Learning the lessons of history
JCB Jamieson Coote Bonds
Investors have been faced with more historic events in the past three years than most people see in two decades. Charlie Jamieson and Mark Burgess share their views on what's ahead and how lessons from the GFC have prepared investors.
Investors have been through a range of extreme events in the past three years. Those trials have included zero interest rates followed by the fastest rate hiking cycle in history, oil prices turning negative, two of the largest banking collapses in US history, several crypto crashes and - most obviously - a global pandemic.
Now, three years on from the start of the pandemic, Jamieson Coote Bonds (JCB) Chief Investment Officer, Charlie Jamieson and Mark Burgess, Chair of the Advisory Board, have shared their views on the path ahead for markets.
SKILL TO DRIVE FUND MANAGER RETURNS
In the years following the global financial crisis (GFC), falling cash rates drove better returns from bonds, according to Mr Burgess.
When central banks cut their cash rates following the GFC (and abruptly 'raced to zero' during the early stages of the pandemic), it helped fund managers deliver generally better results, he said. Typically, banks lower their borrowing costs as the cash rate trends downward. As a result, falling rates reduce the cost of capital for businesses and increase the expected return on investments*. Lower borrowing costs also encourage businesses to invest more in new capital assets.
But that situation has changed with significant lifts to cash rates worldwide in the past 12 months.
Mr Burgess said fund performance will come to lean more heavily on the skill of fund managers. Their ability to pick assets, the strategies they employ and the timing of their implementation will be vital to their success.
"So the choice of manager matters," Mr Burgess reiterated.
"Skill will be the biggest proportion of return, rather than falling rates which has been the biggest proportion of returns in my career. And if you have invested with a fund manager who's not that skilled, you're about to find out about it."
NO 'V-SHAPED' RECOVERY
Mr Burgess explained that while there's little doubt the global economy is in the throes of a bear market, there's some debate over whether this is a normal cyclical bear market, or a structural one. If it's a structural bear market, the correction will be "far deeper and longer" than if it were simply cyclical.
Mr Burgess, however, is not in the structural camp. "For that correction to happen, the structure of the system has to break," he said.
Mr Burgess went on to explain that while the environment remains fragile, lessons from 2008, interventions by authorities in any failing institutions and better capitalised core banking systems, should allow for less cyclical damage than markets such as 2008 or 1970s which saw severe structural corrections.
He noted however that the environment remains challenging, which will limit the ease of an immediate recovery.
"It's no longer about creating credit; it's about how we structure debt and refinance. With high levels of debt refinancing is the key and the recovery there will be challenging."
Although assessing the current bear market as cyclical, JCB does not expect to see a 'V-shaped' recovery in which asset prices enjoy a sharp rise back to previous highs after a similarly sharp decline.
"Barring a catastrophic and systemic shock we're not going to be cutting rates," Mr Jamieson said. "That's why it's such a different go-forward, because all of the things that got carried to that very high place pre-COVID are unlikely to get carried in that same way.
"So, as we've had these adjustments through the bond market, through some credit markets and the like, we're not going to get that V-shaped recovery."
PLENTY OF CASH ON THE SIDELINES
Mr Burgess said one of the big surprises is how much money is currently "sitting underneath the market". This, he said, is likely driven by the lessons learned in 2008 during the GFC.
"One of the advantages of having had a global financial crisis in '08 is that when you get a financial crisis, you actually get some future benefit, and that future benefit is that you know how to handle a financial crisis," he said.
"The way people are preparing for it is that a lot of high-net-worth investors have a lot of cash ready to buy distressed assets."
Most institutional investors have already pre-allocated cash to purchase distressed or oversold assets, he said. However, in some cases Mr Burgess said the volume of cash sitting in some areas such as private equity and institutional and high net worth holding is notable. Other areas however will see cash constraints - such as speculative technology.
COMMERCIAL REAL ESTATE SECTOR SET TO DIP
Property markets have received significant attention as rising interest rates place the sector under mounting pressure. In the residential space the effects of these rate changes are already being felt, Mr Jamieson noted.
"Anecdotally, from talking to my friends, we're all in our 40s - we've got our own families, we've got a high cost base at this point in our family lives - everybody knows it's going to be hard," he said.
"I don't feel like anyone's really well set up for it yet. They just think that they'll make the adjustment if and when it comes."
In the commercial property sector, however, some interesting themes are starting to take root. Mr Burgess noted that between higher interest rates and the 'work-from-home' revolution that started in COVID-19 lockdowns, office spaces may not be generating the same returns.
The outlook for the sector remains negative, he added, and some investors are now looking at strategies to profit off this weakness. He cited Blackstone's newly launched US$30.4 billion distressed property fund as a prime example of this approach.
Mr Burgess cautioned that while he expects prices for commercial property in Australia to continue falling, he doesn't think the downturn will be as pronounced as in past cycles.
"There's not so much distress out there that people are going to have to give buildings away this time around."
BONDS STAGE A RETURN
Throughout the past cycle, Mr Burgess said, markets were plagued by "too much capital" chasing select stocks - with buy-now-pay-later businesses, speculative technology areas and video streaming giant Netflix both prime examples.
This excess capital pushed distorted valuations and ultimately hurt returns. Mr Burgess said much of this excess capital has already "been washed out" of the market but cautioned "there's other areas that have yet to play out".
With this in mind, Mr Burgess predicted a return to "good old-fashioned investing" where investors are wary of too much capital flowing into companies they're looking at.
At the same time, Mr Burgess said investors are starting to look to government bonds as another option for their portfolios.
"What I hear as a bond manager is that people are buying government bonds through gritted teeth, but bonds have gone back into some sort of normalised range," he said.
"Now institutions are gradually allocating to bonds because they're starting to think it actually makes sense. The sharp rise in interest rates have made bonds quickly attractive again".
The key to navigating the next 12 months, he said, would be to consider the current market with fresh thinking, weigh up which direction capital is flowing (and how much of it is moving), and using 'age-old' investing techniques to generate returns. True investment skill will finally be back in fashion he noted.
* Reserve Bank of Australia, 'The Transmission of Monetary Policy: How does it work?', September 2017, accessed 20 April 2023.
Author: Charlie Jamieson and Mark Burgess
Funds operated by this manager: