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ETF specialist Mark Perchtold shines a spotlight on often startling differences between the nameplate of an Exchange Traded Fund and what’s actually under the hood – i.e., the shares it invests in. He offers some thoughts on the ETFs held in the BizNews portfolios (spoiler alert – he doesn’t agree with all of them) and shares how OMBA is positioning its investments for clients as we move deeper into 2023. Perchtold, who is a chartered accountant and CFA, spoke to Alec Hogg of BizNews.
- Mark Perchtold on Sean Peche’s comment on value and the increasing difficulties of buying an ETF as an investor – 01:12
- On how to select an ETF – 03:41
- The Global Financial crises – 05:37
- On European autos – 07:30
- On how he is reading the rest of 2023 after a strong January and how are they positioning their client portfolios to take advantage – 10:32
- On where he sees the interest rate cycle right now – 15:22
- On how they’re positioning their portfolios for this – 18:44
Extracts from the interview below:
Mark Perchtold on Sean Peche’s comment on value and the increasing difficulties of buying an ETF as an investor
Yeah, it’s a good point that Sean makes. I mean, a lot of these factor, or smart beta ETFs, as they’re called, will follow a particular factor like value or momentum or low volatility or quality, for example. And so they’ll overweight stocks that exhibit those qualities like value, we know price-to-earnings multiples, price-to-book multiples, or whatever multiple you want to look at for stocks that trade cheaply are perceived to be cheaper, but they’re often sector neutral, which means they want to maintain a diverse sector exposure. So they’re not necessarily going into value sectors. They’re actually keeping exposure to all sectors within a broad index, but they’re owning all the worst stocks in terms of recent performance.
And so you don’t always get what you expect when you follow these ETFs. And we’ve looked at this quite closely in recent years because, the same point Sean makes, we noticed that some of the factor ETFs, like the value factor, didn’t often give us the value exposures we wanted. And so we’ve started to change our thinking on it to really understand what’s inside those value or quantity or momentum factor ETFs, and perhaps instead own value sectors. For example, the healthcare sector is often more defensive. So if you want more defensive exposure, you might move to healthcare and pharmaceuticals, for example. Or when we’re looking at value, something we’ve done in all portfolios recently is moved toward the European auto sector because it trades really attractively from a variation point. It’s a good strong price-to-cashflows, price-to-earnings ratio. A lot of people have priced in a recession, and you know, people when there’s a recession, they might replace their toaster, or their kettle, which they have to, it’s a small ticket item, but they’re not necessarily going to replace their car. And so the auto sector tends to get beaten up a little. And so we’ve liked that sector; it trades cheaply. It would exhibit value characteristics, in our view.
On how he is reading the rest of 2023 after a strong January and how are they positioning their client portfolios to take advantage
We joked at the end of Jan that maybe we should just move one hundred percent to cash and claim the performance for the year because if you ended the year up that much, it wouldn’t have been such a bad year. But the reality was, as we were saying last year that markets tend to get oversold, and suddenly, they tend to get overbought. We’re certainly not in the overbought territory if you take a long term view, you look at major markets around the world from looking at the value of the price-to-earnings, price-to-book characteristics – they still trade reasonably attractively.
So despite the move up, the price-to-earnings ratios aren’t that high across most major markets. So it’s not necessarily a poor time if you are cash flush to start entering into the market.
However, it’s certainly been a very strong bounce. November was exceptionally strong, and January was exceptionally strong. We’ve come off lows. The way we’ve positioned our portfolios, as I mentioned last time, which started to accumulate more large-cap US technology, and many of those big counters have really started to rebound. We’re currently this week and next week making some decisions on this, debating whether to lighten up some of the US tech exposure we took. That’s one of our debates. We’ve also done well in overweighting parts of Europe like Germany. And that’s really been a decision we’ve taken to remove Germany in favour of sub-sectors within Germany, which includes autos.
So China has been a position, where we’ve been overweight, we’ve weathered the storm, and it’s now rebounded. Fortunately, I think the China reopening is potentially very positive for the world as you’ve got this Chinese consumer which has started to grow, very differently from the China of ten or 15 years ago, which was driven by investment and the Chinese government investing in infrastructure, in new roads, new rail, you know, building skyscrapers everywhere and housing, it’s now actually got a big consumer, and the consumer is growing.
And so where China opens up in this pent-up demand. And one of the things you’re looking at, for example, is tourism across Southeast Asia. You know, if you look at Thailand and Malaysia, inbound tourism from China absolutely skyrocketed. So then we’re looking at Southeast Asian countries and saying, you know, can we capture some of this China reopening story through the tourism sector? But the Chinese reopening story has massive implications for the rest of the world because consumers in China will now start to buy goods from elsewhere. And they can now supply the rest of the world with a lot of supply chains that were somewhat broken because China was locked down, which again will bring in inflation.
So I think the China reopening story, coupled with the fact that employment data in the US is still strong, the US economy is looking okay, actually – sort of. Which could paint a positive picture for how the year unfolds. A lot of bad news was priced in last year about how the war would unfold, and the impact on energy prices. Companies were going to struggle and lose money and all the rest of it. And it hasn’t turned out to be that badly. So there’s a positive view to be taken from that.
But we’re worried about maybe the back end of the year because of the forward market, which predicts interest rates will go up. And you think about the Federal Reserve and the base level of rates is implying that the Federal Reserve will cut interest rates by Q4 or so. Now, the Fed themselves have said they will not. So the market anticipates that the economy might not be that weak, that they have to respond by loosening monetary policy, and cutting interest rates. And so the market’s implication of the future is different from what the Federal Reserve is actually saying, which is a bearish indicator, the market is saying. So I think the strong rally is great. I don’t think we’re necessarily done for the year. I think this is an opportunity to capture more upside as we move through the year. But there’s going to be noise. So difficult is the answer, I think, but we’re not taking all the risk off.
On the interest rate cycle right now
Well, in terms of major developed markets, China’s uniquely in a position to cut rates, and they’re the second largest economy in the world. But if you take other big blocks, like Japan, which is starting to see inflation and they’ve started to allow their interest rates to rise, which is, very unprecedented in recent decades with Japan. If you take the European ECB and the Federal Reserve as the two major other central banks, they’re in a similar place really, they’re still trying to fight inflation. They have indicated they’re getting closer to a peak level of rates, but the Fed has said that they’re likely to stay flat for a while. So once they’ve reached the peak, they’ll keep interest rates flat and then maybe start to cut as inflation comes in.
It’s all going to be driven by the inflation data ultimately, and there are different camps on inflation. There are those who argue that we’re far from done with inflation. Inflation continues to run hot, and they haven’t moved enough yet. And there’s the other school of thought that sits in the deflation camp that says actually, given all of the changes that are taking place in the world – China reopening supply chains post-COVID – is no longer such a big issue. Shipping rates have come down massively. Demand is softening as economies somewhat cool and fears of recession, etc., that inflation is not going to be a problem. Energy prices and other commodity prices have come in from the highs of 2022, so we could actually see a deflationary world.
I think we’re somewhere closer to low inflation, not necessarily deflation, than we are to high inflation. And so inflation is coming in. If you look at the year-on-year readings and even the month-on-month, the January reading in the US was 0.41. So if you annualise 0.41 every single month, you are looking at, 4.8% ish inflation. that’s not that high. It’s high, higher than the target of two, but it’s not where it was, north of ten. And so inflation has been coming in. I think as interest rates have risen, it’s going to squeeze households. You know, if you’ve got a mortgage, you’ve got a student loan, you’ve got motor vehicle finance, you’ve got your company in borrowed money, you now have to repay at a higher interest rate. Or if you need to borrow, you’re going to have to borrow at a high interest rate that’s going to squeeze the economy. And so that will then drop demand. And that dropping in demand will cause prices to decline. there’s this argument – the Fed might have done it perfectly, and there might be a soft landing. And I’m somewhat in that school of thinking based on economic data. Employment data is still very strong. They’ve moved rates up meaningfully, and inflation is coming in. So where we are in the rate cycle, I think we’re getting close to the peak. I do think within a year, or so, you could potentially see cutting as the economy slows down as inflation comes in.
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