Words on What's Next for Markets

In this episode of Words on Wealth, Senior Investment Advisor David Hay is joined by CIO Tim Rocks to explore what lies ahead for markets following the Middle East conflict. They discuss why oil markets proved far more resilient than expected, why the global economy is more adaptable than many commentators suggest, and what a move toward ceasefire could mean for different sectors. Tim also explains why the convergence of AI investment and clean energy infrastructure may be the dominant force shaping markets for the decade ahead. Tune in to find out more.

This episode is also available on Apple Podcast.

David Hay Welcome everyone to our Evans and Partners Client webinar today. My name’s David Hay, Senior Investment Advisor here at Evans and Partners. I’m joined by the ever familiar and ever impressive Tim Rocks, our Chief Investment Officer. Tim, welcome.

Tim Rocks Thank you, David. Thank you all.

David Hay When Tim and I were thinking about this webinar, we were hoping to be able to call it after our favorite band, a iconic Australian band, When the War is Over. But that’s clearly not the case. So today’s topic is After the Conflict, What’s Next for Markets? We will be releasing the webinar as a recording, reasonably promptly, and also as a podcast. And as with the previous sessions like we’ve run here today, you’re welcome to ask questions and pose those through the question and answer function on this call and I will put any of those questions to Tim that we can get to. So a few logistics there. Let’s get into the hard hitting part of it, Tim. Do we still need to worry about what’s happening in the Middle East and I suppose is the key thing oil rather than other issues there?

Tim Rocks Yeah, I mean, that’s a good question. It does look as though a resolution is imminent. It does look as though Trump has conceded a lot, and we are very close to a resolution. But even if we’re not, one of the key takeaways so far is that oil prices haven’t increased. Oil markets haven’t been the bogeyman that we thought they were. I think what has clearly been going on is there was a lot more slack in the system than we thought. In fact, they haven’t even had to release that many reserves to keep oil prices at around a hundred dollars a barrel. And that gives us confidence that even if things do roll on for another month or so, the potential downside for the global economy is still kind of pretty limited. And I think the other point here, which I think we’ll return to, is that the underlying backdrop for economies and markets is still so positive that it has just, in the end, mattered more so far and will be the dominant factor going forward. It is just a really strong environment that we’re in.

David Hay Tim, that non-release of reserves — or not having to release them under necessity — do we have any read on that? Is that consumer behaviour or is that the way that the world’s heading in the usage of vehicles and public transport and other modes of transport?

Tim Rocks Yeah, it’s all of those things. The fear mongering in the press is really counterproductive here. I mean everyone was doing charts at the start — oil matters, yeah, but we use one third as much oil per capita than we did in the nineteen seventies. So referencing the nineteen seventies and thinking that was the type of shock we were going to get, or that we’d get a global recession — it was simply never going to happen. The world has changed. Part of that is, as you say, we’ve moved on from oil to electric vehicles and the like, so we’re just not dependent on it. I think we had those big global supply shocks in 2022 and we learned a bit of a lesson there to put a bit more slack in the system. So all of those things have contributed to us being able to deal with this shock a lot better than expected. But there should be a takeaway from this — the global system is a lot more adaptable than a simple analysis of ‘we’ve got a shock, we’re going to get a recession.’ That is just never the right way to look at a very complex world.

David Hay I think the other takeaway might be don’t listen to the press and just listen to Tim Rocks. But I mean, the press are very hysterical these days so it’s important to stay close to your advisor.

Tim Rocks Look, and if we talk about the CGT and budget, it’s exactly the same scenario. Any kind of commentator that comes up with a thesis that this is going to cause a crash or a recession just gets front page attention or gets attention on the news. But the reality is the economic system is very adaptable and durable and can cope with a lot of shock.

David Hay Well, let’s get back to equity markets, Tim. So the markets have recovered on the basis that we’re going to at some point shortly get a permanent ceasefire. Or maybe you could run the thesis that they didn’t perhaps go down for as long as we thought, and therefore the recovery, while present, wasn’t as much as it might necessarily be. So have markets moved too quickly? Is there too much optimism built in? And in fact, is the optimism not so much around the conflict, but other factors in the world such as AI and global growth?

Tim Rocks Yeah, I think that last point is the important one. We are in, I think, the early stages of a really remarkable economic event — the coordination of the AI story and the clean investment story. The clean investment story has been going on for a while, but will accelerate as a result of this. The AI investment story, linked to data centres and the massive infrastructure build that is required for that, is going to dominate economic outcomes and dominate markets probably for another decade. It is such a powerful and extraordinary thing that’s going on here. So that’s point one. Point two is that now that we are at the end of this geopolitical event, or close to it, history tells you that markets do tend to end up higher after geopolitical risks. That is because we will enter a reconstruction and repair phase — that is economic activity. And what also tends to happen is governments overreact to perceived crises and give you some stimulus which you don’t need. In Australia’s case, we’ve had those reductions in the fuel rebates; in the US, you’ll probably get some fiscal policy. And then my final point perhaps on that is, actually, if you look at the bounce in markets you’ve seen, it has actually been quite narrow. It has been linked to either the AI theme through US tech or Asian tech, or commodities — copper, lithium, that sort of related stuff. So it has actually been on those themes. It hasn’t been a broad-based equity market rally so far.

David Hay And Tim, if we do get a permanent ceasefire announcement — an actual one — is there potential, given markets have run hard, for a pullback? And again, there’s equities and bonds and all sorts of different markets, we’re throwing ‘markets’ out there as a pretty broad term. But yeah, could markets actually pull back a bit on the actual confirmation of the news?

Tim Rocks I mean, yeah, look there’s always a risk if markets have gone up for nine weeks in a row — markets do tend to do that kind of ‘buy the rumour, sell the fact’ thing. So there’s a possibility of that, and you can’t rule that out. But on the other hand, there are a broad range of sectors that have not been doing well that will do well if the oil price goes down and that kind of risk is taken off. For example, there’s been a lot of concern about the consumer — consumer confidence has hit record lows in a bunch of countries, US and Australia, and consumer spending has been under pressure in some key areas. That concern is removed. There’ll be more excitement about travel stocks, airlines and the like. So those particular beneficiaries of an easing in concerns about the consumer will benefit. I think there’s also something potentially going on in bonds as well. The bond market has actually been really interesting in this — it has not anticipated an end to the conflict at all. Long-term interest rates are close to record highs in some countries. In Australia, we’re at a 15-year high, or close to it, for the 10-year bond. The US is similar, Japan is actually at a record high. So there’s the potential that if oil prices come down and people stop worrying about what central banks will have to do because of high oil prices, then bond yields will come down as well. And that’s a benefit to those markets also.

David Hay Slightly different one, Tim. If there is a ceasefire and it’s maybe not to the US’s liking or other countries’ liking — what I mean is the conflict isn’t fully resolved, but it drags on, and for instance there’s the piece about enriched uranium staying in Iran and things like that. So we get this sort of uncertainty perpetuating for a period of time and bubbling along. Do we go through a period like we’ve just been through over the last two or three months for investment markets? Or do the sorts of things around a permanent ceasefire and markets bouncing today stay true into the future?

Tim Rocks Yeah, I mean, if the Strait of Hormuz stays closed and there’s that lingering uncertainty, I don’t want to be too bullish about that scenario because there are still a range of other broader effects that are just really hard to get a handle on. For example, fertiliser supply is one thing that’s been affected by the straits, so that could have other consequences. There’s been all those other potential effects on the semiconductor chain because of helium. Again, the disaster story hasn’t played out yet, but if the strait does stay closed for another month or more, then we have to be wary of those anyway.

David Hay Yep. Let’s leave it there because we can’t actually answer that question with any certainty. Tim, you mentioned interest rates and the Reserve Bank and bonds. Those next two questions are sort of interlinked. Australian equities have lagged in this bounce — is that a local issue and is that linked to the Reserve Bank and interest rates, or is it a bit to do with the composition of our market, i.e., resources, banks, energy? We’ve got some innovators in AI and tech and data centres, but not as big a concentration as the rest of the world. So are we lagging — is that a localised issue?

Tim Rocks Yeah, I think it’s all those things you just mentioned. Number one is probably the RBA. The RBA is the only major central bank that thought it was a good idea to tighten into this. Their concern was that there would be quicker pass-through of higher oil prices into a broader range of other prices, be it food or those types of things. But that hasn’t happened — the data last week proved that. In fact, the oil price hasn’t gone up. So I think the RBA looks like they’ve got this wrong, and we’ve had two rate hikes that have the potential to cause other consequences for the housing market. The recent data for the last few weeks is showing that’s having an impact — auction clearance rates and the like. So I think it’s genuinely fair to be more concerned about the Aussie economy and the effects here than you would be in other countries. If you look at the Aussie market in more detail, what you see is that commodity prices have gone up and that’s had a bigger impact on the resource sector. But the other sectors face challenges — partly because, as you said, we don’t have a lot of beneficiaries of the whole AI story. And then some of the other big sectors are affected by their own problems — banks by concerns about housing, the healthcare sector where there’s a bunch of one-off issues, and in the tech sector our companies are seen as potential risks from AI, not beneficiaries of it.

David Hay Yeah. So talking about your comments on the Reserve Bank, thinking about the bond market and rates, what’s the outlook there? Is there an opportunity for investors today? I take from your comment that perhaps you don’t feel there’s another interest rate hike coming anytime soon.

Tim Rocks Yeah, well let’s flip that around. Actually, if you’re thinking about this from an investor’s perspective, one of the really great things at the moment is that the whole interest rate securities asset class is looking the most attractive it’s looked in 15 years. And the good thing for investors — if you’re not as optimistic about how some of these things play out as I am — well, actually you can make pretty decent returns on high quality interest rate instruments now. You can make six-ish percent on a lot of investment grade credit, even up to seven or eight on relatively high grade stuff. So if you don’t want to really play the game, if you think you want a more conservative approach, then actually you won’t be losing out on all that much by having more in those. In particular, what we’ve been doing is locking in sort of high fixed rate lending — government bonds are at around five percent as I said, and some corporate bonds have also gone up. So you can lock in some decent returns there, and there’s plenty of other stuff that’s actually pretty interesting as well.

David Hay Just a reminder to viewers that they can pose a question via the Q&A on the call. We’ve focused on a couple of pretty succinct topics here today, Tim — obviously the Middle East and domestic. Are there other things that keep you up at night? We haven’t mentioned what’s happening in other conflicts around the world — Ukraine, Russia — or China’s influence on the region, more so in demand for iron ore and their economic growth. What are your views there?

Tim Rocks I think China’s looking really interesting now. Number one, China is a big beneficiary if this whole clean energy transition gets a kick along from oil — China produces ninety percent of the world’s solar batteries, dominates solar panels, and dominates batteries in electric vehicles as well. You’ve also seen some stabilisation in the broader economy — we’re five years into a property market decline, but that seems to be stabilising now. So China looks all right. And actually when we’re thinking about opportunities from this conflict, emerging markets have been doing very well, but it has actually been Korea and Taiwan — it’s just been the tech universe that’s dominated. So there’s the chance that spreads out to other emerging markets. On China specifically. In terms of the risks, there are two other geopolitical regions people look at: China-Taiwan and Russia-Ukraine. Both of those are, I think, different from each other. China-Taiwan I think is on pause for at least five years — partly because Taiwanese domestic politics is actually pro-China now, and the Chinese military is in disarray, so I just don’t think they’re going to do anything on that anytime soon. Russia-Ukraine is really interesting — Ukraine is fighting back, and I’d encourage people to read up on that a bit more. Ukraine’s adoption of drone warfare has basically levelled the playing field. The negative from that is what does Russia do if it starts to fall behind. But I think Russia-Ukraine is neutralised as an issue for now.

David Hay And Tim, US fiscal policy — there seems to be a hell of a lot of debt still being generated out of that region. There’s the inflation story, and I suppose everyone talks about midterm elections. Have you got any sort of medium term insights for us there?

Tim Rocks Look, they’re all viable issues and they could all at different points cause some volatility in markets. Of all of those, I think the one that might matter the most if it happened would be a more sustainable rise in US inflation, just because it forces central banks to tighten rates and the like. But the bigger picture in the US is actually that the economy is very strong. That AI data centre build is just such a big amount of money — we’re on track for data centres to be spending more than a trillion dollars a year in building. That’s more than one percent of GDP we’re heading towards. Then you have to have all the grid investment to support it, so it has a sort of a long trail. I think that’s going to matter more than anything else really. And actually a strong economy will probably help some of their fiscal outcomes as well. So yeah, I think that’s not a big issue and not going to dominate things in the short term anyway.

David Hay But you sort of try and bring this all together for a message to our viewers. We’re talking about conflict, which is — the human toll is horrific. And we’ve talked about a few challenges out there, so I could get nervous. But we started off with you talking about global growth and optimism and ten years of AI and innovation, et cetera, so I can get quite positive. So let me ask you this: first, from an asset allocation point of view, have you changed your views? What’s your key message to an investor today? And again, everyone’s different on the call — some like income, some like growth, et cetera — it’s just a general comment. Where do you sit?

Tim Rocks Actually, I would say the number one call is not bullishness nor bearishness — it’s that this is a really great time to diversify portfolios. So if you don’t want to play in the AI sphere, the point I mentioned before — that this is the best time to be buying interest rate securities in fifteen years — is an important one. You can build a portfolio that can return six or eight percent with a relatively safe set of securities. Gold looks interesting. Infrastructure looks interesting — there’s so much infrastructure investment around. So that’s number one: it’s a very good time to diversify. Number two, my own view is that this is actually a very good outlook for equity markets over the next three to five years. What we would be changing in the short term is that there might be some rotation from laggards. So far in the last few months it has only been AI and commodities that have cut through, but there might now be some laggards taking over — some of these other sectors that have lagged, like consumer and travel, or some other regions that have lagged, like other parts of emerging markets. And small caps, which has been something we’ve been pushing for a long time, has done okay and might do better when people are more confident about the durability of growth.

David Hay So I think your key message, Tim, is that there are opportunities out there, they’re not all in one asset class, and really each investor needs to chat to their advisor to prosecute those opportunities as they’re appropriate.

Tim Rocks Yeah, that’s right.

David Hay Right, we’ve got some questions. And this is the first one — the inevitable question — and I hope you’ve got another hour or so, Tim, to wax lyrical here. The last federal budget. What are your thoughts on CGT, negative gearing changes, et cetera?

Tim Rocks Okay. So my main point is one I’ve already made. The media attention and the doomsday scenarios about what this all means is just so exaggerated. My one political comment on this is the changes actually won’t achieve much in terms of revenue or in terms of achieving their stated goals — so I’m not really sure why they’re bothering. But it’s a long step from that to say that this is going to cause major impacts on asset markets or that people really should change their investment views in any big way on the back of it. On financial assets, yes, at the margin this does mean that income producing assets are now a little bit more attractive than they were. Does that mean you go and change your portfolio? Well, no. The way you make investments is you buy good assets — you buy assets that you think are going to appreciate over time. The fact that the tax man is going to take a little bit more at the margin just shouldn’t really change the fact that you should go out and buy good assets. On property, I think it is a bit more nuanced. There is the risk of some impact on property prices because investors won’t be able to — their purchasing power will have gone down and some will choose to sell. That’s a fair point. But how much are we talking? We’re talking one or two percent on property prices, and you’ve got a lot of other people that’ll step up to buy if prices do go down that much. So look, deep down, I really don’t think this should change people’s approach to their portfolios.

David Hay Good question from Paul online — he’s called me out really to some extent, I haven’t asked this question, Tim. Can you comment on the outlook for Europe?

Tim Rocks Yeah, well actually if you’re thinking about laggards that might benefit, it is Europe. Europe was always the region most vulnerable to the energy shock, particularly from LNG, because they’re so dependent now on Middle East LNG — and that is the one that could take some time to recover. But having said that, an end to the conflict is good, and in theory Europe might be the one that can benefit most from that. The challenge for Europe in terms of the ten-year story is that the US is just eating their lunch — US companies are doing the AI, so there’s much, much better upside in the US in terms of earnings and the like. But Europe is undervalued and has been a big laggard, so to that extent there is potentially a trade in Europe. As part of a broader portfolio, yes, I think some exposure to Europe makes sense.

David Hay Tim, just conscious of time — a couple more questions I might pose to you quickly. One comes from Archie: the Aussie dollar outlook. What are your views there?

Tim Rocks I still think it’s going up, perhaps not as much as I thought before. The big story for the Aussie was that RBA rates were going up and US rates were going down. Now from where we are, that’s a bit more of a convergence — actually US rates could even go up and Aussie rates are flat to going down. So that interest rate differential as a driver has largely gone away. But commodity prices are still going up, so I think there’s still some upside potential from that. We’re still thinking it could get to eighty cents, and the direction is still up. That causes us to think you should still have a decent amount of hedging in your portfolio for international equities. So yeah, still up, but perhaps not as much as we were thinking a few months ago.

David Hay And a final question, Tim, from Alan. Gold has been quite volatile. Why?

Tim Rocks Honestly, I don’t know the answer to that. Everything that’s going on should support gold being better — more inflation concerns, a bit more geopolitical angst. The big driver of gold for the last five years has been central banks deciding to sell US bonds and buy gold instead. That trade can only get a further kick along by the US acting irresponsibly on the global stage. So I don’t think anything has changed the positive environment for gold, and we’re very happy to continue to recommend it in portfolios. But exactly why it’s lagged — yeah, that’s in the ‘I’m not sure’ basket.

David Hay Tim, we might leave it there. Thank you for your insight as always — it’s terrific and thought provoking. And as we always say on this call, what we’ve talked about today is general advice. Everyone who wants more specific advice must speak to their advisor and get that advice. So Tim, thanks for your thoughts today.

Tim Rocks My pleasure. Thank you, David. Thanks all.

David Hay Good. And again, just to harp on the point — today is general advice. For those looking after personal advice, please reach out to your advisor. Tim and I will be back in front of you again when it’s appropriate, sometime over the next six weeks or two months, with the next topic that we want to discuss more broadly. Take care out there. Cheers.