Randal Jenneke

Following a week on the road meeting with clients, the most common questions I’ve been asked surround interest rate rises. Some of the effects of rate increases across the globe have been more obvious than others (see prices of high valuation tech stocks). However, in Australia the most interest rate sensitive area of the economy and one yet to fully bear the pain of interest rate adjustments is housing. This has big implications for the broader economy and investors.

We have had the boom, and now we will have the bust. The question is just how big the fall will be? We believe the correction will likely erase all the house price gains seen during the Covid period, when prices soared to unsustainable heights. This would equate to the largest peak-to-trough decline on record, vastly eclipsing the previous correction of 10.2% in 2017. As illustrated below, it is already the fastest (Chart 1) and there is much further to fall back to the levels of January 2020 (Chart 2).

Another takeaway from past cycles is that price falls typically continue until we see the RBA not only stop rate hikes but shift into reverse and start to cut.

At this stage, rate reductions seem like a high hurdle given the board’s determination to bring inflation back within a more tolerable band. Indeed the RBA has modelled its own expectation of housing price falls and seems comfortable with a 20% decline over two years. When was the last time our central bank was unperturbed by such a level of house price decline? As we know asset price declines are unpredictable and aren’t easy to control (both up and down)!

A large portion of Australian borrowers are still yet to feel the full effect of the RBA’s hikes to date. This is given the substantial proportion of loans written during the Covid period were at very attractive fixed rates. As a percentage of all loans, fixed rate mortgages ballooned from 15% pre-covid to 46% of new lending at its peak (Chart 3). We estimate that approximately 50% of the current residential mortgage loans on banks’ balance sheets were written over the Covid period. This risks associated with writing housing loans, in one of the biggest housing booms and lowest unemployment period in decades, will be evident in coming years.

This translates to an enormous wave of mortgages that will transition to variable rates in 2023. The average fixed rate of roughly 2% will move to a rude variable rate of 6.5% at current forecasts. The debt servicing ratio (the proportion of household income that goes to principal and interest payments) is expected to rise to a record high of 18.4%.

Australia is much more sensitive than its US counterpart in this respect. For perspective, variable rate mortgages make up only 5% of US mortgages. Debt servicing there is expected to only rise to 7.6%.

The sensitivity to such rate increases are compounded by the high level of household debt in Australia (5th most indebted in the OECD). At its peak during the covid period, a quarter of all new loans were written at a debt-to- income ratios of more than 6. The combination of these factors ranks Australia as the 3rd most rate sensitive housing market globally.

That said, one potential source of support is the savings buffer that was built during Covid as expenses were slashed and transfer payments were squirreled away. This would help households bear the brunt of mortgage rate increases in the near-term. However, this savings buffer is rapidly evaporating (higher cost of living expenses such as energy prices also impacting) and will not sufficiently protect households from their mortgage adjustments next year (Chart 4).  The RBA’s Financial Stability Report highlighted that under current forecasts, even if variable-rate borrowers reduced their spending by 20%, a third would deplete their buffers within 6-24 months.

Not only will there be a hit to spending in order to meet higher mortgage costs, but the wealth effect will be real. Housing makes up roughly 68% of household sector net wealth, for a total of A$10 trillion. A simple calculation tells us that for a 20% fall, A$2 trillion of household wealth would be destroyed. In turn, falling prices should deflate some of the more boisterous consumer activity witnessed when homeowners saw the value of their primary asset rise so dramatically (Chart 5).

Finally, the flow-on effects on construction are worth noting. 1 in every 10 jobs is tied to housing and construction contributes roughly 7.5% to GDP. Currently we are sitting in a construction backlog, blocked by supply constraints, labour shortages, and weather. As such the decline in construction activity will lag prices by longer than usual. However, as this blockage eases, construction should follow the substantial fall in building approvals and prices lower.

Overall, in what is a passionate topic for Australians, I probably have not made any new friends by highlighting the extent of the woes facing the local housing market. At the same time, we emphasise the importance to understand these issues and position appropriately. Our outlook and positioning has been cautious since late last year and we continue to prefer more defensive quality exposures that we believe will be better placed to weather the downturn.

By Randal Jenneke, Head of Australian Equities and Portfolio Manager, Sydney

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Randal Jenneke

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world. This was partly reflected by the ASX 200 claiming pole position versus most major markets last month (Chart 1).

In last month’s update we addressed the tall wall of worry that has stood forebodingly in front of investors of late. Yet, many of these issues such as the war in Ukraine, monetary tightening, inflation, (or its more feared cousin, stagflation) vary in their degree of severity across regions.

For example, Europe’s growth and company earnings outlook has been severely marred by the ongoing war in Ukraine that has led to punitive sanctions on Russia. Across the Atlantic, US inflation is at its highest since Olivia Newton-John’s “Physical” topped the charts (December 1981), forcing the Fed to move aggressively, while recession risks continue to rise – the latest warning indicator was the US 2 and 10 year spread flipping negative earlier this month (Chart 2).

Growth for the US and major European economies have been downgraded in the wake of those developments. Conversely, the economic outlook for Australia is relatively positive. We are far enough removed from the conflict in Europe to avoid direct impacts and stand to benefit from Russian sanctions. Our main geopolitical risks are closer to home as highlighted by the recent developments in the Solomon Islands. Similarly, the inflation picture had been much less heated than offshore (particularly the US). However, this week’s CPI figures suggest this may be more of a timing issue. Higher domestic inflation can be expected to translate into faster action from the RBA to raise interest rates to slow the economy. We believe the strong commodity price environment, high level of domestic savings and tight labour market will help provide support to the economy, but inevitably an economic slowdown is required to get inflation back under control. The risk is that we get tipped into recession in the process.

The recent surge in prices across the commodity complex, from agriculture to metals, provides a large uplift to our terms of trade. There has been a sizeable gap in some commodity trade created by sanctions on Russian exports.

Australia can help to plug that gap as a top exporter of many of the same commodities (Chart 3). Moreover, our largest trading partner China, is moving in the opposite direction to most by embarking on monetary easing and fresh fiscal stimulus.

Hence, it is not surprising that the miners and energy players have been among the top performers locally this year. At the same time, not all of these commodities enjoy the same outlook. Oil and gas names have benefited from the spike in energy prices. However, longer-term the terminal risks for the sector have increased. The importance of energy security is front-and-center and as such the need to shift to renewables has accelerated. This has reinforced our long-term preference for those commodities leveraged to electrification – nickel, zinc, copper and lithium for example.

More broadly, the Australian equity market’s earnings outlook has improved relative to peers, who are in contrast facing earnings downgrades. Further despite the price correction offshore, valuations are also more attractive than markets like the US with a larger than average P/E discount that has persisted throughout the pandemic (Chart 4). These factors combined with the relatively stronger economic outlook have driven an increased allocation to Australia from Global asset allocators, who are for the first time in many years increasing their weighting to the Australian Equity market.

Overall, the global investment landscape is certainly not rosy. We have written many times that we have passed the peak of global economic momentum.  Australia is also poised to decelerate. However, we are in a relatively stronger position to endure some of the global storm fronts. If only we could be as fortunate with our own weather fronts.

By Randal Jenneke, Head of Australian Equities and Portfolio Manager

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Nick Vidale joins as an investment analyst, bringing more than 20 years of investment experience across the financials, industrials and consumer sectors in Australia and Asia. He is responsible for identifying investment opportunities in the financial sector for the firm’s A$1.5 billion Australian Equity Strategy, reporting to the team’s Head of Research, Ryan Martyn.

“The seniority of this hire underscores our commitment to delivering performance through a high conviction approach backed by rigorous research,” said Randal Jenneke, portfolio manager and Head of Australian Equities, who leads the firm’s Australian investment team. The team comprises seven investment professionals and has dedicated research coverage across various sectors of Australian equities.

“Nick’s extensive investment experience and financials sector coverage are a great complement to our growing team. His appointment is another key step in our continued build-out of greater depth in Australian equities. We are excited about the value our expanded team will add as we seize the investment opportunities in a post-COVID environment,” Jenneke added.

Most recently, Vidale was a senior equities analyst at Perpetual, covering the Australian banks, diversified financials, property developers, gaming and industrials sectors. Prior to Perpetual, Vidale was a portfolio manager at GLG Partners in Hong Kong covering Asian financials.

David de Ferranti joins as a portfolio analyst in T. Rowe Price’s Investment Specialist Group (ISG), a team within the investment division dedicated to handling the flow of information between clients and portfolio managers, and reports to Nick Beecroft, Hong Kong-based Head of ISG, Asia Pacific.

In this newly created role for the Sydney office, de Ferranti works alongside the firm’s local and global equity investment teams to provide Australian and New Zealand clients timely market and product insights, while allowing portfolio managers to focus on delivering performance. He joins from Pendal Investment Management.

T. Rowe Price currently offers a global range of investment strategies offered to institutional clients in Australia and New Zealand as well as five Australian Unit Trust funds to retail and advisor-directed investors in Australia. The T. Rowe Price Australian Equity Fund and the T. Rowe Price Australian Equity SMA were both rated “Highly Recommended” by investment management research house Lonsec in 2020.

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Kim Tracey

Global Investment Firm, T. Rowe Price has further expanded its Australian equity team with the senior appointment of Kim Tracey as an investment analyst. The Sydney based investment team is led by Randal Jenneke, portfolio manager and Head of Australian Equities. 

Tracey will be responsible for identifying investment opportunities in the Healthcare and REIT sectors for the firm’s A$2 billion Australian Equity Strategy. She will report to the team’s Head of Research, Ryan Martyn. 

Tracey has more than 20 years of investment experience across the healthcare, consumer, industrials and real estate sectors globally. Most recently, she was a portfolio manager and investment analyst at Colonial First State Global Asset Management (CFSGAM), covering the Australian Healthcare and REIT sectors. Prior to CFSGAM, she was a portfolio manager and investment analyst at Five Oceans Asset Management, where she invested globally. Tracey has also worked as a senior analyst at Merrill Lynch Investment Management and Bankers Trust / Principal Global Investors.

“Kim’s experience, skillset and capability are a terrific complement to our team. Her appointment reflects our strong commitment to deep insightful proprietary fundamental research,” Jenneke said. “The addition of Kim increases the Australian equity team to 7 dedicated investors, which is also supported by a four-person local dealing desk.”

“The seniority of this hire is a testament to T. Rowe Price’s long-term commitment to deepening its investment capability in Australia and globally. We are excited about the value our expanded team will add as we seize the investment opportunities that higher market volatility creates. Our investors will benefit from our ability to combine local insights with global perspectives, our high conviction approach focused on quality growth investing, combined with our rigorous risk management framework.”

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Wu joins T. Rowe Price from Macquarie Investment Management where he focused on Australian large and small cap stocks as an equity investment analyst. His position reports to Ryan Martyn who, following seven years working as an investment analyst with the firm, has been promoted to the role of Head of Research.

The team, which has grown steadily under the leadership of T. Rowe Price Head of Australian Equities, Randal Jenneke, now comprises six investors with recruitment underway for another senior analyst.

Mr Jenneke said the internal promotion of Martyn, the appointment of Wu and additional recruitment plans reflected the firm’s commitment to deepening its investment capability for investors with astute analysts who thrive in a collaborative, research-enabled environment that enriches local views with global perspectives. “We expect that investors seeking risk adjusted returns will increasingly select managers for their ability to source alpha using a global lens, prudent and disciplined risk management and capacity to move quickly,” he said.

“We are tremendously excited and optimistic about the value that our expanded team can bring to Australian investors as they navigate higher levels of volatility and the opportunities this presents.”

T. Rowe Price Head of Relationship Management Australia and New Zealand Murray Brewer said the market support for the Australia Equity Strategy, which surpassed A$2.0 billion¹ in assets under management this week, is largely due to the team’s rigorous, steadfast ability to stay its course and its relentless focus on the creation of long term alpha.

1 As of 22 May 2018. Preliminary data. Subject to adjustment. Includes a Unit Investment Trust and separate accounts.

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Randal Jenneke

T. Rowe Price’s Australia Equity Strategy has been added to Colonial First State’s FirstChoice investment menu to provide an investment choice suited for the current environment where investors seek strong risk adjusted returns from genuine active management at attractive fees.

Led by the firm’s Head of Australian Equities, Randal Jenneke, the strategy provides investors with access to a high conviction portfolio that seeks to identify high quality growing companies with positive structural industry dynamics, strong competitive positions and which can sustainably grow at attractive rates of return.

The strategy relies on extensive proprietary fundamental research by an experienced Australian equity investment team that collaborates with and draws insights from the T. Rowe Price global research platform. It is the second T. Rowe Price strategy available on the FirstChoice platform after the firm’s Global Growth equity offerings was added in May 2016.

“Active management is critical to generating attractive return potential, particularly in a more volatile market environment. Our quality growth framework and valuation discipline helps to identify companies that have the potential to grow faster than the market with an attractive rate of return, but also importantly offers downside capital management, due to lower drawdowns in periods where the equity market sells off. We are delighted that more Australian investors can co-invest with us and our world class globally integrated research platform,” Jenneke said, adding that he remains optimistic on the outlook for Australian Equities.

“We believe it’s very important for advisers and investors to review their Australian equity managers’ ability to meet their stated objectives both now and in the long run. Investors should determine if what they invested into 10 to 15 years ago is considerably different to what they originally bought as a consequence of significant asset gathering. A strong discipline to capacity management, as is the approach taken by our strategy, helps to mitigate these issues,” said Murray Brewer, T. Rowe Price Head of Relationship Management Australia and New Zealand.

T. Rowe Price’s Australia equity strategy has successfully raised over A$1.2billion in assets under management from Australian sourced clients. The firm manages assets of over A$1.32 trillion globally. Its range of other equity and fixed income strategies across multiple asset classes throughout the developed, emerging and frontier markets; the Global Equity Strategy (Hedged and Unhedged), Dynamic Global Bond Strategy, and the Asia ex-Japan Strategy offerings are available for financial advisers in Australia.

The firm has been steadily building its Australian business aligning its growth focus with its founding principle of putting clients first and constructing investment solutions that draw on the firm’s deep local and global investment capabilities.

Most recently, T. Rowe Price’s Australian operations have been granted an Australian Financial Services License (AFSL) and have commenced trading as T. Rowe Price Australia Limited, effective 1 May. The move will enable the firm to access new market segments and develop new products for its growing client base, reflecting the firm’s continued commitment to the Australian market.

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