“Definitely valuation-wise, it reminds me a bit of 2007 or 2000,” says Catherine Allfrey, about whether today’s markets have anything in common with two of the great modern bubbles.
“People are very optimistic, shall we say, about the future with the way that they’ve been willing to pay out and look out in terms of duration for earnings for companies. There’s a lot of view in the market that everything will be OK. People are giving everyone the benefit of the doubt at the moment, they’re pricing everything in and they’re looking over the horizon to try and get these valuations to stack up.”
However, that only applies to certain sectors, the WaveStone principal says. Other sectors, including banks, “people just don’t want to know about”.
“There is such a dispersion in valuations currently. The technological disruptions that we’re going through as well and the way that’s turning this model on its head is also probably another reason why it is what it is. It’s not like the dotcom era, these are real cashflow businesses – Google, Facebook – I am a believer in that and I am a believer in the technological change we’re witnessing.
“From that perspective I get it. But I think some of these businesses have run ahead of themselves in terms of valuations.”
‘This is getting crazy’
Ten years ago, WaveStone was a much smaller investment manager, but it had a front-row seat to the crisis in Australia via its absolute return fund. Today it oversees $4 billion.
“Most equity investors in 2007 were saying, ‘this is getting crazy, and this is getting out of control’. At that time, in 2007, some things were starting to go wrong. November 2007 was the peak and there were the problems with the property trusts. That started around that time and I still remember … we actually shorted Centro Property and it collapsed 90 per cent in two days.”
Allfrey remembers an ill-timed Christmas mail-out arriving from the wobbling Centro. “Their economist at the time or something suggested that they didn’t need to worry about what was going on in sub-prime markets in the US, because people would have more money to spend,” she recalls.
“The model at the time was just wrong. Today they’re very focused on leverage within the actual model, they’re very different beasts. But it was also dependent on the quality of the underlying property as well. The problem for Centro in hindsight, that really was the canary in the coal mine, because they were exposed to low-grade retail assets.”
After a four-year litigation, Centro and its auditor PwC settled for $200 million with shareholders in 2012.
That was the first sign the global crisis had arrived on Australian shores and worse was to come.
“Shortly after, the whole thing exploded. It was a bit of a crazy time. What happened was this whole tightening and the lack of liquidity in the market then ended up being an economic downturn. It wasn’t as long as it could have been, and in hindsight, I think the authorities globally did the right thing. Remember we had the short-selling ban, there were so many different things that happened during that time.”
ASIC banned short-selling in financials in Australia in 2008, falling into line with other regulators. It was not lifted until 2009.
“I remember at the time we went to zero in small caps. People forget,” Allfrey says. “These small caps become like lobster pots, you can get in but you can’t get out. One of the best decisions we made during that time was to get out of small caps.”
The market was down nearly 30 per cent for the year to March 2009, and WaveStone was down 7.9 per cent. “That’s still painful,” the fund manager says. The business found a big brother in Challenger, which itself was not immune to the wrecking ball smashing through the financial system.
“I still remember Warren Buffett was coming on rescuing these companies – Goldman Sachs. He would be on CNBC every second day just calming everyone down. And then the market would lurch another 3 to 5 per cent down.”
Everything was suddenly highly correlated and there was nowhere to hide to protect returns. It reminded her of the distressing events around September 11, 2001.
The circuit breaker was the capital-raising binge in early 2009.
“The ability for the superannuation system to underwrite the Australian corporates shouldn’t be forgotten. That was testament to the fact we had the liquidity on the equities side, we might not have had it from the credit markets globally, but the Australian banking system could do heavily discounted rights issues through that March quarter of 2009.
“Something like $80 billion was raised by the banks and corporates.”
Stimulus had arrived
That required investors who had managed to hang on to pivot as it dawned on the market that defensives were the wrong place to be: the stimulus had arrived and it was working. Everyone had to go into cyclicals, so resources took off.
“The problem was we could have all been very clever until the beginning of March 2009, but if you weren’t positioned for the market recovery from that point – the market moved 6 per cent in March. You had to be buying at the right time,” Allfrey says.
Price-earnings multiples “were in the tens for the market, as opposed to nearly 16 today”. “It was just incredible, absolutely incredible. CSL, what was that priced then? Some of these businesses were ridiculous. Seek was at $3.”
Years later, the fund manager watched The Big Short, the film based on the Michael Lewis book of the same name, at an outdoor cinema in Sydney. As painful as the subject matter was, she loved it.
“It’s really the other side of the story, that we weren’t being told just how bad it was.”
Appraising the world today, Allfrey concludes once again there is a lot of leverage.
“Every asset class has been bid up in terms of valuation. Plus, we’ve got a household sector that is very leveraged here in Australia, so the question is, is that due to the fact we’ve had low interest rates? Absolutely.”
At some point, “rates will increase again”.