Expert: Kerry Craig – Winter is Coming | J.P. Morgan Asset Management

Bryce: [00:00:15] Welcome to another episode of Equity Mates, a podcast that follows our journey of investing. Whether you're an absolute beginner or approaching Warren Buffett's status, our aim is to help break down your barriers from beginning to dividend. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you going?

Alec: [00:00:30] I'm very good, Bryce. I'm very excited for today's episode. We've got a returning guest, a returning favourite from J.P. Morgan Asset Management.

Bryce: [00:00:38] That's it is it is our pleasure to welcome Kerry Craig back to the studio. Kerry, welcome.

Kerry Craig: [00:00:43] Thanks, gents. It's great to be here and to have done a good enough job to be invited.

Bryce: [00:00:47] Back with Kerry is a global market strategist at J.P. Morgan Asset Management. At J.P. Morgan Asset Management he is responsible for offering thought leadership and explaining market data and trends to wholesale and institutional clients, investors and the broader investing community. Thanks to J.P. Morgan Asset Management for sponsoring this episode. And we have so much to get through today. There's so much going on at a macro level, we cannot wait to get stuck in, so let's do it.

Alec: [00:01:15] Yeah. Kerry And we're calling this episode Winter Is Coming, and I guess that's both literally in the northern hemisphere. Winter is coming, but also metaphorically, like the Game of Thrones inspiration it is feels like there's some tough times ahead. And so that's what we're going to unpack today. But before we do for people who haven't listened to our last interview with you, can you just remind us what you do at JP Morgan Asset Management?

Kerry Craig: [00:01:45] So my job if I boil it down, is just to provide clarity around what's happening at market level and to understand in times like these two, to think about what really matters for investors because there is so much uncertainty, we try to dull that down and cut through a lot of that. We tend to lean on this phrase putting the pieces of the puzzle together so you can see the big picture. And that's really what it feels like at the moment. There's so many pieces going on that sometimes the picture of what you're actually trying to achieve, investing can get lost. So just about providing clarity around the markets and I guess not to say reassuring people, but having them a better understanding that can help them make their own investment decisions.

Bryce: [00:02:22] Well, the macro picture can sort of feel a little bit bleak at the moment. And in preparing for this interview, you mentioned this sort of big three big themes that we should be aware of as global investors. There was the there's the energy crisis, possibility of a European recession and then the forecasts for the US Federal Reserve. And we're going to go through each of those today. So let's start with the energy crisis. To kick it off, are you able to just summarise where where we're at?

Kerry Craig: [00:02:50] Actually, when we look at the energy crisis, I mean, we're focusing on Europe, right? So we're thinking about the impact of the Ukrainian war, what it's done to gas prices, the flow on effect to oil prices. And in the last few weeks, that's changed, right? Oil prices have come down meaningfully. Gas prices also come down. And then you've obviously had this flare up based on some alleged sabotage around the pipelines and the gas prices going higher. And it is very, very vertical. Think about winter is coming because as Europe heads into that northern winter, it's all about how cold that winter is going to be, what other actions Russia might take to cut off gas and how much gas that you're really has stockpiled so far. And what's been remarkable is they've done a great job of stockpiling gas. They have a target of filling up 85% of their capacity and they're pretty much on track to do that by the end of this year. And that does leave them in a pretty good position to think about drawing down those stockpiles throughout the winter. The question becomes if it's a very severe one to those stockpiles and it come down faster, and then once they have run down and you're thinking about the spring and the northern hemisphere, how do they rebuild those? How are they going to go through having voluntary cutbacks to people using gas in manufacturing, or are they going to have to have them enforced? And quite frankly, if you have enforced ones, companies aren't making things, you can't sell anything and that dampens your economy. So all that does add up to a recession in Europe, but a relatively mild one. And I'd say that because you've seen this huge well, huge but significant increase in fiscal support from governments at both the national and supranational level coming through. But those numbers are sort of anywhere between three and 6% of GDP. If you look at across different countries and you compare that to the response during COVID and that fiscal response was between ten and 20% across different countries. So some way to go to offset that in terms of the complete impact would have on the economy. But we do think of it as a cushion. So softening that blow to the economy, getting up in a recession is probably going to be a little bit milder than we had thought because of that fiscal response. But it's so much does depend on their first response. And there is still this huge uncertainty around what Russia's going to do and potential further cut off of gas supply. So coming out the other side is just as important.

Alec: [00:04:51] A lot of people see the news about the potential European energy crisis, about the potential alleged sabotage of Nord Stream one and two. But at J.P. Morgan Asset Management, a lot of what you do is take the news and then translate it to what it could mean for investors or for different asset classes around the world. And we've. We've sort of seen some of what this energy crisis has done. I guess like the first order effects we've seen, higher energy prices for consumers. We've seen, you know, the UK Cup energy price rises to sort of protect consumers in some ways. We've seen trouble for energy utilities. Uniper in Germany got nationalised and there's a bit of trouble in that sector. But I guess beyond that, what are some of the effects that we should expect to see as investors?

Kerry Craig: [00:05:41] The biggest one is that a lot of that pricing is going to start to wash out when it comes to in terms of inflation, which is probably the most important. So when we think about the impact on headline rates of inflation in our expectation, as those start to come down, as those energy prices on a year on year basis look better in 2023, the impact on the economies in terms of what's happening in Europe is very much one where you're going to see that recession. It's going to be difficult for top line revenues to be growing. It doesn't really make us very attractive or very appealing to want to own European assets in this environment because it just looks like earnings are going to be further downgraded. It is cheap when you look at the prices of equities in Europe and relative to the US and other parts of the world, they do look attractive. But it comes back to this question are they cheap enough? And they probably aren't. Given that uncertainty that's overweight and overhanging the European economy. So it keeps us very cautious on thinking about European assets in this environment. And it also means that we do have this inflation that is going to fall over the course next year, but we do know is going to rise in the near term. And we've seen that from actions from the European Central Bank, the Bank of England. They're going to continue to hike rates in this environment. So we think those bond yields in Europe are probably got a little bit more to go. And again, as why we wouldn't think about owning a lot of European debt in this environment.

Bryce: [00:06:55] Now, you mentioned oil, and we've seen it come down from highs of, what, near 135 or thereabouts, a barrel or 130 or whatever. And sitting at about, what, 80, 80 a barrel now? Yeah. And OPEC is now saying that they're going to be cutting supply, given how cheap, cheap it is. What where do you see oil going from here and. Yeah, what are your thoughts?

Kerry Craig: [00:07:17] Yeah, it was great. Got down to that sort of the Brent oil price. Like that's the benchmark for Europe in the world and not the WTI one, which is as the US got down to about 84, it's actually popped up today to about 90 and I think there's actually more support from that. So if we think about what drives oil price, you've got supply and demand. Obviously think about our winter coming and the weakness in demand as the global economy becomes much more sluggish and you have those recessions, demand falls. That should draw down energy prices. The flip side of this is that you do have a case where we think about those OPEC plus companies, countries excuse me, saying that they're going to want to increase the price of oil to $100 a barrel because that's what they want to see it at. You've still got a risk that Russia could do more actions given the sanctions are being placed on them. You know, the theory ss that they wouldn't turn off their oil production because it's too costly to restart it. But they could you never know that would have a big impact. And then you've also got these sanctions being put in place on Russia throughout the year, not fully coming into effect until December. So they're still washing through. And again, this is all going to sort of constrain supply. There's been no deal with Iran. You've got a terrifying hurricane hitting Florida, which could easily disrupt refining capacity in the US. You know, all these things are going to be impacting the supply side just as we think about demand weakening and that's going to create somewhat of a floor, the oil price. It's not going to see it surge back up. You know, I don't think it's going to go back up $227 a barrel, but it's likely keep it supported. And actually, that's going to be quite good if we think about how well energy stocks have actually been performing.

Alec: [00:08:39] Yeah, I mean, quite good for energy stocks. The supernormal profits of the you know, the energy majors has been something to behold this year. It's been nice to see petrol prices come down a little bit. But I guess, yeah, the question is, you know, if India and China keep buying Russian oil, that's one thing. If they stop, then they have to buy oil elsewhere. We've talked about natural gas. We've talked about oil are probably one of the hottest energy topics. Thematics in the Equity Mates community is nuclear, and there's a lot of talk about nuclear, first of all, because of the European energy crisis, but also because of the broader climate change and net zero debate. Do you think this European energy crisis changes the I guess the the future of nuclear in anyway.

Kerry Craig: [00:09:25] I think it has reopened that debate about whether we can say it's it's green and sustainable and it fits into this not as a renewable but something that's not creating as many carbon emissions as burning fossil fuels. And it could be used given that there is already some capacity to generate nuclear energy in parts of the world to create a stop gap until you actually meet those renewable energy targets in terms of the amount of time it takes to build all this infrastructure, I think when it comes back to many investors, they have to make their own decision about whether they're to see, decide and think that nuclear is actually fitting their environmental standards. When they think about ESG investing, it's really, I think, a personal choice or a choice of an institution rather than one that should be forced on you by simply government saying we're counting nuclear as green. And I think this is going to be one of the biggest impacts as we see investors rotate towards a lot of that sustainability. The flip side to that is that given. How markets have been performing this year and that, you know, investors have felt a lot of pain in their portfolios. You know, equities going down, bonds going down. Often times like that, it's more about fixing your portfolio before fixing the world. So I think the focus can change a little bit in the short term as well.

Bryce: [00:10:27] Do you think there's anything that the market is getting wrong or thinking incorrectly about what's going on in energy at the moment?

Kerry Craig: [00:10:34] I think the thing that got wrong was that you were just going to have this shift to renewables and and realise there had been this huge underinvestment in fossil fuels and just ignoring how dependent the world still is on fossil fuels, just, I guess underestimating the amount of time it takes to actually change and shift from an economy that runs on fossil fuels to one that's actually going to run on minerals. Right. We think about all the inputs to, you know, batteries for electric cars or electrification of industries. That's really what's already been under-appreciated. And I think that's going to fuel that next shift. If we think about, you know, where do you actually access those materials? What countries of the world are going to be important? I mean, it was an article today and if I heard about Indonesia and the fact that it has tons of nickel, you know, it's going to shift a lot in terms of thinking about global supply chains, which countries are important as countries and economies think more about food security and energy security. I think there's going to be big shifts that play out in the next few years. And again, I think that kind of that's what people got wrong. It's probably just the length of time it's going to take to see that adjustment.

Bryce: [00:11:30] Yeah.

Alec: [00:11:31] Yeah, I think I think that's been no clearer than in Australia now for ESG reasons, I have never really thought about investing in coal, but a lot of people thought, you know, the days of coal were.

Kerry Craig: [00:11:43] Clean coal. It's clean coal.

Alec: [00:11:46] And you know, like the there was talk with the last government about subsidising coal plants and all of that stuff because they they needed to remain competitive. We had a look at some data from the ASX like the biggest sort of 200, 300 companies and four of the best five performers this year, year to date, coal companies. It's just like that's something the rest of the market got wrong. The future of coal. [00:12:09][23.1]

Kerry Craig: [00:12:09] Yeah, a lot of a lot of company countries around Asia are still reliant on coal. They've built new coal plants in the last decades, which are actually more efficient than the old ones in developed markets. And so they still have this huge reliance on coal that's going to remain. And again, it's going to be that that shift towards renewables. It takes a lot longer to come through, even if the desire is there. It's just a process of the fact that you need that much investment and it takes that much time to build the infrastructure.

Alec: [00:12:35] The big headline today was that Queensland's building the world's largest pumped hydro scheme, like 65 billion or something. And they won't they they forecast they won't need coal 20, 35 and onwards which is exciting.

Kerry Craig: [00:12:47] Yeah, those are aspirational dates for. A lot of these things. I hope that is. The case, but it does seem like a long way away right now.

Alec: [00:12:55] The the flow conversation from energy really becomes the possibility of a European recession because winter is coming both literally and metaphorically. And if it's a cold winter and energy stockpiles go down, energy prices go up, businesses and consumers feel the pinch at J.P. Morgan Asset Management, how what what's your weighting of probabilities? How much how likely do you think it is?

Kerry Craig: [00:13:18] And I guess a recession in Europe? Yeah, it's almost guaranteed. It's about how deep it is.

Alec: [00:13:22] There we go. I guess let's change the question. How bad is it going to get and how worried should we sitting on the other side of the world?

Kerry Craig: [00:13:30] But I don't think we need to. Be that worried. I mean, it's a it's something we've often thought about as being a regional effect, like the energy crisis in Europe is affecting Europe. Perversely, Australia's benefited from some extent given our export of energy and the impact around Asia has been relatively muted. Obviously, as Europe has sucked in more natural gas and the rest of the world, it means it takes it away from places like Asia. They're feeling it a little bit more in terms of they have to either pay higher prices or shift to other sources of energy, get that switching between gas and oil, for example. But it is relatively a European problem. The US insulated its self-sufficient energy largely here in Australia. We're not seeing the negative benefits and help to our tune in terms of trade talked about the coal companies there. So I think it is rightly an issue for Europe to where it becomes a bigger issue and where you could see it becoming more important is the sentiment effect. So we think about the UK, which is probably going through a recession as well. Europe heading for recession. The US is a bit touch and go at the moment. China's slowing down. Suddenly you're thinking about are we heading for a global recession? And that's really going to impact sentiment and attitudes towards risk assets at a time where you've seen markets be very weak already.

Bryce: [00:14:39] Mhm. So for someone who's just tuning in for the first time or has come up from a submarine from a nine month expedition, has no idea what's going on. Is the energy crisis the, the only thing that is driving us or Europe towards a recession or what other factors are at play that we should be aware of that are contributing to this this sentiment?

Kerry Craig: [00:15:00] Actually, what's been. Well, yeah, if you look at consumer sentiment in Europe, it's it's it's plumbing record lows as it would be when you're facing this kind of crisis. But what's even more remarkable is that consumers are still been spending you've actually had a lot of resilience in the economy. Data hasn't nearly been as weak as we had expected it to. And you've had quite a shift in terms of how governments are approaching it, being really willing to act and try and offset that. So you haven't had this idea that, you know, austerity was the thing that central that governments in Europe wanted to provide. You've got a better starting point from not is there a fiscal union in Europe, but you've had definitely an idea that countries are acting more in unison around approaching that common problem. We are. Go back to the debt crisis. It was always about, you know, us in the in between some of the smaller economies or say Italy and the southern economies and the other ones like Germany, where it's much more unified now. I just had.

Bryce: [00:15:49] A follow on for so the spending piece because it feels like it's sort of similar here in Australia that, you know, discretionary spending is probably still pretty high. I imagine it just feels that way. What do you say.

Kerry Craig: [00:16:04] You mean by, you know, lots of unnecessary things that we're just running out of but mean? You look at you look.

Bryce: [00:16:10] At the results, you look at the results from a lot of the retailers around the world in the most recent earnings anyway. And it wasn't it wasn't dire. I mean, they were probably sort of forecasting that the next earnings season is going to be a little, little bit worse. But what's your sort of timeline for the flow on effect of all these interest rate rises? Like it feels like it hasn't quite had the impact on consumer spending that it otherwise might have had.

Kerry Craig: [00:16:33] It hasn't. And even the retail sales came out for Australia, you know, for August we actually did better than expected. And I think that's a lag effect coming through. Consumers are relatively cashed up. You had stimulus and money transfers from governments to people during COVID is still being well wound down. Australian savings rate as you know, basically cash compared to disposable income is still above average. That still has scope to come down. It's come down in the US a lot more, but they still have more cash to spend. So a lot of that is the reason why you've seen consumers willing to spend and then you can look back and say, well, there's been the opening, people are catching up on all the spending they didn't do and we've seen a surge in travel and all that kind of stuff. So that's definitely been the case and is going to start to change from here. Now, though, I think that there is the ramifications that a lot of those interest rate rises which do actually lag on the economy, do affect how people spend, given that, you know, if they were refinancing mortgages and it hit some later on, that is going to start to create a drag. So we wouldn't think about that pace of spending to be maintained. And also, when you look at those numbers, you've got to remember they're not just volumes, they're prices. So they are saying that the fact that prices are rising is capturing a bit of that as well, not just absolute volumes of what people are actually spending. So we would think about that coming down. The flip side of that, and you mentioned corporate earnings is that companies have shifted from this idea of having just in time inventory systems to just in case. Right. So they have huge stockpiles of injuries. They've had to get rid of them. And I think that's going to be something to watch out for in terms of the upcoming earnings season from a lot of those companies in the US around inventory levels. Are they going to start slashing prices to try and clear them again? Would that be a disinflationary impulse? Potentially. But I think that that weight around consumers and what they expect them to do in that forecast will be very important. We think about the upcoming earnings season and how that might feed into analyst expectations, which looks a little bit high when we think about consensus for for earnings around the world.

Alec: [00:18:20] Okay. Heading back to Europe and the European recession, we speak about Europe as a block these days, but it still is multiple different countries with multiple different economies. And previously you mentioned Italy and they're obviously in the news because of a new government, but also a slow moving debt crisis. I think $2.7 trillion in debt, 150% of GDP. Mario Draghi couldn't sort it out and he was the former chair of the European Central Bank. I guess how do you think about the Italian debt crisis and what that could mean for the rest of Europe?

Kerry Craig: [00:19:00] Well, I think the Debt crisis in Europe is probably not the issue right now. The change in government and the shift to the right is probably a little bit more worrying. I think it's the whole debt crisis thing has become less of an issue more broadly because you have had that shift towards, again, more of a fiscal it's not a fiscal union, but more of an understanding of the fiscal ramifications of the blocs working together. I think what we can say as we look at the UK and what's happened is that in the last two years everyone has been very happy when governments are willing to spend, you know, rack up debt, fine, get us out of this hole. We've been in great a lot of that supported markets during that period. And there was the idea that, you know, governments could spend more freely because interest rates were low. What we've seen out of the UK is that when you're ramping up your debt and it's unfunded by tax and it is funded by issuing more debt. So we get fiscal stimulus, which is just ramped up by more debt. The markets are now looking at and saying, well, really, is it sustainable when interest rates are going up? And so that's what's changing. I think that the idea that governments could just spend freely and that central banks would always be there with low interest rates, and that's put pressure on the pound and the crisis in Europe. The energy is more weighing on the euro and the recession rating on euro. But, you know, that's where that infections could come through if. It's become a little more comfortable with those debt levels and say, hey, actually, we don't think this is very good when interest rates are going up. And when it comes to, say, looking at Italy, it's all about how much those spreads on debt widened compared to the power of the bond. And we see those come through. And then if they did get too wide, there would be some expectation the ECB would step in with some sort of measure, as they have pointed out the past, but never actually had to use how wide those rates had to become. No one really knows, and it's more likely the ECB would start talking about it before it actually did anything. So there are those backstops there to prevent that crisis occurring again.

Alec: [00:20:45] Okay. Well, that's a that's a glimmer of hope. Things are one point where things may not be as bad as as it May 1st appear. I guess let's let's grab onto this sliver of hope and and talk about any positive stories coming out of Europe. You know, we mentioned it's multiple different economies making up the one big European economy. Are there any countries that are looking really positive or that are beating expectations or surprising despite the challenges that Europe is facing?

Kerry Craig: [00:21:17] Not really, to be honest. I'm pretty happy I don't live in England anymore right now, to be honest. It's not a it sounds like. I think if I could summarise it, just say it's not as bad as everyone else makes out. There is this sort of idea that fiscal support, the fact that the economy has been a bit resilient just means that that recession that they are going to have is not going to be as bad. And it's because it's coming back down to the recession has been caused by too much inflation. It's going to be a policy induced recession by interest rates going up. And we have this very unfortunate situation with the energy crisis as well. And again, it does come back to that fiscal support and how much can come through and how much it actually does filter through to the real economy. We do think in our forecast it's going to be a relatively short few quarters of recession and not nearly as bad as like COVID or the GFC, which is what everyone leans towards. And again, because there's not those massive underlying imbalances in the economy that we may have seen in the past. For example, the banking sector is in a much better place than it has been in prior years. That allows us to think about the improvements you could see on the other side of the economy when it starts to come out. And a better functioning financial system, better flowing of credit obviously helps markets get back up, helps the economy get back on its feet.

Bryce: [00:22:29] So, Kerry, the pound is getting crunched and the US dollar is on an absolute tear. For new investors just joining the Equity Mates community. Should we care? Is it something that matters for us sitting here in Australia.

Kerry Craig: [00:22:44] For the pound less than the US dollar? Massively. All right. That's the world's reserve currency. And where it's heading is infecting everywhere else in the world through multiple channels. So the first is that as the US dollar gets higher, it means that every other country is getting weaker and currencies getting weaker. That means the input costs are higher. It feeds into inflation at a time the US is benefiting from disinflation because you're inputs are cheaper. That's the first channel. It's impacting earnings in the US. You know, you've got 60% of earnings in the US from foreign sources. Stronger dollar weakens their earnings. So you can think about the way it applies on the equity market and then the pressure it's applying like the euro and the UK and making and emerging markets and thinking about the negative impact it has. There is is is a problem. There's been lots of talk in the last day or two around the intervention and going to see a plasma accord kind of situation. No, I mean, the Fed wants the dollar strong to bring inflation down. They're not going to start hiking rates until they really have control of inflation. It's about how many other central banks around the world become more aggressive in their rate hikes or about how much growth actually looks better around the world compared to the Europe, to the US because you have the US dollar smile, even I've heard of. So the dollar smile suggests that, you know, when the economy around the world looks bad, anything about recession, everyone heads off the safety of US assets. So you think about buying bonds, think about by the US dollar. And so the currency rises in times of, of, of really weakness. And then, and the flip side, when everything's looking really good, money flows back to the US because equity markets are going up and you want to own the world's largest economy where everything's booming and it's actually in the middle. When you have mediocre growth in the US, when you have interest rates that are roughly the same as the rest of the world and the rest of the world is growing, that you're thinking more about diversifying around the world, and so you're in the middle as well. So that that sort of right hand side of the dollar smile, if you want to put it that way, in terms of everyone's flying to the safety of the US dollar, that's what's really underpinning it at a time when you have interest rates moving higher as well. So we see little to get in the way of that dollar smile and to get in the way of that dollar strength. At the moment the Aussie dollar is like down about 10% year to date. What I would say is that everyone asked me this like, Oh, the dollar's gone down versus the US dollar, the dollar's gone down with the US dollar. What's important for the Australian economy is the trade weighted index, like who we actually trade with, the trade weighted index. The Aussie dollar is up about 2% this year because we've been selling tonnes of energy to the rest of the world, mainly into Asia and China, and that's actually been quite good for our economy. So just avoid the trap. But think about that one currency. Think about the trade weighted by. Set for the impact on the Australian economy.

Kerry Craig: [00:25:14] Yeah. It's a very long winded answer. I'm sorry. Short answer is yes, we should care.

Alec: [00:25:20] Yeah, yeah. I mean, I know you're looking more macro than that individual stocks, but but one thing that just has fascinated me around the conversation of the strong US dollar and the weak pound, obviously everyone's looking at, you know, the the US stocks who are now going to be potentially have a revenue impact because of how strong the US dollar is when they're bringing revenue in from overseas. But the weak British pound feels like a real opportunity for some of those big British stocks because they're massive exporters like Diageo, the alcohol brand. Only 20% of their sales are in Europe, in the UK and so they're.

Kerry Craig: [00:26:00] Going to be seen of the revenues of this. The footsie come from outside the.

Alec: [00:26:05] Euro and so they're going to be booking, you know, US dollars, Aussie dollars and then reporting it in pounds. Surely they're going to be laughing next reporting. Yes.

Kerry Craig: [00:26:12] And they had seen the 32 bit better than expected because of that. But the makeup of their market is kind of similar to to Australia. So you've got a lot of resources, got a lot of financials in there as well. So from a diversification benefit, if you're Australian invested, you wanna buy more of the same you have. In your home market. And also you've got to think about how much those revenues are actually generated in Europe. We're heading for recession at weakness. So those are the corollary factors. You could say that same thing about Japan. Obviously, the yen has been very weak. Again, a cyclical market. We have a lot of offshore revenues and it's one area you might say, well, I love, I hate Japan. It's been on off for years. Those are supports for thinking about why, you know, the topics or the Japanese equity market might do better than other markets around the world because of that weakness in the yen. You have to offset that with, again, a cyclical market that might slow as the global economy slows. But the weakness in the currency is a support thing about the benefit of the the equity market and those offshore earnings.

Bryce: [00:27:06] So we've covered energy crisis. We've covered possibility of a European recession. Well, not possibility, but how deep are Europe in a European recession? So let's head over across the Atlantic and turn to the US because everyone is watching the Fed and we'd love to know what J.P. Morgan's asset management's view is on the Fed. Where do they go next?

Kerry Craig: [00:27:29] Um, I mean, this is the longest I've sat in a room with someone without the Fed being.  The first thing. That's means since inflation and the Fed. Obviously since Jackson Hole meeting in August, it's kind of spooked the markets. They came out and said, we're just committed to getting inflation under control. You could use that as as a code for saying we're trying to regain our credibility after getting inflation wrong for so long. But many central banks do that. And so it is a case of the Fed moving higher. You know, their up, their interest rates, any five basis points. They're sitting at this 3 to 3 in a quarter band now. They're probably going to do another 125 basis points by the start of next year, push that interest rate to around about four and a half per cent. And there's a couple of reasons why we think it's going to go that way. What the Fed has said is they're not really going to start hiking interest rates until they get the yield curve back into positive real territory. So we think about nominal yields adjusted for inflation. So as inflation comes down, we do think about that being a positive, but it does mean that the rates have to be above that level. Inflation is still right now, you know, three, three and a quarter still well below inflation. So they've got some way to go. And their preferred measure of inflation is something called the core personal consumption expenditure index. It's just different measure inflation that they've focussed on currently running at 4.6% year on year, right. So they are at three in a quarter so they have to get that up. If that PC number starts to come down to say three and a half or three by the end of next year, they do have to get above that and they've never stopped hiking rates when those real yields have been negative. So they've got some way to go. And I think that's an important thing to watch out.

Alec: [00:29:01] I mean, it's good that it's 4% because I was thinking, you know, I like the headline, inflation's 8.3% and they're to get higher than that would be.

Kerry Craig: [00:29:09] Yeah, our expectation is that those headline numbers are going to come back down to those two 3% levels in most economies around the world by the end of next year, because of the impact of food prices going down, energy prices coming down, the flow on effects, other parts of the inflation basket, core goods, you know, the things that apparently everyone stopped buying except you. Got to buy everything and you know they're coming down and that will weigh on inflation. But it's things like, you know, labour markets are really tight. You've got a lot of wage negotiations going on and wages are going up year on year. Housing is very important in the US given the rents a big part of the inflation cycle, you got those sticky parts of inflation which are going to be more important for things when you think about the core level of inflation outside of headline, and that's why there's always an upside risk to the Fed or the RBA or us doing more because those core levels, that measure of underlying inflation, the economy's not really going away. For us, though, those headline inflation coming down is what's really probably more important. The fact that we are thinking about doesn't cost so much to fill my car with gas. I'm not spinning so much. The supermarket, you know, maybe some of the inventories that companies are trying to get rid of mean. Things we buy a little bit cheaper and that can actually based on that drag on terms of that consumer spending. But for us, the Fed, they're going to go until they get those real yields back into positive territory, until it's a clear sign that inflation is coming down. And that does mean it's going to be a very much data dependent story in terms of watching the inflation prints that come out every month, watching the labour market, prints that every month, seeing if there's that weakness there that would suggest wage growth starts to slow down or reverse a little bit. And that's where we're at. It's unfortunately going to still be a very choppy and volatile outlook when it comes to central banks.

Alec: [00:30:43] Yeah, because I was going to ask you to sort of square the two narratives that you're hearing. One, that all these commodity prices are falling, you know, like lumber is down 70%, oil is off 40%. Like all these raw commodities are down. But we're also hearing people say the Fed and other central banks are going to raise keep raising rates and be higher for longer. But I think you've explained that there with the labour market and the housing market being two key drivers. Is there anything else is or is it just those two markets in the US?

Kerry Craig: [00:31:16] It's a shelter costs which are rents and things related to the housing markets, 30% of the inflation basket. So it's a big chunk, right. And then everything else because the US is such a services based economy comes back to how much you're paying your workers. And you have seen, you know, companies that have a lot of workers, tech companies and stuff like that, they're actually starting to retrench and, you know, lay off workers because, you know, it costs you much to hold them now. But more broadly, you've got a very tight labour market in the US. There's two jobs for every unemployed person at the moment. The participation rate is very low and that's troubling you. Think about where we're going to get more workers from. So the prime age working group, those last 25 to 55 go out and, you know, create a sweat making making money every day they've come back. You know, they're working at like those peak levels that were prior to COVID. And then everyone over the age of 55 is either taking an early retirement or maybe during the COVID reasons hasn't come back. And that's where you've seen the workforce drop. So it's how you replace those workers when you've effectively closed your borders to immigration. Yeah, you've got an. Ageing population anyway. So you know, that's, that's the challenge they think about how do I actually get that participation rate up, the unemployment rate higher and that wage growth lower. And the way you do that is by creating a recession or at least really slowing the economy as far down as you can without creating a recession as the hope for the Fed employment.

Alec: [00:32:33] You hear a lot of the conversation around immigration, as you just said. And, you know, hopefully as borders start to reopen and immigration starts to normalise, you see more workers and some of that heat in the employment market comes out. When it comes to housing, the conversation is a little bit more difficult. And unlike in Australia, most mortgages in America are fixed. And so everyone who fixed their mortgage at the start of this year has like a two or 3% interest rate. And if they were to sell and buy another house, that would be getting a 7% interest rate now. And if the Fed keeps hiking, it might even go higher than that, which feels like a structural problem for the US housing market. So how are you guys if that if housing is one of those key markets that we've got to watch, how are you guys saying it at J.P. Morgan?

Kerry Craig: [00:33:20] Asset Management is a it's a structural problem you've had on the head there. And I mean lots of smug people in the US who like I fixed my mortgage activity.

Alec: [00:33:29] But they can't move now..

Kerry Craig: [00:33:30] They'll stay home, maybe have more kids. They're sharing rooms because we're not flipping houses. So yeah, you've got to. Wonder about the transmission mission, transmission of higher rates into the economy like so. And here, you know, it's a pure effects every two years. So you have that sort of lagged effect on the economy as rates go up, you're going to have to impact over there. It's not so much when you look at the housing market, you have seen activity slow. So housing starts are coming down kind of makes sense. The problem is that you have a structural impediment and terms of there's just been a bigger population growth, more household formation, you know, people getting married, having families than there has been in housing growth in terms of actual stock of houses. So you've got more supply than you have demand as prices have gone up significantly when interest rates are really cheap in the US house price affordability became very poor so people are forced to rent. And so you've had a big growth in rents that's pushed up rental prices. People moving away from cities or relocating during COVID has also seen pockets of growth in different parts of America that again had that under sort of under Stockton housing. That's created more renting pressure. And so that's not going to go away because you're right, if the interest rates are going up, maybe the house you would have sold a house you would have bought to rent. As an investor, it's too expensive now. You're just going to stay where you are and therefore you're worried about that supply of housing to come through. So that's why rent becomes a much more slower moving part of the inflation basket. So we think about those things that can react very quickly to prices or energy. Obviously, things like clothing because you can have sales. Rents are a very slow moving part of the inflation basket and that's why it takes a little bit longer for them to come down. That's why they're called stickier and that's why it'll take longer for them to to run off. But we are. Saying that slowing in the housing market, prices are coming down. Stocks are rising a little bit. And that has spooked people thinking around subprime crisis. But, you know, lending is happening at higher rates. Their FICO scores in the US, those FICO scores, the banks are leaning to a higher. We're actually not seeing any to too many massive declines in prices and is a very important indicator. You can look at months of supply. And typically, when months of supply hits over six of new and existing houses. That's when you see year on year prices start to move negative months supplies around about three at the moment. And so it's not really in those alarming territory. So we don't have too much worry about the the housing market in the US. You're probably much more worried about the housing market in China at this point. Well, what about the housing market in Australia? What's J.P. Morgan Asset Management's view on the hottest asset class domestically? Well, I'm sure. That everyone else prices falling except mine. Unfortunately not. So yeah, you can look at the. Cycles of housing through the last five years. I mean, 2017 house prices fell ten or 11%. It's got to be worse than that. I'm a great barometer of this because I bought my first house in 2017 when I was. Just taking a fall. And we just bought a house early this year at the peak and now it's fallen. So I'm the worst person down. So when you move again, exactly when's the peak? When I buy a house. So it's going to fall more than that. I mean, it's going to come down between 15, maybe 20% and it's going to seem painful to those prior drawdowns we have seen. But it's coming from very high prices as the first starting point. And again, a lot of the lending that's happened by banks has been a higher quality. So again, again is going to create a drag on the economy in terms of the housing market activity. It could hit some of the banks in terms of their activity for lending. But again, it's probably not going to be systemic in terms of worried about the broader financial situation. And the other thing is that you can look at these numbers and say, well, higher interest rates are a problem, but, you know, this huge amounts of money offsets, accounts and all these kind of things. What's really going to change the housing market is that all those price cycles, when the house prices are falling, it doesn't start to turn until the RBA cuts rates, doesn't really start to change until the RBA really starts to loosen up rates. And so there's no expectation of the RBA cutting rates next year. So we could be in this sort of prolonged downward cycle 2017, it was close to two years which house prices came down over. So we could be in this sort of downward trend in houses for the next sort of 18 to 24 months again. But it depends. I mean, could fall into a massive recession. We could cut rates more back on buying houses for cheap.

Bryce: [00:37:38] Interesting. Well, love to hear that. We've got some time on our side. Ren. When not in the housing and not in the property market. But maybe we're coming closer tonight.

Alec: [00:37:49] So, Kerry, winter is coming. Literally and figuratively. There's a lot of reasons to be worried about there. But the job of an investor being a professional at J.P. Morgan Asset Management or a retail investor like Bryson is to remain positive. You know, investing is literally deferring consumption today in the hope that you'll be able to consume more in the future and look for opportunities. So in this context where there's a lot of reasons that you could be worried where winter is coming, where a J.P. Morgan asset management saying opportunities. I mean it's it's a tough environment to say there's lots of positive opportunities out there but for some reason as far as. So the song called times like these times I get to sing at times like that. So it's times like these we learn. To love the bond market a little bit more. And so it has been troubling given the most recent weeks we've seen this massive surge in yields and prices fall and you thinking, why don't you want to own bonds? That would be a lot of capital loss. Prices are falling as yields rise. But when we look at the world, we think about companies revenues being squeezed, input prices going up, earnings expectations being a little bit high, valuations falling on equities and not really providing a cushion to further earnings downgrades. It does really keep us very much underweight on the equity market. In the short term. We wouldn't be thinking about huge potential there, but we do like a little bit more obviously as the bond market because you've had this huge run up in yields and as the global economy falls and as you think more around growth rather than inflation becoming the problem, that is going to mean that yields should fall and that you will see price rises in bonds and a bit of risk adjusted returns from owning bonds in this environment. And that, again, feeds into this idea that if you're looking at your portfolio, you want to make sure you have adequate resilience to these shocks that are out there to wrap up well from that cold in the winter that's going to come. And you want to make sure that you have a high quality in your portfolio. So that does mean thinking about investment grade credit, probably leaning away from the riskier parts, the credit markets such as high yield at the moment because they're not really pricing in a recession that could come and thinking if you are in your equity portfolios, I mean, being underweight just means you don't own as many as you would normally would. It does mean any thinking about the quality of those earnings. There's been a big debate around, oh, doesn't growth stocks do really well when things are going down? They have earnings that deliver promise that those growth stocks are very sensitive to those bond yields. And as yields have risen, we've seen those growth stocks come down. So it keeps us very. On thinking about growth versus value and thinking much more about a quality bias, and that applies across sectors. One of the weirdest things at the moment is that as we think about slowing growth, it's not been those defensive sectors that have been doing well. It's been the more cyclical ones like energy. So it's hard to say that things are behaving as they should in this environment. There's greater dispersion across stocks, so it's better to be a stock picker across the market rather than thinking, I'm just going own this one sector based on historical movements and what I think is going to play out. So it is a case of being a little bit more cautious or resilient in terms of how you approach the market at the moment, given there's a lot of uncertainty out there, given there's this idea that we are going to have very sluggish growth, we could see that recession in the US, that we could see central banks tighten interest rates much more. And just to be patient, I think in terms of things go a lot cheaper, just be patient about rushing back in and picking up things you think are going to be cheap. Just really ask yourself the question are they cheap enough and carry?

Alec: [00:41:09] One final question as we wrap up. You know, Brian, why long term investors here? And there's a lot of reasons to be concerned in the short term, but I guess time and time again, the stock market asset class, a lot of asset classes in general climb that wall of worry. So final question, will the Australian stock market be higher in 20 years than it is today?

Kerry Craig: [00:41:33] Yeah, I mean I can say, hey. I did paint a rather dull picture of the world. I mean, it is a case of thinking about, you know, the rollercoaster that it has been on the course of this year, that, you know, it does feel like a run of one of those those downward spiral that a roller coaster. But, you know, on the outside that you get the ups. Right. And I think that's one of the other things that investors should really think about right now is that so many of the conversations I have around like, oh, should I have more bonds? Are the yields going to go higher or should I just have lots of cash at the moment? And, you know, surely you can do that. You can hold lots of cash and be defensive. That's not going to help you, you know, consume more in the future, as you put it. You know, it's not going to help you achieve your investment goals in the long run. And I think it really does come back to thinking about we do know there's going to be eventually an upside. How do you sequence back into risk? How do you start looking these markets that are got cheaper and have that plan in place? Now think about when are you going to start? Is it going to be credit? You going to be back at a high yield? Is it going to be those growth year parts of the market that do have those better earnings because it feeds into all those secular trends that don't really relate to the cycle? You know, you can think about robotics, AI, cloud computing, the fact that, you know, we have all these digital transformations that affect us every day in our life and we adopt technology so much faster than we have in the past. All those things are going to play out over the next ten or 20 years. They provide opportunities. And then as we talked about earlier, obviously we've got the whole story around renewables, the massive amount, there's investments there. Those secular themes are still very present. And as those companies become cheaper, you can start thinking about are they going to be an allocation? And your time horizon matters there because you realise why maybe they're going to slip in the next few months, but they're going to pay off in the long run. So it's a good time to again approach those secular themes that you might think about in your portfolio that you want to achieve and think about those long run goals because valuations matters so much in equities. So if you pay something for the stock market now, say seven times times forward earnings on a pay over one year, it doesn't matter because it's the cash flows, the companies that the earnings that matter over five years, ten years, it matters if you pay 14 times pay, you're going to get a much bigger return. And the same in the bond market. You know, if you're buying a bond that has a yield of 1%, your return is pitiful. If you buy a yield that has a bond there zero 4%, your returns mean much, much better in the long run. So those prices are really much something that for the long term resistant investor has become much more attractive. And again, we publish something called our long term capital markets, which is asset returns over the next 10 to 15 years. We cut those off every year at the 30th September. It's a start point because of where markets are. That is typically this year. I mean, it's going to have a pretty positive impact on what we think those returns going to deliver over the coming decades.

Bryce: [00:44:04] Nice. Have to get our hands on that report.

Alec: [00:44:06] Is that public?

Kerry Craig: [00:44:07] Yeah. We publish it every year it's. Going to come out on here in Australia on the seventh November and we'll be doing a release late. But it's, it's the long term view of markets, but it has some great thematics in there as well that we look at. So not only do we go through all the different asset classes and what's affecting them, so equities, bonds, private markets as well. Think about alternatives. It's also a macro view in the long run and we build on some semantics around what's changing. So globalisation is going to be a big one that affects it moving towards a 10 billion population planet, thinking about just active versus passive and what's at that range. I mean, there's a big case of being much more active these days. So yeah, there's some really good thematics about what we think is going and that markets.

Alec: [00:44:45] Well, I feel like I feel like we're going to be getting you back on at some point to talk about. Juxtapose the , you know, not the negativity, but the risk of the moment with the hopefulness of the 1020 approach.

Kerry Craig: [00:45:00] So it's a mess. There's a big opportunity being created, especially in the bond market in more recent times. And I think that time horizon is so important for thinking about your allocation, right? Now because personally I have an allocation. I don't look at what I earn on a daily basis. I just have that horizon system we'll worry about in five years, or if it's mostly my kids I worry about in ten years. So I think that Horizon is hugely important. We look at how markets are behaving lately. Yeah.

Bryce: [00:45:25] Well, Kerry, we definitely will have you back on. That is for sure. And we love you coming in and helping us unpack all that's going on at a macro level. It's fascinating chatting with you. So thank you to JPMorgan Asset Management for supporting the episode as well and we very much look forward to catching up again. So thank you very much.

Kerry Craig: [00:45:42] Thanks very much and take care.