Q&A with Martin Conlon, Head of Australian Equities

Graeme Mather, Head of Distribution sat down with Martin Conlon at our 2021 Market Outlook Event: Through the lens. Visit our events portal to watch the recording, download a copy of the speaker presentations, read content for your clients and more.

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Earnings season is coming up - are there any specifics or thematics you are concerned about?

Martin Conlon: It's tough at the moment in an earnings sense just in terms of the number of ups and downs coming off the back of Covid-19. Earnings this year are going to be much tougher to interpret than most just because you've had things skew away from normal. Airlines, for example, their earnings results in the context of a longer-term value adjust is irrelevant this year. Some of the material stocks (the Rio’s, BHP), will have great results and good dividends. We’re more focused about trying to fathom the longer-term outlook than focus too much on earnings results from this season.

Now that retail investors can manipulate markets is it frustrating that valuations become less relevant?

Martin Conlon: It's certainly a big risk and perversely I'd say that I think the passive risk is more than the retail investor risk so I've always been arguing for a level playing field. I think retail investors should be able to do exactly what institutional investors can do and I don't think there are too many arguments again that. You've seen it in things like Tesla, where you thought it was crazy a year ago, the passive investors are now buying it at two times - crazy from the people who thought it was crazy a year ago. My take would be the leading S&P construct portfolio is really dangerous and I think it's going to draw a lot of attention to what those rules should be in index construction. You'll get lots of game playing and so on where people will be looking to artificially turn over stocks to get it into an index. Real rules based investing, rather than standing back and thinking, overwhelms fundamental investing, to the extent that it has unfortunately of recent years.

All things being equal, what earnings yield is the minimum you seek when selecting share investments in a low interest rate environment?

Martin Conlon: My take would be that the premium that people expect to earn for owning equities over lower risk assets like bonds has stayed pretty constant. Yet as a ratio of bonds, it's changed hugely. And that's a long-winded answer of the earnings yield question. You can still get, even at 20 times earnings, a 5% earnings yield, that's 4% more than 1% bonds, and we used to talk about a 4% equity risk premium when bonds were five. So as a ratio of bonds, you’ve still got plenty of scope for equity risk premium or the earnings yield to compress a little bit, which is why I'm not so sure that, even though equities are expensive versus history, that they look horrible versus other asset classes.

Some big names are publicly questioning low rates, is the RBA out of touch and may they soften their approach by H2 2021?

Martin Conlon: Obviously we've been pretty outspoken and I think in a portfolio context you can tell that we haven't anticipated that rates would get to these crazy low levels. Our take was that all of the evidence post-GFC suggested that taking interest rates lower really wasn’t doing much for the real economy. It is important for the real economy to start to keep pace. That probably means that policymakers are going to have to and they’ve got plenty of temptation to. If the central bank will fund more than the entire budget deficit for the next year, the government doesn't have a lot of incentive to tighten its belt. It may as well hand that hand that money out to constituents, try and get the economy going, and hopefully get those that that rebalance that I talked about.

The RBA have announced more bond buybacks - is it really necessary?

Martin Conlon: To me that's just price fixing. Having someone buy $100 billion of something at a price that they announced to the market, all you're really doing is saying you're not letting free markets work, and you're going to let governments borrow at a totally artificial price. That to me is not great for free markets, it's not great for the future of free markets, and we should be looking to minimise it not maximise it. I’m not big on a bunch of people in Martin Place thinking that they know how to run the whole economy, better than the millions of people who are the constituents. Unfortunately that's the direction we're going.

What is the effect of closed borders and next to no immigration for the building materials space?

Martin Conlon: There will potentially be a hiatus, albeit there's a fair bit of pent up demand in the domestic economy with expats moving back from overseas but we would fully expect that immigration would open up again once the pandemic has passed and vaccines are rolled out. Just like everything, you're buying long-dated assets here and we do believe that we should be trying to look through this, and immigration is unlikely to be switched off in anything other than the short-term, so we don't think it's going to disappear as a driver of volumes and Australia and New Zealand are going to remain very attractive places to live relative to the rest of the world for a while to come in my view.

Is your overweight to resource stocks underpinned by iron ore at $150/t?

Martin Conlon: In no way did we expect $150 iron ore prices. I could write a long list of things that I didn't expect in the last 12 months but that will be on it. The game of valuing iron ore companies is we use $65 iron ore, implicitly that says we expect the iron ore price to fall a long way. Unfortunately, when prices are rolling over, share prices do tend to track the commodity prices. Also, valuation of iron ore stocks is not as attractive as some other areas of the resource economy and the material sectors. So actually, our position in iron ore is not nearly as aggressive as it might have been a year or two ago, while the stocks are OK we do feel that there are better opportunities out there now.

If you could take a listed company private, which sectors (or even companies) appear attractive at present?

Martin Conlon: People talk a lot about listed companies going to private. There's not a lot of evidence that there are as many listed companies going private as vice versa at the moment. At a portfolio level all of the attraction is in the real businesses with established revenues and established profits because they're valued at very sensible prices, relative to technology which is why everything being IPO’d is in technology. If you've got a technology company or a seller to the listed market the reverse prices, the things that private equity and private asset owners are going to be looking to take private, are generally going to be in the established business real revenues that are not at egregious multiples.