Inflation, high debt levels a risk to stocks, says Allan Gray’s Simon Mawhinney

The economy is ‘precariously positioned’ leading into the Federal election on Saturday, according to Allan Gray managing director Simon Mawhinney.

Simon Mawhinney, Funds Mgr at Allan Gray at The Intercontinental Hotel in Melbourne.

The Australian economy is “precariously positioned” leading into the Federal election on Saturday, according to Allan Gray managing director Simon Mawhinney.

“It’s the bus you don’t see that kills you and it feels like there are quite a few buses on the road at the moment,” said Mr Mawhinney, speaking after the Allan Gray investment forum.

His buses? Inflation, massive supply chain issues, cost of living pressures, and how reliant Australians are on asset prices remaining at least at their current level.

Mr Mawhinney said it was pointless for a contrarian investor such as Allan Gray to consider political risk this close to the election but he did point to high levels of house hold debt being a significant risk regardless of who wins power.

“Our housing debt is huge. It’s all worked really nicely as asset prices have inflated over the years but if they stop inflating the party is over.”

House prices are already showing signs of weakening after the Reserve Bank of Australia this month raised its official interest rate – for the first time in almost 12 years – and flagged further rises to get the annual inflation rate of 5.1 per cent back down to its 2-3 per cent target range.

The Reserve Bank predicts home values could drop 15 per cent if interest rates rise 2 per cent.

And while the country finally has its lowest unemployment rate since 1974, earlier this week the latest wage growth figures showed an increase below market expectations.

In Australia we are hugely reliant on China buying our iron ore and residential property prices not falling.

“It’s like we are having a white tablecloth dinner on top of an active volcano,” said Mr Mawhinney. “In Australia we are hugely reliant on China buying our iron ore and residential property prices not falling. That’s our volcano. For as long as those two continue we will probably be fine. If either stop I think it will be less rosy.”

His warnings follow a bloodbath in the US on Wednesday night. Like Australia, the US is facing higher costs and rising rates. Overnight shares in US retailer Target lost a quarter of its value, the biggest drop since the sharemarket crash of 1987, as the company said higher costs were hitting margins.

Allen Gray, has positioned itself well for the current macro headwinds according to Morningstar senior analyst, manager research, Chris Tate, who pointed to being sizeably overweight to the energy and materials sectors, which currently stand at around 18 per cent and 12 per cent greater than the ASX 200 Index exposure at March 2022, respectively.

“This positioning have proven beneficial to performance in the current macroeconomic environment, as factors such as the Russian-Ukraine conflict, lockdowns in China, and supply chain issues, among other things, has increased the price of many energy sources and commodities. Should prices remain elevated, and Allan Gray maintain exposure to these sectors, that positioning is likely to continue to be rewarding.”

When asked about specific stocks at the conference, Mr Mawhinney had mixed views about gold, stating that while he was positive on the commodity, most gold companies were “crap” with the exception in this market being Newcrest.

“I think gold prices will go up from here. Underlying fundamentals are solid but many of the companies have poor deposits, crazy management teams, and shoddy capital allocation. They are quite crap.”

He does hold Newcrest and physical gold also makes up about 5 per cent of the Balanced Fund.

On the issue of Woodside, he said that while it was currently “extraordinarily cheap,” shareholders may have to settle for dividends rather than capital gains.

“There seems to be a buyers strike and some selling pressure, coming from ESG related investors and the buyers strike might be because if you are an investor and you don’t have Woodside, why would you buy it now when there is a whole BHP Petroleum transaction about to take place and every BHP shareholder is going to have a bunch of Woodside that they might not want.”

On the question of AMP, which Allan Gray was an outspoken activist investor calling for the heads of Boe Pahari, he said he could see at least $1bn of upside.

“It’s been somewhat enhancing but off a very low base.”

Allan Gray invests in value rather than growth stocks.

“What matters is what are the cashflows that I’m going to get. If you invest in those sorts of companies you are either going to get your returns from a rerating or from dividends, and I’m agnostic as to which way it comes. Both is also good,” Mr Mawhinney said.