Words on Tensions in the Middle East (Part 3)

David Hay Welcome everyone and thank you for joining us for our Evans & Partners webinar today. The topic we’ll be discussing is escalation and exit, of course, around the evolving events in the Middle East. My name’s David Hay, Senior Investment Advisor here at Evans & Partners and joined by our ever familiar face and voice, Tim Rocks, our Chief Investment Officer. Tim, welcome.

Tim Rocks Hello, hello all, thanks for dialing in.

David Hay The topics we’ll discuss today are fairly obvious, following on from our two other webinars and podcasts, we’ll discuss our evolving thoughts, as I said, as things are playing out in front of our eyes. There is the opportunity to ask questions here today, so that’s on the question function on this Zoom call, so please feel free to type them in and we might get to answer some, sorry, ask Tim to answer some of them at the end of today’s session. Tim, let’s start off. ⁓

We were in front of clients two weeks ago. The state of the conflict now, where do you think we’re at? And I suppose at a broad level, has your thinking evolved or changed at all?

Tim Rocks Great. Thanks, David. Yeah, I mean, obviously it’s hard to know exactly. I’m not sure I want to put myself in Donald Trump’s head and try and understand it. ⁓ But it does seem to me that they can’t declare victory until the straight is open. And it feels like Iran is a long, long way away from conceding anything. So it does feel like it’s going to go on for a little bit longer. But again,

I think the right way to think about this is on a say, let’s call it a six month view. Six month is important because Trump will have those mid-year elections, midterm elections in his mind. ⁓ And so we will be over at some point before then. And I think from a market perspective, we’ll look back in six months time and think, you know, this was a good entry point for markets.

⁓ The valuations are lower, interest rate securities are yielding more. So it’s important to have that perspective, I think.

David Hay So Tim, you’ve said on previous ones, you don’t believe that these events will lead to a global recession. Is that still the case? I mean, it’s four weeks, give or take, since the start. Is your thinking involved there at all?

Tim Rocks ⁓ That has not changed at all. I still think there’s a mindset about oil prices that was based around the 1970s experiences that won’t be repeated. Remember, gasoline, petrol are small parts of consumer spending, only sort of two to three. You’ve got to also remember that war creates GDP.

So Trump has said that he’s gonna ask for $200 billion of new spending to replenish that arsenal. That’s 0.7 % of GDP and that’s actually greater than the hits that people are talking about from the high oil price. Also gotta remember the 70s was pretty unique. ⁓ Were the recessions driven by the higher oil price or were they driven by the fact that interest rates went up five and 10 % in those two kind of sagas?

⁓ And then also aside from all of that is we have gone through $100 oil price before. Remember that the oil price was above $100 a barrel for four years from 2011. World didn’t end. The oil price was above $100 a barrel for six months in 2022 and the world didn’t end. So I think we’ve really got to put these things in perspective is if all this is a higher oil price for a period of time.

That’s not great, but it is nowhere near enough to cause a global recession.

David Hay Himy, comments sort of focus perhaps a little bit more on the US versus the globe. Are there other parts that will Europe potentially be a bit more affected or emerging economies? Again, I’m trying to put you on the spot, but are there other impacts elsewhere?

Tim Rocks Yeah, that is absolutely true. maybe we’ll talk about Oz in a minute. ⁓ so Europe is a bit more so US is actually pretty good because they are self sufficient in oil doesn’t mean there aren’t any effects. But that’s a good starting point. Europe is more challenged because they need natural gas and they buy that at spot prices, particularly the UK. So they will have a bigger impact ⁓ because of that.

that will filter through to electricity prices unless the government does something about that. So again, is that enough for a recession? Probably not, but it is a bigger potential hit in the short term. And then when you’re talking about Asia, there is a greater vulnerability to Middle East supply. So again, there’s a greater price shock, but provided it’s only a price shock and not a complete shortage.

then I think those economies can deal with it.

David Hay Yep. And domestically, Tim, are we a little bit more at risk because of the settings we had coming into this event that’s going on?

Tim Rocks Yeah, so I think Australia is more vulnerable here because of the risk of shortage. That’s not a realistic possibility in most other countries. But again, because of that policy error, or multiple policy errors probably, of getting rid of our domestic refining capacity and having one of the lowest reserves of oil stroke petrol in the world, that has created a vulnerability.

And so again, I come back to this thing like a price shock is one thing, it’s not great, but a supply shock, an actual shortage has the potential ⁓ to cause more disruptive unexpected effects. So, ⁓ and if you’re thinking about Australia, you particularly think about diesel, the diesel shortages do appear to be a bit more and diesel is important because it has more industrial stroke farm uses.

⁓ So we need to watch that. Again, I don’t think we’re at the point now where you’d factor in a high probability of a significant problem in Australia. But if this was to drag on for a couple more months, then, and the government did not deal with it sensibly, ⁓ then there could be a greater risk. So.

Yeah, Australia is a little bit more vulnerable. Again, I don’t think there’s any sense that we need to panic about earnings and markets and the like yet, but we need to be a bit more aware of it here.

David Hay Yep. And Tim, this is a, I might grab a dart board and put it up behind me, but you the oil price in a year’s time. mean, I think it’s important just to put that out there so people viewing can get what we’re thinking about and have their own thoughts. Where do you think the oil price could be in 12 months time?

Tim Rocks Yeah, so it’s important to realize that oil above $100 shouldn’t be the base case here. That as soon as the conflict is over, there is going to be multiple levers that can be pulled that will get the oil price down pretty quickly. You’ve got a lot of reserves in all these countries, you’ve got the potential to allow Russia to export more. So that you can have increased production in the US, all these types of things.

So the base case is oil price goes back to maybe a little bit above where it was before, but not the $100 a ⁓ barrel for a long, long time. So again, really the debate here is all about the length of this conflict and being aware that really this is a US created problem and the solution.

is and the US is highly motivated to sort it out, even if they have to pay a lot of money in some kind of reparations through some third party to actually sort of get that done.

David Hay Is the scenario that oil assets, ⁓ transport refining assets were damaged in the Middle East or further damaged if you like, does that change that view there?

Tim Rocks Yeah, so so I think that that is, yeah, the scenario of oil being above $100 for an extended period would require significant damage to energy infrastructure. And it is notable that in the last couple of weeks, when that when there was some damage when both sides did the tit for tat damage to energy infrastructure, we very quickly stepped back from that. So there is some

Common sense, there are some kind of lines here that are very obviously not being crossed by both sides.

David Hay Antium, quickly, mentioned the UK and gas. ⁓ What does the oil price mean for the gas price? Because they’re linked, I’m sorry.

Tim Rocks They are a lot of the, you think about the impact for Aussie stocks, it does vary, but a lot of the pricing mechanism for natural gas is priced off the oil price and not the spot LNG price. So it’s still, I mean, it’s still gonna be great for those Aussie energy producers ⁓ in the longer term because natural gas,

supply looks like it will be affected for a little bit longer. And they will get somewhat of a higher price, but they’ll only get a higher price pretty much based on the oil price, like some function of the oil price and not the natural gas price.

David Hay Yep. So let’s broaden it out a bit, Tim. We’ve talked enough about oil and the view is fairly clear. Let’s think about our viewers’ portfolios. You’ve said, you know, it’s too late to sell or you wouldn’t be doing any selling now. Does that remain your view as things have, you know, dragged on, if you like, in the conflict?

Tim Rocks ⁓ Yeah, absolutely. We’ve got to remember, we have diversified portfolios for a reason. It is to protect us against these types of unexpected events. And I think what we’ve seen so far is well within the bounds of the kind of protection that diversification is meant to provide you. So we really don’t have to do anything and it is definitely too late to sell.

Remember, if you sell now, you’re reducing, well, all you’re gonna do is miss the bounce back effectively. But I also think we’re at the stage now that there have, as always, been indiscriminate changes in prices. There are some assets that have fallen way too much. this, are now in a period where we can start to look for those opportunities, buy assets at cheaper prices, and then…

lock in the potential for better returns in portfolios on a sort of two to three year view. And that’s starting to happen across asset classes now.

David Hay I’ve got some questions coming in too, so thank you to those people who posed the questions. There is a common theme. We’ll get through my questioning at Tim and then we’ll get to some viewer questions. ⁓ So where would you be looking, Tim, from a sort of an equity market point of view for those sort of opportunities? And everyone’s different, everyone’s portfolio looks a bit different, but they’re sort of broad areas that, ⁓ you know, viewers may engage that conversation with their advisor looking for some opportunities.

Tim Rocks Yeah, so ⁓ at an equity, pure equity level, regional level, we’re looking at US and China, ⁓ more broadly emerging markets. US equity valuations have come down a lot. mean, there’s a common story here, which is, know, the world was really, really strong before that. The outlook for earnings was really, really strong. And I really don’t think that’s changed. But US valuations have actually sort of come down quite a lot now.

So they’ve come down into the broad range of fair value for the first time in a few years. That’s partly, as I said, prices are down 5%, but earnings are up 10 % in the last six months or so. You’re even seeing it some of those big caps, some of the big mag seven type stocks like Microsoft and the like, where they’re now the cheapest valuations they’ve been since about 2017. So all those that miss playing the AI theme, actually these stocks are back below the levels.

levels in valuation terms they were trading at before the AI hype. So I think that’s pretty interesting for Big Cap US. And then China, I think China is really resilient here. ⁓ It’s got 30 % of its electricity is from renewables, half its cars are electric. And all these themes around oil are going to ⁓ push a greater trend into electric vehicles, solar batteries, where China

of the production of all those kind of goods. So I think China and US are kind of the big standout regions from this, I think.

David Hay Tim, you mentioned the Mag7. Is it a bit of a perfect storm for those AI related stocks? They’re a bit out of favor with people, investors not being able to get their mind around who are the winners and maybe those that don’t win through an invention of AI. And then you’ve got this risk off sort of environment where it’s currently in.

Tim Rocks Yeah, I mean the whole AI trade had become very different anyway, so the initial hype was AI is great, let’s just buy everything. And then we went through a phase through the last few months, which was more thinking about, well, there’s gonna be winners and losers. And particularly those broader tech stocks, particularly anything that could possibly be labeled software was being.

was being hit. Some of that was indiscriminate and has created opportunities as well. But anyway, the like the most of those Mag-7 are very clear winners from AI. And yeah, the valuations have come down quite a lot.

David Hay Let’s talk about commodities, particularly gold and copper. They’ve been knocked around ⁓ quite severely through this period. Why is

Tim Rocks I mean, good question. I mean, I have a theory that’s hard to prove, which is that a lot of the hedge funds like the big hot money, you know, took risk off the table when this event happened. And if you’re taking risk off the table, you’ve got to sell what you own and what they owned was copper, silver, gold. So they were ⁓ unnecessarily sort of dragged down from this. But gold’s particularly, actually, I think both

Gold and copper are interesting for different reasons here. Gold, because if we’re going to be in a period of greater uncertainty and more concerns about US dollar, they’re the reasons the gold price was running and they’ve been reinforced. ⁓ On copper, well, again, ⁓ if the reason you were buying copper was there’s push towards electric vehicles, broader electrification, energy transition.

all of the reasons that you’d want to do that have got a massive kick along. ⁓ And so they should even more greatly reinforce the copper story over time. So we like those, but it’s also the case that the miners that are doing both gold and copper have come down quite a lot. They’ve actually sold off more than is proportionate to the decline in the physical price. So

⁓ Probably my number one trade at the moment is to take advantage of that reset in prices in ⁓ gold, copper, the gold miners and the copper miners.

David Hay move away from equities for a minute. Bond yields, Tim, are there opportunities in that part of the market? And I might just delineate that between the Aussie market and global markets. Your rate settings here are different and I suspect interest rates here are continuing to go up. So where do you sit in the bond space?

Tim Rocks Yeah, so we’ve actually been rejigging our bond portfolio, Sue. Just generally as a general rule, the returns on interest rate securities have gone up pretty much across the board. In AUS that’s because the, I mean, the RBA did raise rates or has raised rates twice now this year. So that’s, yeah, that’s a good base that’s gone up. But the Aussie government bond yields, so the 10 year government bond yield has hit 5 % for the first time in a few years.

So that’s sort of pretty interesting. You’d also say the yields on things like hybrids have gone up 20, 30 basis points as well. So across the spectrum, there’s more yield on offer. So that’s quite nice, but the biggest change has been for the Aussie government bond yields. And we’ve started to put some of those in our portfolios for the first time in a few years.

David Hay And while we’re touching on it, Reserve Bank has increased interest rates at their last meeting. What’s your view on that? Is that a mistake? I mean, we’re all going to be sort of taxed a little bit more on the bowser, for instance. You know, that’s going to put pressure on the consumer. So, know, a rate increase here is it would have you done it or what’s your view?

Tim Rocks Yeah, it’s a pretty hard one. I mean, it’s pretty obvious that the consumer is going to take some kind of hit from this big increase in petrol prices. I think the RBA felt stuck in the corner. you all your credibility is around interest rates and the inflation rate is sorry, is bad inflation and the inflation rate is above target and rising, you’ve really got to be seen to be acting.

So I think that’s what they did at their last meeting. But I mean, I think they’re sensible enough. They’re not gonna keep doing it ⁓ if the risk to the economy continue. I think they take some comfort from the fact that the overall economy was actually pretty healthy going into this. And you’ve got a bunch of other really interesting things going on the Aussie continent at the moment. You’ve got a lot of spending going on, on like the Brisbane Olympics, setting up for the Western Sydney airport.

a lot of electricity infrastructure being built. So these are solid leaks of activity that will kind of continue. So again, unless there’s some major problem here with shortages of fuel, I think the Aussie economy will still get through this. ⁓ And yeah, as I said, I think the RBA will be sensible not to push it too far.

David Hay Tim, a couple of questions that have come through and line around a similar theme and expenditure. ⁓ Storage capacity for energy, oil, petrol, et cetera. We’re not going to ask you to guess if the government will change policy here, but is that a potential that through this we decide that we need bigger stockpiles and the like and capital flows into those areas?

Tim Rocks Oh, it’s pretty obvious we do. So the Australian government signed up to a sort of a global commitment from all developed markets to have 90 days of reserves and we’ve been running at 30. Yeah, and you know, lot of countries like China are above 200. So it was a, you know, it was a major policy error, only to have 30 days of fuel.

And I think very quickly once this thing is resolved, they’ll reverse that.

David Hay Yep. So we’ve gone through a lot of areas before we go to question, Tim, know, gold, copper, equities, oil, gas, etc. Yeah. If there’s one thing you could do in your portfolio right now, what would it be?

Tim Rocks I mean, definitely your mindset’s gotta be, ⁓ let’s look around for that opportunity to make your portfolio better. About once a year, maybe every two years, we get these opportunities where prices do reset. ⁓ They do reset indiscriminately. ⁓ So it is a second chance to have a look at what you might’ve missed out on on the way up, be that the Magnificent 7 or some of the Aussie.

resource companies and say, okay, this is the chance. I’ve got to look through the noise. I’ve got to be well aware that, you know, the news flow, the people that get on the news and the 7.30 report are always the doomsayers. They never get on people that are going to say it’s all right. So I’ve got to look through that. I’ve just got to focus on whether the earnings of these companies are fundamentally going to be changed by this ⁓ and then just, you know, and just do it.

David Hay Some questions. ⁓ Tim Dougs asked on the live chat about resources. I think he’d be pretty succinct with this one. What are the prospects short and long term? We’ve been positive on the long term prospects in the resources sector. Does that remain intact?

Tim Rocks ⁓ Yes, I mean, absolutely. I mean, obviously, it varies by commodity. ⁓ The standout ⁓ of the industrial metals anyway is copper, because you know, when you’re thinking about metals, you’re thinking about both demand and supply. And what makes copper really interesting is that the supply side is really constrained, and it’s going to be the case for a long time.

And it’s also the case that those demand drivers are really long tail drivers, this whole electrification and energy transition stuff. So I think both of those are really in train for, I mean, we’ve called it before a super cycle ⁓ in resources. And yeah, still very much of that view.

David Hay of the spectrum with these two questions. The first one, Tim, I’ll ask. In past conflicts and events that the world’s lived through, there categories, industrial categories, that survive or thrive no matter what, despite everything that might be playing out on the news screens before our eyes?

Tim Rocks Yeah, so that’s a good question. So thinking about what is immune to these types of things. And, you know, some things that stand out. Number one, actually, it’s always commodities. In any kind of conflict, any kind of disruption, any kind of supply problem, it’s always commodities and energy that ⁓ tend to be winners in the short term and long term, point one. Point two is probably defence stocks.

aerospace, that type of thing. They’re going to get a big kicker for a long, long time now. Yeah, and particularly the new technology ones, because it’s pretty clear that whole space with drone technology is changing. So I think you’ll want to perhaps get a farm to do that. You don’t want to try and pick the stocks themselves, but I think that they’re always interesting. Then number three is you think about ⁓ products that have got

demand that’s not really cyclical. So that’s probably healthcare. And that’s probably things like, you know, essential consumer staples, you know, in Australia, that might be Woolworths and Coles, for example, that, you know, people aren’t gonna, well, very unlikely that they’re going to buy less groceries, but they also might sort of trade down, you know, like a KMAR Big W sense from sort of, you more expensive items to sort of cheaper items.

⁓ Yeah, yeah, and healthcare is particularly one that has been really hard hit by this in the last month or so for reasons that I don’t quite understand. So healthcare is actually one of those ones that’s another opportunity here.

David Hay And if it’s possible, if things could get worse, Tim, are there investments that are more vulnerable than potentially your consumer staples, for instance?

Tim Rocks Yeah, so I mean, I guess you think, you know, it’s perhaps the more cyclical end, it would be your higher end discretionary consumer kind of items, which is the flip side of that trading down thing. People aren’t going to be trading up. Airlines and transport are a bit hard here. ⁓ But yeah, so I think they’re always going to be vulnerable because, you know, oil is obviously a sort of direct input. ⁓

is a bit of a hard one here because interest rates are going up. So the rates tend to be valued more directly off the bond yield. So they would be things that might have a bit more downside if this thing continues for a little bit longer.

David Hay Timmy, Ben caught out a bit here, question online. You haven’t mentioned the Aussie dollar. What’s happening with the Aussie dollar in your view?

Tim Rocks Aussie dollars been really interesting. normally you would think that if this type of thing happened, the Aussie would just fall say 10 % off the bat. It’s a really kind of, you know, risk ⁓ seeking kind of currency. I think the thing that’s been different this time is probably that the RBA is RBA’s actions are so different to the rest of the world, raising rates while

you know, basically the only one raising rates. So I think that’s kinda explained it. Maybe it is still vulnerable in the short term if things go on longer than we expect. But again, with that two to three year timeframe, I keep coming back for the potential for commodity prices to be a lot higher over time. And that tends to be, you know, those trends to the.

tend to coincide if the commodity prices are gonna go up, the Aussie’s eventually gonna follow. And that’s important when you’re about currency hedging, we still maintain that from here for the next few years, you wanna maintain a pretty healthy level of hedging ⁓ in your international equity holdings. And again, a reminder, that’s fairly easy to do these days because many funds and ETFs offer a hedged version so they can do the hedging for you.

David Hay Tim McArthur, that hedging typically is not very much different to the unhedged version. One final question. ⁓ We focused on oil and gas once again, but fertilizers and other chemicals, are a number that come out of the Middle East. ⁓ Is that a threat ⁓ in food prices, inflation, margins, et cetera, because particularly fertilizers.

sitting with a farming client yesterday and they had a quote for your rear from 1200 bucks on a Friday and 1500 bucks on the Monday. That’s like you get their hands on it. is that a phenomenon we’ve got to take care about?

Tim Rocks Yeah, definitely, you know, the whole ag sector and the potential flow through to food prices is definitely one of the effects we need to be wary of now. ⁓ At a regional level, that probably matters more for Asia, they’re more dependent on getting their, you know, their nitrogen based ⁓ fertilizers, you know, from the Middle East effectively. So that’s,

Definitely one of the effects. Again, is it big enough to be, you know, global recession risk? No. Will it cause some, you know, pain in segments of the market? Yes.

David Hay Yep. Very good, Tim. Conscious of time. I think we might leave it there. Thanks for your continued insight, comments and guidance. Much appreciated.

Tim Rocks No worries, thanks all for joining.

David Hay And thanks to all our viewers for logging in today. The recording of this will be disseminated in next 48 hours and it will be available as a podcast too, I believe. ⁓ And we won’t commit to when we’re gonna be in front of you again, but as we’ve proven over the last month or so, as things evolve and we think we’ve got an important message to deliver, we’ll certainly be arranging another call. Just a final reminder that everything we discussed today is considered general advice for those after personalised advice.

please reach out to your advisor. Thank you, take care all, see you next time.