The challenge to leadership
Global Investment Insights
By Rob Tucker, Managing Director, Chester Asset Management
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Leadership is being challenged in many ways currently. We have (surprisingly enough) much empathy for politicians currently as they grapple with ever changing variants of the COVID-19 pandemic, while battling to keep supply lines open and the economy moving. Embedded cost pressure is everywhere. Fortunately, as Australians we are a compliant nation, and vaccination rates appear to be working in managing a more significant health crisis. Geo-political leadership is being tested with Russia and China probing at the US/Western alliance’s desire for global democracy. Are Ukraine and Taiwan susceptible to a change in control? Does the US still have the fortitude to be the world’s policeman?
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Inflation is going to be a persistent problem in the 2020s.
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These issues may seem poles apart, but from an investment perspective, they form part of the same landscape in 2022. Risk appetite and investment leadership is changing.
We have been consistent in our view that inflation is going to be a persistent problem in the 2020s. Absolutely, the cyclical element of supply chains and logistic bottlenecks should theoretically unwind over the course of the next 12 months. The structural components of a willing workforce being incentivised to work (wage pressure), decarbonisation (cost of energy increases), localisation of supply chains (increased CODB) and asset price inflation (cost of living increases through shelter costs going up) appear to be more embedded. Hence, the most likely roadmap ahead is inflation remains stubbornly high (above 3-4%), but is likely to peak over the next 3-4 months (fall from 7%) as the rate of change starts decelerating. To reiterate though, this is the first time in 40 years that inflation has been considered a problem. The change in leadership from a growth friendly environment to a far more appealing backdrop for value based investments (focusing on near term cash flow delivery, dividend yields and asset backing) is now starting to play out. In our experience, this is not a 3-6 month trend, but is more likely to be a 2-3 year trend.
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The challenge to leadership is happening very quickly in equity markets as investment flows have started following a significant change in monetary policy.
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The challenge to leadership is happening very quickly in equity markets as investment flows have started following a significant change in monetary policy by both the Federal Reserve and the ECB over the past 8 weeks. With the focus of central banks now firmly on fighting inflation, the subsequent style rotation from growth sectors to a value bias with asset backing has been very sharp. This all but ensures more volatility occurs over the first half of 2022. It is worth watching credit spreads closely for broader contagion. Since the end of the GFC (2009), it has been a very popular trade to invest heavily in long duration assets, as interest rates have done nothing but fall.
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Investing heavily in long duration assets has been a very popular trade in the falling rates environment, since the end of the GFC.
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In that environment growth and momentum investing had been successful, but a large element of speculation had crept into equity prices over the past 18 months. With the prospect of interest rates rising, the landscape has well and truly changed, and is poised to benefit the investment style we adopt in allocating capital.
Applying a framework that focuses on asymmetric investing where, at the outset, the aim is to minimise the downside of an investment, and then identify catalysts that unlock the value inherent in that investment. The most recent examples of this line of thinking have been Origin Energy (ORG) which was purchased in the low AUD4.00 range and Nufarm (NUF), which was added to the portfolio in the 3rd quarter of 2021. Both deeply unloved at the time, yet applying this approach, identified both earnings drivers and stock specific catalysts for both companies to close the gap between the prevailing share price and our assessed valuation. The fact that both companies were trading below book value at the time lends itself to our asymmetric risk profile. This will be an interesting year.
Disclaimer
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