Groupthink around the low interest rate environment being the “new normal” could lead to compression and then an explosion, says Telstra Super.
The whole idea about markets is that people should have different points of view, different time horizons and come to different conclusions. When this does not happen the market becomes compressed and then it explodes, Kevin Branton, portfolio manager of Australian equities at Telstra Super, told delegates at the Equities Summit in Melbourne.
“It always worries me when everybody thinks the same thing,” Branton said. “For example, maybe there were some people that predicted Brexit, but everybody I knew thought it wasn’t going to happen, and then all of a sudden it did.
“And if everybody thinks exactly the same [about the low rate environment], I’m guessing there might be some sort of explosion. Whether it will be inflationary or deflationary I won’t go into, but the implications for portfolios are very different under those scenarios.”
For instance, Branton sees large systemic risks in areas such as REITS.
REITs have a cap rate compression and will likely continue to experience this, despite bond rates being so low, as someone from somewhere, such as Japan, will come in, see the yield and choose to buy it.
“And we think they are low risk because they have low market beta, but they have a very high credit beta in a lot of cases.
“So they are carrying a lot of systemic risk even though they appear on the superficial basis to be low risk. Another way of looking at is a carry a very high level of systemic risk and that’s true of the insurance sector as well.”
The low rate environment and the weird world of quantum physics
According to Branton, part of the issue is that the low rate environment has caused havoc because normal valuation techniques are now problematic.
“We’ve had things like gold, resources, REITS, growth stocks and defensives all performing well at the same time in [a] certain situation, which makes no sense.
“It’s a little bit like quantum physics. As soon as you get down to the realm of quantum physics all the rules [of Newtonian physics] go out the window – you can kick a ball and it goes multiple different ways, and through walls, but it ends up at the same spot.
“When you get interest rates down at these levels you can get some strange things happening with finance theory and get some strange outcomes and results. And we are seeing that now; a lot of that is playing out in terms of the market’s reaction to things.”
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