Key points: 

  • Morningstar's Matt Wacher says there's a 'big chance' the RBA over-hikes, causing growth to slow substantially in Australia. 
  • Having different return drivers in a portfolio offers protection during times of uncertainty
  • Bonds are back to being a reasonable diversifier.
  • Some value seen in tech stocks, China and European financials


Also see: Why a slowing economy can produce buying opportunities.

Transcript: 


Sarah Dowling: Hi, I'm Sarah Dowling. I'm here with Matt Wacher, Morningstar Asia Pacific's Chief Investment Officer. A big focus this week is around the RBA. We're in the middle of the tightest interest rate hiking cycle in decades, but you're seeing chance of interest rate cuts later in the year.

Matt Wacher: Yeah. So, I've been quoted a bit around that lately. But I would say that we're prepared in our portfolios for multiple different interest rate scenarios. I think that what we would consider in terms of our portfolios is that there is a big chance that the RBA over-hikes and that could lead to growth slowing substantially in Australia. I mean, there are tailwinds from China and things like that that could play out. I think there's probably a few issues around that thesis as well in that China are looking elsewhere for some of the commodities that they need. In Africa and Brazil, for example, supply is really starting to open up. But in terms of the interest rate call, I think that if things play out and consumer spending starts to really go off a cliff, then the RBA will be really forced to consider what they're going to do, and that could lead them to cut rates later in the year. It's not a fait accompli. I think there's a few rate rises to come, or at least two, I would estimate. But it's not core to our investment thesis across the portfolios we run. But it's something that we're very much aware of that things can change very quickly.

Dowling: The consumer in Australia, I suppose, might be particularly sensitive to interest rate rises compared to other countries. Do you think that markets are not fully factoring that in?

Wacher: I think in the Australian market that's probably the case. We think that the Australian market, it's at all-time highs or very close to. And that doesn't quite gel with the thesis that rates have risen to the extent they have consumers. Retail sales have started to really show some signs of deterioration. And we haven't even got to what people out there are calling the mortgage cliff. And once those fixed rates come off that basis of the idea of the mortgage cliff, there will be a big jump in rates and consumers will be hit even harder. And so, I think there's only so far the RBA can go before really inflicting some pain on the economy. But we're still already seeing some of that consumer weakness at this point in time.

Dowling: Is that pain going to be starting to be seen in earnings, company earnings, do you think, because we're heading into reporting season now, which I suppose reflects a different cycle where the full impact hadn't been seen?

Wacher: Yeah. I mean, I think that you saw some great numbers from places like JB Hi-Fi, Harvey Norman as well where consumers were really spending and then some of those consumer discretionary names really had that tailwind to them. I think I would say that we're going to start to see that taper off quite substantially. And what's priced into markets, I think it's starting to get a little bit speculative at this time in the Australian market in particular. And so, in terms of earnings, we focus on the long term, but we'll start to look at how we think that some of that's playing out, those consumer sentiment and the actual spending that consumers are undertaking, how that's starting to play out in the broader economy and see what that does to valuation.

Dowling: And so, with the environment being quite uncertain at this moment, how do you manage that in your own portfolios?

Wacher: So, we want to have multiple ways to win in our portfolios, I guess. So, we want to make sure we have different return drives in the portfolio. Especially at this point in time, where you look across the world and there's lots of divergence in markets, you see interest rate policies different or stages of interest rate hikes being different in different parts of the world. Emerging markets got ahead of things in terms of trying to get inflation under control well before developed markets. You see the US potentially getting to the top of their hiking cycle. Europe still got some big rate rises in the works according to the ECB. And so, there's lots of divergence out there, but at the same time, valuations have improved across the board since this time last year. And so, we think that you can have a much more diversified portfolio at this point in time. Bonds look like a reasonable diversifier. So, that's one way to play things from a defensive perspective. We think that quality stocks, while some are still expensive, we want to own some of those assets. And then, we think that there's still room to move in some of the areas that might be a little bit more cyclical. I think some of the tech stocks that got hit very badly last year. China is another area that we think there's some value. And Europe, and particularly European financials are better capitalized than they have been for a very long time, and they're showing some value as well.