In late June and the first half of July, we attended the largest wealth management forum globally, IMPower Fund Forum International in Monaco, followed by meetings with wealth managers in Europe and the UK.
As we enter our eleventh year, we have tried to make the Fund Forum conference and European manager visits an annual event (COVID allowing). The views of so many leading global investors provide great insights to the direction for asset classes, and we believe that the learnings we have gained from conversations with other wealth managers have helped us position our firm for the future.
There were three main themes of our discussions – 1) where to next for risk-based assets, in particular equity markets, 2) Artificial Intelligence or AI, and 3) Private Markets.
The outlook for equity markets is wide and varied at the moment. They say it takes two to make a market and we found that equity market managers were bullish, however economists and fixed income managers were more cautious on the outlook for equities. Seldom have we seen such a disparity in views.
The reason for the disparity in views is that equity market managers are coming from a bottom-up valuations basis whereas fixed income managers and economists look at things from a top down or macro point of view.
The rally that markets have experienced has been narrow, in that seven technology stocks have driven an extraordinary bounce in the NASDAQ and the US market in general but, to be fair to equity managers, the market has bounced based on the view that interest rates are near their peak.
As we have often said though, ignore fixed income markets at your peril. The US yield curve is inverted with the 2-year bond currently yielding over one hundred basis points higher than the 10-year bond. Fixed income markets are factoring a shallow recession in 2024.
Fixed income markets may be broadly correct in that the US will enter recession, but the equity market believes a recession can occur without earnings being severely damaged. Once a recession is clear, lower interest rate expectations will take hold which in turn will support equities. Could markets however react with more fragility than this scenario suggests?
The debate in Europe was about whether the effect of a slowdown on earnings has been fully factored in. How will markets react if the US tightens further than is currently anticipated? Just last week, US Fed chairman Powell made it clear that future rate rises above the current Fed Funds rate of 5.5% would be data dependent but he also made it clear that the market is too optimistic about how quickly the Fed will start to cut rates once they have peaked.
Meeting with Capital Economics in London, they pointed out that on only five occasions has the US market rallied during a recession and those times were based on depressed valuations or created a bubble as a result of the rally.
Capital Economics believes the second half of calendar 2023 will see the US S&P500 pull back somewhat before “powering ahead” in 2024-25 as the US looks beyond a recession. They also pointed out that the market has indeed fallen on the basis of valuation, the Schiller CAPE peaking at 39 near the end of 2021 versus a level of 30 today, but this cannot yet be described as a “depressed” valuation.
We agree that it is too soon to say that we are at the start of the next bull run for equities, but we acknowledge that recent data supports the view that inflation can get back to central bank objectives without a significant economic downturn. As a result, we have moved back to a neutral weighting for global equities, via adding to global small cap equities where valuations are at recessionary or “depressed” levels.
Respected commentator Mohamed El-Arian points out that current inflation has resulted from restrictive supply rather than excessive demand and this is why he believes the US Fed should be near the end of its hiking cycle. He argues that the Fed should be targeting an inflation rate closer to 3 per cent, rather than “put the economy through the wringer” to force the rate down to 2 per cent and cause a severe recession at the same time.
With respect to Artificial Intelligence (“AI”), whilst the bears are arguing that AI is creating a technology bubble similar to what we saw in 1999, we do believe that AI is a transformative technology, but the true benefits are perhaps 2-3 years away. It is worth remembering that Amazon fell 92 per cent when the dot com bubble burst, on its way to transforming the retail shopping market.
AI dominated discussions in Europe and left us in no doubt that this is a strong area for investment. It will change the world and will change our industry as well.
The present size of the AI market is USD136.5Bln, with EY estimating the size of the market to surpass USD15Trillion by 2030. The large technology companies are investing heavily in the area (Alphabet $35Bln and Meta $21Bln).
The focus was on Generative AI which goes beyond labelling and characterises data, generating or creating new data based on training data on the model.
The most talked about area of AI is Chat GPT which achieved a million users in 5 days and 100Mln users in 60 days (Instagram took 75 days to reach a million users) and which has definitely moved the market. It was mentioned that it is unprecedented to see big tech refocus on AI as a core part of their strategy and at the speed which they have done this.
Everyone is raving about Chat GPT’s functionality, but one wealth manager raised the issue of privacy and questioned whether these issues have been clearly sorted out.
You will see 90 per cent of online content generated by AI by 2025 and already Bloomberg have launched Bloomberg GPT for financial analysis.
Someone wisely said to us that every CEO would be looking at AI and wondering how to implement this and therefore one of the big winners would be the management consultants and therefore Accenture as a listed company in this space.
The third key discussion point from Europe was Private Markets and the “democratisation” of these markets.
We want to stress that this term democratisation is talked about by managers for the retail market, in making private assets more accessible to these investors. There is no doubt many public markets such as our own ASX has shrunk as many companies shun listing due to the availability of private capital, or delay listing by an average of six years from a decade ago, again due to the access of private capital.
Many investors focus on Private Equity when they think about Private Markets, but they also include Private Credit, Infrastructure, and direct Real Estate.
We have had vehicles in Australia with full or partial liquidity in these asset classes for Wholesale Investors for some time. HWP is a strong believer that for the right clients Private Market exposure has both lowered volatility and enhanced returns with valuations that are realistic in this environment.
For Wholesale investors in Australia looking at this part of the market don’t get fooled by the over emphasis on democratisation – just because you can access doesn’t mean you should.
Being knowledgeable on the asset classes is paramount before you invest, and you should be aware of:
- Projected return features and the cost structures in these funds.
- The liquidity of the funds and can the fund be locked up if redemptions exceed a certain monthly level?
- How often do valuations occur? To be fair to provide for instance monthly liquidity requires monthly valuations.
- Time horizon of the investment.
- Do you as an investor understand what you are investing in?
On another note, most wealth managers pointed out interest rates are close to their peak. With Australian 10-year government bonds providing a yield of approximately 4% per cent, in the case of an economic slowdown bonds will rally and we are increasing exposure to duration in our portfolios as distributions come in from fund managers.
We are still concerned with many areas of private credit. We are comfortable with the managers we use but we don’t intend to chase yield whilst exposing portfolios to unnecessary risk, especially as the word is deleveraging. Liquidity is key.
With underlying yields where they are today, investment risk decisions have now changed and we do not believe that many have worked this out yet!
As we have been doing over the last eight months, we leave investors with our scenario analysis. Markets do have an edge of optimism about them at the moment, but it is what is around the corner that we are closely watching for.
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