be sharing videos of our Question & Answer sessions with professionals from our network. These sessions form part of our investment committee’s intel collection and assist us to ensure we’re recommending a best of breed solution. We’re excited to open some of these discussions up to a wider audience and hope you find them enjoyable.

In this session, I had a chat with Alexis Gray, Senior Economist at Vanguard, about the current state of share markets.

We focused on the following questions and themes:

  1. The average investor is torn right now. They can’t believe the market has been so resilient over the last 12 months and fear a correction but at the same time they can’t afford to sit in cash. What can you remind these investors caught on the fence? What drivers supported the market over the last 12 months and what drivers will support the market moving forward?
  2. What are the concerns and red flags? Also what are some myths from the media drumming up fear but not necessarily a major reason for a long term concern?
  3. What sectors/industries are well placed to benefit in the post Covid environment over the coming 3 years?
  4. Australian’s tend to hold a large allocation of their portfolios in Australian shares. Access, currency and familiarity are key features supporting this, but what can you share about the issues in holding Australian shares over international shares?

Please feel free to get in touch on 1300 925 081 or send an email to info@cxcfp.com.au if you’d like to book in a chat on the above or on other portfolio matters.

Video transcription: [Tim Hobart] Hello everybody, and welcome to the latest Q&A session where I sit down with some of the leading minds in financial markets. We’re really lucky today to be joined by Alexis Gray, who is a senior economist with Vanguard. Welcome Alexis, before I sort of launch into it more in-depth background about your career.

[Alexis Gray] Hi Tim, yeah, thanks for having me.

[Tim Hobart] So for those that may see a familiar face there, Alexis has a very rich background in markets and has appeared on many of the prominent media channels like Bloomberg, and CNBC, really operating as an ambassador for the Vanguard brand.

Alexis also operates as a manager in Vanguard’s Investment Strategy Group, and I’ll just quickly read a quick blurb on that. So the team develops multi-asset class allocation strategies, conducts research on capital markets, the global economy, and deals with portfolio construction across many asset classes. She works closely with the Fixed Interest Group, which oversees nearly $1 trillion in assets under management.

So certainly very experienced and we’re in good hands today. So Alexis, just quick, a bit of housekeeping. Today obviously no advice will be provided, just general information. It’s really just sort of exploratory session for Alexis and myself.

It doesn’t necessarily reflect the formal opinions of CXC Financial Partners or Vanguard. Anyone that needs advice, you’re very welcome just to give CXC Financial Partners a call – we’d be more than happy to step you through advice to meet your specific circumstances.

So we’ll aim to keep this session under about 20 minutes but there’s a lot going on in the broader market. So if we do need to extend it, I think we should take the opportunity. All right, so just to create a quick backdrop for you Alexis in terms of what a lot of our clients are saying, a lot of the broader investment markets is that I think probably confusion is a key word. A lot of people in the market have been happy with the returns, but are starting to get quite fearful as to how long those returns can last.

And on the other side, we’re seeing that those who have been reluctant to get into the market due to a lack of maybe trust as to the longevity of this current cycle. And they are getting penalized because they’re not getting any return on low cash rates they’ve got on their savings. So again, it’s a tough backdrop.

So maybe just to open things up for you Alexis, with the first question, and certainly not after any crystal ball stuff, really what we’d love to learn is what would you remind investors right now, either those in the market, out of the market, caught on the fence, what should they know?

[Alexis Gray] Thanks Tim. Well, let me explain a little bit of a backdrop and why it may be confusing for investors. We’ve had this major economic shock which of course was the pandemic. Not many people saw that coming, maybe if you are an epidemiologist who knew that was possible. But that was a big economic shock, and really the largest one that we’ve seen in our lifetimes in terms of thinking about the fact that the economy really switched off during those lockdowns last year. And there are large parts of the world that are still in those lockdowns. That was reflected in the share markets, and so we had what we call a bear market where the price of the global market fell by more than 20%.

It recovered really swiftly, and that’s what’s surprising, I think for investors is that that recovery has occurred before the economic recovery has completed itself. As I said, in parts of North America, Europe, South America, we’re still seeing the pandemic causing a lot of economic damage. So that’s been a surprise.

Now how I’d explain that, is that the markets are forward-looking. So they price-in what’s coming down the track. They’ve always been this way. They price-in new information very quickly. What they know is that we’ve now got multiple, highly effective vaccines that are being rolled out and that are reducing death rates and hospitalization rates. And so the countries that have rolled out the vaccine fastest have now started to get back to normal faster. So that’s where we’re heading. So the market is quite optimistic about that news, and that’s really already been priced-in. Add on top of that that even though there was this big economic shock, we had a lot of support. The government, even here in Australia, we had JobKeeper program, we had grants for companies, and those kinds of packages were really delivered across the world. And the US has only just now, just delivered another big fiscal package, the Biden administration is putting through nearly 2 trillion US dollars. So the markets have priced a little of that in already, and we’ve seen really share prices getting back to where they were before the pandemic.

So what can you do about this as an investor? And I can imagine that some investors have a sense of FOMO, they kind of Fear Of Missing Out. They’ve seen, well, the recovery has already happened, I wasn’t expecting that and maybe I wasn’t in the market, or not to the extent that I wanted to be. To some extent I think you have to put that behind you. The past is the past, and you can’t go back in time. Where we are now is, I think that we’re getting closer back to, maybe a little bit more of a normal time for the markets.

So the outlook, I would say, for the share market is still reasonably good. We produce long-term expected returns, we have some modeling that we do. On average, we think the market will give you about four to 7% over the next decade. And that’s for Aussie shares or global. That’s quite a good outlook, and if you compare that to what you would expect for say cash, leaving your money in the bank or in a term deposit, or even if you bought fixed interest, we expect that to achieve around zero to 2%. So we’re still quite optimistic about the outlook for the share market. We don’t think that on the whole, the market is overvalued. Although there are pockets that you could look at. Look at the tech sector in the US for example, there’s been so much enthusiasm. We think it’s hard to meet expectations there, but overall we’re still relatively optimistic.

So it’s important really to get into the market at some point, that’s what I would say. Being in the market matters more than when you get into the market, and it really should align with your own personal goals too. And that’s where an advisor can help you. What’s the right amount that I want to invest in my portfolio, what proportion. One way to maybe alleviate your own concerns is to say, I’m just going to drip-feed my investment into the market. I’m not going to do it all in one day because I’m worried about what might happen tomorrow, so maybe I’ll put a little bit in every month, over several months. And that way I feel a bit more confident that I’m not going to throw all of my eggs in one day and potentially lose some money in the short run.

[Tim Hobart] Agreed, that’s great advice. Really takes out a lot of that timing concern that people do have. I know we won’t get too much into the speculation on investment returns, but a lot of people are after income. So when you mentioned those types of, sort of projected long term and quite a wide range of returns, what’s the breakup of income versus capital growth? And maybe we’ll just focus on the equity space. Okay, we’re back after a quick technical issue.

So my question Alexis, a moment ago was in regards to the yield. So you mentioned a range of returns, long-term sort of 4% to 7% range, obviously depending on where you invest. But what should people be planning in terms of dividends from let’s say the Australian market, which at the moment, is I think sitting at about a 4.5% grossed-up yield, so including franking credits. What’s the expectation for the next few years?

[Alexis Gray] Well, I think unfortunately we’re going to continue to be in this low yield environment that we’ve been in for some time, and that’s been affecting income streams of all types. So you mentioned dividend yield which has been trending lower and is not likely to lift much from there, if anything it might even shrink a little bit more. But the same is true if you look at the return, the yield side, for example on cash or fixed interest, even on property, rental yields have been pretty low, especially during the pandemic. And of course that’s a conundrum for people who are looking for income, if you’re, for example, a retiree, and you rely on that to meet your living costs.

And so what we advocate to people is not just thinking about your portfolio in terms of generating direct income from those income streams, but thinking about other ways. And so we talk about a total return approach, which is yes you might take an income stream from those typical places. Although a lot of people have been doing that, and we would say that there’s perhaps now, some expensive pockets of the share market where dividend yields are high. They look a little more expensive than the rest of the market.

So perhaps the return on those investments, and in fact, if you look back over the last decade, they’ve underperformed on a total return basis. So what you can think about doing is drawing down on capital. And that can be uncomfortable for people because you think of that as being your nest egg. However, if you compare that strategy of driving income from the typical income stream, dividend yield, so forth, plus capital drawdown, that has outperformed simply taking the the income stream on its own. So because, if for example, you’re holding these riskier asset classes like shares, they tend to perform and produce higher returns over the long run, and drawing down on capital while holding those types of investments has tended to serve people well. So that’s the way to think about solving that difficult problem.

[Tim Hobart] That’s really interesting. That’s a real mindset shift, isn’t it, for many Australians that have historically held the big 10 sought after the dividends at any cost and had that mindset to not draw down capital while that can be a good concept, I think it is time in these different environment where we need to challenge some of those longer term concepts of wealth creation. Like you said, it’s okay to maybe take some of that capital from your profit as opposed to just searching for the dividend. So that’s good insight, thank you.

So now focused more on some concerns or red flags that you see in the market, you can focus on the Aussie market if you like. But we tend to feel that the trends a lot of the time are driven by that sort of herd mentality concept, where the media can drive a lot of sentiment. So what are some of the myths that you’re seeing in the media at the moment that’s drumming up fear, but not necessarily a major concern. So I guess to unpack that question, there’s two parts. What are the real concerns, what are the fake concerns?

[Alexis Gray] I mean, I think the media is trying to make money by selling stories. So at times they can hype things up. I mean, even if you think about the stories about the property market, over the last 12 months there was a lot of fear, and in the end property prices didn’t really fall. In fact, they’re rising pretty quickly at the moment. So that was one that the media was probably a little bit wrong about. There’s a certain degree of fear of inflation at the moment, because we’ve had so much of this stimulus, whether that’s government sending us cheques or central banks, putting interest rates all the way down to zero, that that’s going to generate a higher cost of living for all of us. And I think at the margin it’s true that it will, inflation will be higher than what it would have been, but I don’t, you know, I think the fear of going back to the days of inflation we saw in the seventies or eighties is, you’d have to make some pretty extreme assumptions to think that we’re going back to that place.

In fact, we think, central banks like the Reserve Bank here in Australia, are going to continue to try and keep inflation relatively anchored. Let’s say at 2%, two and a half percent. We think that they’ll be quite effective in doing that. So I wouldn’t worry too much about inflation getting out of hand, but that’s one risk.

And I guess the other one I mentioned in the first question was the fear of a market correction, which is a perpetual fear. I think that fear is a little bit over done, especially as an investor, if you have a very diversified portfolio, you’re holding investments from different parts of the world, different industries, and you’re holding different asset classes, that spreads your risk. And so the risk of losing a large amount of money at one point in time, I think is low. And even at the moment, even though the market has performed very well, we’re not worried about a major market correction.

[Tim Hobart] And to your point around taking some of that timing risk out, of course if we just focus long-term, it tends to be less relevant, but also the drip feeding approach, the dollar cost averaging into the market. So a drop in the market can actually present a real opportunity. So it is important that you can stay somewhat liquid, and opportunistic for those times as well. So, yeah, thank you. And so in terms of sectors or industries that you feel are well-placed to benefit sort of post COVID you mentioned about sort of industries that have done very well during that time and a lot of the kind of work at home, the stay at home stocks, the tech stocks have done incredibly well. What do you see as the next horizon in terms of the longer term growth sectors?

[Alexis Gray] Well, I think having that kind of digital platform has been really important. So companies that were able to sell to us, sitting in our living rooms have done very well, when you think about Amazon or Netflix. But I think as well even if you look at other industries, if you look at the grocery sector, if they’re able to deliver to our homes, they’re well-positioned versus a small store around the corner that only has a shop front. I think the push, this trend that we’ve seen towards the digitalization of the economy has been accelerated.

I’ve just come from living in London and they’re quite advanced there, you can, I mean I could order something online and it’s at my door at 8:00 AM the next morning, and Australia is probably heading in that direction. So these companies that are well-placed to deliver to home or to deliver directly into our living rooms, are probably those that are going to perform well. And then of course, you’ve got pharmaceuticals, unfortunately have benefited through this health crisis. Now the trouble with all of that is that investors already know all of this and it gets priced into the market very quickly.

So if you think from an investor’s perspective, in fact, I would almost say the opposite which is those firms are probably more richly valued than others like the kind of consumer staple type investments which didn’t perform very well during the crisis, but may actually now be somewhat cheap relative to those kind of tech or other kind of shares that have performed well during the crisis. Even just stepping back from that, what I would say is that it’s very difficult to time sectors. You have experts in the industry who get that wrong.

And so what we tend to say to people, and I take this advice myself, which is holding a broad range of sectors and buying and holding actually is very hard to beat. Every time you switch in and out of sectors, you’re generating transaction costs for yourself and that tends to weigh you down. So I think, as a regular person I would say, don’t worry about it that much, buying and holding the whole market actually is a very very robust investment strategy. And it leaves you the free time to get on with the rest of your life. Not kind of worrying about reading the newspaper every day.

[Tim Hobart] So it’s about controlling the things that you can control. And we’re very big advocates of having a decent part of the portfolio sitting in index funds and sitting in ETFs and getting that broad exposure. So, you look at the parts that you can control as opposed to guesswork, and you can control fees, and you can control the, I guess the certain level of tax because some of the active managers tend to justify their existence with a lot of transactions. So I think it is very important for people to not get too caught up in, like you said, that form of picking the wrong stock, or picking the wrong sector. That diversified portfolio time and time again, as boring as it is, has proven to generate some of the higher returns in the industry.

[Alexis Gray] Sure, yeah, so the point that I was making has just left my mind ’cause we had a little tech issue there. So it can be boring not to be trying to time the market and speculate. However, it’s not boring to build a lot of wealth. If you look back in time, and you’ve not made the mistakes of mistiming the market or really throwing a lot of money away on fees, that’s really much more exciting. That’s really much more exciting.

So, the other thing I could say is, yes you might, if you really love playing in the markets, keep a certain proportion of your portfolio for that. Keep 10% aside and have that be your fun basket, and leave the rest in the boring part. So you can have your fun and be confident still that most of your portfolio is well set up and well positioned to meet your long-term investment goals.

[Tim Hobart] Yeah, I agree. Yep, exactly. Great, so my last question is in regards to the Australian market. And I often find it interesting, not wrong, but just interesting how many Australians have a very large exposure to the Australian market. And on the surface there would appear to be very obvious reasons for that, things like access is just easier, currency sits in the same currency and overall familiarity. We’re investing in companies that we know and we use every day. But I also find it to be a somewhat of a paradox, where we’ve got the Australian market might make up, what, less than 2% of the global market. Yet we might hold 30, 40, 50, 60 and above exposure to Australian equities. So just a bit of a broad question there, but clearly there’s some biases at play, but would you be able to talk a little bit more about the Australian market and your views on that concept of exposure?

[Alexis Gray] Sure, and it’s true to say that we have this home bias. Maybe, that hasn’t been irrational because the Australian market has performed well over the long term. In fact, if you look at performance of the share market back 100 years, Australia has outperformed virtually every country in the world, right? Now, who would have known that was going to happen? Think of where Australia was as a nation a hundred years ago. It was very different from where we are today, we’ve evolved a lot. Will that repeat over the next hundred years, or the next 10 years, that out-performance, who knows. Because past performance is not a reliable indicator of the future. But there’s been a rational reason that I think investors have done that. And as you said, there’s a comfort factor.

And in fact, we see investors in all parts of the world displaying this same bias towards what’s familiar. Now I’d say that the reason to think about investing outside of Australia is getting access to different opportunities. So in Australia, the top 10 shares in the market make up nearly half the total market. So we’re talking about big banks, we’re talking about mining companies, telcos, and so you’re very concentrated in a few firms. Now, if anything were to happen, I think if you know those businesses, you’d probably say, well, they’re on sound footing, but if anything were to happen and any of those industries were disrupted or those individual companies, you would stand to potentially lose some money.

And so thinking about spreading your risk across not only more firms, so thinking about having a larger pool, hundreds of investments rather than just dozens, and thinking about other sectors, let’s say during the pandemic, if you only held local investments, you missed out on the tech boom. There’s been a tech boom and that has driven the market, the global market it’s been the big out-performer.

So getting access to those kinds of opportunities and those other themes that have been driving markets is one benefit. And also minimizing the risk that your portfolio will fall on the value of just a few different names. Another thing to think about is, many people already own a house and the profits of banks are driven by housing.

So if the housing market in Australia went through a stretch where it didn’t perform very well, you would feel that pain, not only with the value of your house, but with the value of your investment portfolio. So once again, it’s really a question of risk and making sure that you’re kind of risk proofing your portfolio by diversifying.

[Tim Hobart] Really good points. And it does tie back in very nicely to the start where you were talking about some of the drivers that might support a further uplift in markets being the vaccines and obviously our reduced exposure to the virus and the incredible government support, both monetary and fiscal.
So then with our ties to China, yeah, I think our market is still quite well-placed. So hence having an exposure to Australian equities above 2% would no doubt still be quite prudent.

So yeah, look, thank you Alexis. Really, that wraps up the questions. I could probably talk to you all day as there is just so much to unpack in this current climate but some fantastic insights, and I think there are some very, very good learnings for people is not to get too caught up in the short term. Don’t get caught up in the stock selections, don’t get caught up in trying to pick that next sector, by all means, carve out a portion of your portfolio and have some fun with it and take some independent stances but the tried and true method of wealth creation is about being in the market for the long term, and investing in the index has proven to be a terrific way to just compound your returns at a cheap cost. And also it can be quite tax effective as well. So again, thanks a lot, Alexis. Any closing comments from you before we turn off?

[Alexis Gray] No, you did a great summary. In fact, I almost feel like you were a Vanguard spokesperson ’cause those are all the key messages that we tend to keep so you’ve done my job for me too.

[Tim Hobart] Yeah, I think a lot of people tend to try to look smart and overcomplicate markets, but at the end of the day, it is those tried and true, somewhat boring approaches of consistency, that gets the job done. So I think we’re certainly on the same page there. Well, thank you so much for your time, Alexis. We’ve been very lucky to have you and yeah, thanks again. And look forward to talking with you again soon.

[Alexis Gray] I appreciate it, thanks for having me Tim.