Still, the more expensive parts of the market are likely to remain under pressure, the fund manager says. Since the start of the year, the highly-valued tech sector has retreated as investors worry that rising long-dated bond yields will dampen its appeal.
“It just gets more difficult for those sort of stocks in that environment, so there will be some good sorting of quality from junk in that part of the market,” Bruce says.
“Overall, we’re pretty positive. There will be lots of corporate activity,” he adds, pointing to recent deal activity around wagering company Tabcorp as an example. “There will be no shortage of people trying to extract value that way.”
T. Rowe Price’s Randal Jenneke is less optimistic about the outlook for growth and the market, saying the signs are pointing to peak growth and inflation. If that’s the case, the easy gains for the companies leveraged to the economic cycle may be over.
Jenneke, who is head of Australian equities at the US investment giant, says he’s been trimming his positions in the banks and miners, and moving towards quality sectors of the market, such as healthcare.
He acknowledges his view is “probably a bit contrary” and that the general expectation in the market is for continued growth and inflation.
But he pushes back on that expectation. “I think that’s the wrong way to think about it because the only way that can happen is [continued] fiscal policy to provide a really strong source of growth,” he says.
“And that’s not what’s going to happen. You can see that in the budget numbers,” he adds, in a reference to the federal budget released last month.
“We are going to move from a deficit of close to 8 per cent of GDP back down to close to 3 per cent when we get out to 2023-24.
“[Treasurer Josh] Frydenberg was quite happy to say that Australia is going to see one of the strongest fiscal consolidations out of any country with the strongest credit rating.
“We are in that phase now with that budget, with that fiscal consolidation and that means that source of growth that has really pumped up value is really going to start to wane.”
Jenneke has been taking profits on the miners. “Commodity prices are at record levels and obviously share prices have reflected that. I’m concerned about the sustainability of commodity prices, particularly the iron ore price,” he adds.
Quality as a style
Iron ore prices hit a record high in May, surging past $US230 a tonne on strong demand from Chinese steel mills catering to economies that are reopening at a time of persistent supply constraints.
“I think we’re at a [commodity price] peak,” says Jenneke. “It’s always difficult to know when we will start to see weakness but I think that more signs are starting to point to the fact that the current levels won’t be sustained.”
He points out that quality as a style hasn’t looked as good for five to six years. There are opportunities in stocks that have been left behind in the wave of value-focused buying, and he is keen on Goodman Group and Carsales.com.
Healthcare had its worst year in a decade last year, he points out. “That’s where we see good opportunity. ResMed is an example of a stock that we think is really attractive. Valuations are back to the most attractive level in five years. As the US economy reopens, the sleep business can get back to normal and there’s a new product cycle coming.”
Jenneke is more interested in tech stocks after this year’s bout of share price weakness because of the prospect of higher interest rates. “Tech is looking a lot more interesting,” he adds.
Mark Arnold, chief investment officer of Hyperion Asset Management, is a long-term investor in tech stocks, including Afterpay, Wisetech and Xero. He considers these companies to be examples of modern businesses that aren’t too leveraged to the economic cycle and deploy disruptive technology.
Healthcare is also favoured by Hyperion, which invests in blood products company CSL, implant firm Cochlear and ResMed. “Fisher & Paykel Healthcare has been a big exposure for us over time,” Mr Arnold says.
“We don’t really have direct banking exposure. We have got Macquarie but we see that more as a fund manager rather than a traditional bank.
“We have exposure to James Hardie as well. That’s obviously a cyclical business but we think it’s got structural growth over the longer term and a big addressable market, particularly in the US.”
Arnold is comfortable holding these businesses during a period of economic expansion because he expects growth generated by coronavirus-related reopenings to subside over the next year and a lower-growth environment to resume.
“There’s an abundance of growth in the short term. But we think that abundance will disappear once you start to roll into 2022-23. Growth will become much more scarce during that period,” he says.
“And that’ll make it more difficult for your average-type businesses, which are highly dependent on economic growth for their growth.”
He says Hyperion’s investment style is premised on investing in businesses that do not rely too much on economic growth but instead grow mostly by taking market share.
“We’re not really relying on the Australian economy growing or the global economy growing materially over the next 10 years,” he says.
“We are not investing in the overall market, we are just investing in a small segment of the market. We still believe inflation is likely to stay low over the longer term. And that the current pick-up in inflation is cyclical.”
Inflation has started to rise in economies such as the US, where the consumer price index surged in April to a level not seen since 2009 on a headline basis. Core CPI was even stronger, rising the most since 1996.
But Arnold says surfacing signs of inflation are “really just a function of the cyclical recovery in the economy from the current COVID-19 lockdown. We got some government stimulus as well.
“Our view is that, over the longer term, there are still a lot of factors that will suppress inflation over the next decade.”
He says these include technology, innovation and disruption “and just making better products for cheaper prices”.
Cheaper energy in the form of renewables and better battery technology is a big part of his investment thesis. “Solar, wind and batteries are all on technology cost curves. So they are likely to get cheaper at double-digit rates over the coming years. And that will feed through into cheaper and cheaper energy prices and that will be disinflationary.”
The outlook for demand isn’t robust, Arnold says. “We think that demand, once we get through this cyclical uptick, will be quite low because of structural factors like ageing populations and high debt levels and rising wealth inequality in most countries around the world.
“We think that the overall outlook for economic growth is quite subdued once you get through the cyclical recovery that’s occurring at the moment.”