Market Update - 12 December 2019

There is a strong consensus today that is critical to the positioning of all financial markets globally: it is widely believed that interest rates will stay low, near or even below zero, for a long time to come.

“Lower for longer” is a view we’ve held for several years and was the focus of our roadshow in 2016. But today, when investors are talking about when rates go negative, rather than if rates go negative, it’s indicative of just how strong the consensus view is.  And markets are positioned accordingly.
 
However, when the consensus is this strong, it is important to consider under what circumstances that this view might not hold.  And then to think about the potential impact on markets.
Questioning the view of the crowd is at the core of what we do at Platinum.
 
So, let’s compare today’s interest rates with how low they were in times of crisis.
 
US 10 year bonds are around 1.8%, having been as low as 1.5% recently, similar to levels in 2012 during the European Sovereign Crisis and 2016 during China’s investment slowdown^[i].
 
10 year German Bunds are at -0.3%.  They were at 1% in 2012, Europe’s darkest days since the GFC^[ii].
 
In Australia our bonds are at 1.1%, lower than the 2% we saw in 2016, when China, our major trading partner, was in a hole, and the 3% we saw in 2012^[iii].
 
Rates today are consistent with a grim global economy, but is it really that bad?  In the last five years, the US has created nearly 10 million jobs, Europe has added almost 9 million, and even Japan has added over a million^[iv].  Jobs may be a lagging economic indicator, but this data suggests a relatively robust global economy.
 
There are always issues: China’s slowdown drove the world into a manufacturing recession, and protests in Hong Kong and Chile have a common thread of income disparity at their core.  But the employment data certainly suggests an economic environment that is better than the headlines would have us believe.
 
There are limitations on how negative interest rates can be.  Simplistically, banks cannot broadly offer negative rates as depositors will remove their funds, breaking the system. 
 
We now hear calls from central banks suggesting their governments should increase fiscal spending. With unhappy voters, what government, given permission by their central bankers, won’t be lulled into additional spending?  We are already seeing a rise in budget deficits in the US and China, and this is likely to spread to Europe.
 
As China’s current account surplus has vanished, Europe is effectively funding the rest of the world.  If Europeans elect to spend at home, we will see more competition for savings, potentially forcing rates higher.
 
Meanwhile any additional government spending will come at a time that labour markets are reasonably tight, many commodities markets are tightening, and manufacturing activity seems to have reached a trough.
 
It’s not hard to envisage some upward pressure on inflation and interest rates in such a scenario, and the US treasuries back at 3%.
 
The implications for markets?  Today, investors are being pushed into equities by low rates as they seek higher returns on their savings.  This is occurring at a time when there are significant concerns in markets, such as the political tensions between the US and China, manifest in the trade war, and the impact that technological disruption is having on many traditional businesses.

The response of investors has been to:

1. Seek investments that are perceived safe havens, such as utilities, real estate, infrastructure and consumer staples.
2. Seek investments in strong growth areas such as payments, software and e-commerce.
3. Avoid stocks with any uncertainty, particular companies potentially impacted by the trade war, such as autos and electronics, as well as cyclicals and banks.

The crowding into ‘safe havens’ and ‘growth’ stocks has seen valuations in these areas pushed to extraordinary levels.  If we see higher interest rates, these types of investments will be particularly vulnerable, similar to what we saw in December 2018.

On the other hand, for stocks that have been overlooked due to their inherent uncertainty, any push for growth via fiscal spending will be beneficial.
 
As we have noted in our communications this year, we are positioned against the crowd here.  We own a lot of companies perceived as facing uncertainty, whilst shunning, and selectively shorting the hotter areas.  This is consistent with our investment approach.
 
I’d like to mention some of the specific opportunities.
 
In the US, we have invested heavily in semiconductor stocks.  Examples include: Microchip, a manufacturer of microcontrollers that are used anywhere with embedded applications – from whitegoods, to autos, to toys.  Skyworks Solutions is a producer of radio frequency chips which appear in any device that is wirelessly connected, such as our mobile phones.  They will be beneficiaries of 5G and the Internet of Things, yet were sold-off as a result of the slowdown in mobile phone sales and the Huawei bans.
 
We have also been increasing our exposure to Japanese industrial companies.  Examples include MinebeaMitsumi, the dominant global maker of miniature ball bearings and other industrial components, and Nitto Denko, a manufacturer of adhesives, films, semiconductors, and other components.
 
Over in China, after last year’s slowdown, the trade dispute and Hong Kong protests continue to create uncertainty, but that is creating the opportunity.  Asian economies will continue to grow and our focus has been finding the domestically oriented companies that will tap into the resilient growth trajectory.
 
Our Chinese holdings in many ways look like what has been working in the rest of the world, at much more attractive valuations: high quality defensible businesses such as life insurers, Ping An Insurance and AIA, are complemented by dominant internet platforms including Tencent and Alibaba, and the more locally familiar platforms such as Momo and Meituan Dianping, which resemble Tinder and Uber Eats.
 
Elsewhere in the region, India is a great story, but the locals are onto it.  We are exposed to the consolidating telecom industry via Bharti Airtel, and retain exposure to financials, such as Axis Bank. In Korea, the consolidation in the memory chip industry means Samsung Electronics is very well positioned to continue to dominate a growth industry, while still perceived by many as a deep cyclical.
 
The key thing to remember is that while the fundamental drivers of economic development are entrenched in the region, the Asian markets remain out-of-favour, and make up the largest part of our portfolio today.
 
Finally to Europe, which is in focus again with the UK elections and Brexit implications.  But, let’s look at the facts.  Yes, European economic growth has slowed, dragged back by the global manufacturing recession, but this is only 20% or so of the economy^[v].  The remaining 80% is services, and growing nicely.
 
The employment rate in Europe has been increasing for two decades and is at record highs.  73 out of 100 working age Europeans are employed^[vi].  Job security is high because unemployment rates are falling and, in many countries, they are at record low levels.  Wages are rising.  Inflation is falling.  Consumers are enjoying increasing spending power.  The housing market is going well.  Credit, which has been retrenching for many years, is growing again.  So, the services sector is in good shape.
 
The risk is that we get contagion from manufacturing into the services sector through deteriorating consumer and business confidence.  But manufacturing has been in recession for over a year now and there are very few signs of spill over.  The economy has been extraordinarily resilient as a result of many improvements implemented over the last decade.
 
We are finding opportunities in cyclicals – we have previously mentioned Glencore and BMW among these.  Great companies facing short term challenges.  But, in recent times we have been able to add strong companies such as the Bank of Ireland and Ryanair, the low-cost airline, both victims of the Brexit uncertainty.
 
So, as we go around the world, the result of the strong consensus on interest rates poses the simple question:  what happens if there is a small change – be it fiscal spending or a realisation that economies are solid for now, against a backdrop of political turmoil?  Given that the lower discount rate remains the key justification for the valuation of many of the hotter stocks, we are comfortable building a portfolio in the out-of-favour parts of the market.
 
The key exposures in the Platinum International Fund are to semiconductors, energy, materials, autos, financials, and China.  The long book has a price-to-earnings ratio of below 12x^[vii].  Our net exposure has risen in recent months as we have put some cash to work and reduced index shorts, but it remains at a relatively cautious 83%^[viii].
 
The performance of the Platinum International Fund calendar year-to-date is 16%^[ix], a reasonable absolute return, though obviously lagging the broad market.  The broad market has been driven by a rerating of the expensive growth and defensive stocks.  We will continue to avoid these stocks, as at best these represent, in our view, very low return investments, and at worst, highly speculative ones. 
 
 
Andrew Clifford
CIO
 

_{This information has been prepared by Platinum Investment Management Limited ABN 25 063 565 006 AFSL 221935, trading as Platinum Asset Management ("Platinum"). It is general information only and has not been prepared taking into account any particular investor’s investment objectives, financial situation or needs, and should not be used as the basis for making an investment decision. You should obtain professional advice prior to making any investment decision. You should also read the Platinum International Fund product disclosure statement before making any decision to acquire units in the fund, a copy of which is available at www.platinum.com.au. The market commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. Certain information contained in this presentation constitutes "forward-looking statements".  Due to various risks and uncertainties, actual events or results, may differ materially from those reflected or contemplated in such forward-looking statements and no undue reliance should be placed on them. No representations or warranties are made by Platinum as to the accuracy or reliability of this information. To the extent permitted by law, no liability is accepted by Platinum or any other company in the Platinum Group®, including any of their directors, officers or employees, for any loss or damage arising as a result of any reliance on this information. Past performance is not a reliable indicator of future returns.}