Welcome to the Fear and Greed Business Interview. I'm Sean Aylmer. Global share markets, including Australian equities are, I suppose, in the doldrums is one way of putting it. Markets in the US and locally are down 7 and 6% respectively since their July highs, a little more perhaps, and there's not a lot of confidence about the next few months. Naturally, when some sectors seem relatively cheap within equities, investors start looking for opportunities. So I wanted to talk to one of our regular guests about what he's seeing in the market right now. Remember, this information is general in nature and you should seek professional advice before making any investment decisions. Matthew Kidman is the principal at Centennial Asset Management. Matthew, welcome back to Fear and Greed.

Welcome to the Fear and Greed Business Interview. I'm Sean Aylmer. Global share markets, including Australian equities are, I suppose, in the doldrums is one way of putting it. Markets in the US and locally are down 7 and 6% respectively since their July highs, a little more perhaps, and there's not a lot of confidence about the next few months. Naturally, when some sectors seem relatively cheap within equities, investors start looking for opportunities. So I wanted to talk to one of our regular guests about what he's seeing in the market right now. Remember, this information is general in nature and you should seek professional advice before making any investment decisions. Matthew Kidman is the principal at Centennial Asset Management. Matthew, welcome back to Fear and Greed.

Hi, Sean, how are you?

Hi, Sean, how are you?

Well, thank you. I went away for five weeks, Matthew, or four and a half weeks, and I thought the world was okay, get back this week and oh my. What is going on?

Well, thank you. I went away for five weeks, Matthew, or four and a half weeks, and I thought the world was okay, get back this week and oh my. What is going on?

Yeah, we're definitely blaming you. You were the catalyst for markets to roll over, so can you stay put for a few weeks? I know that's hard for you, but that'd be nice if you could just stay at the desk. Yeah, it's been tough, and I think the catalyst for equity markets to be soft and Australia's probably done worse than even the US where the problem really exists, where we've got bond yields shooting up again in terms of the yields and the actual bonds, the inverse correlation with prices down, yields up. And it's not really about inflation because the short interest rate or the short- term rate that's set by the central banks is well above the existing inflation rate now. It's more about the fact that the US has seen its economic growth accelerate when it's defied all logic and all forecasts. When rates have gone up, it was supposed to slow, but for the moment, the US economy's chugging along and rates have gone higher and equity markets don't like that.

Yeah, we're definitely blaming you. You were the catalyst for markets to roll over, so can you stay put for a few weeks? I know that's hard for you, but that'd be nice if you could just stay at the desk. Yeah, it's been tough, and I think the catalyst for equity markets to be soft and Australia's probably done worse than even the US where the problem really exists, where we've got bond yields shooting up again in terms of the yields and the actual bonds, the inverse correlation with prices down, yields up. And it's not really about inflation because the short interest rate or the short- term rate that's set by the central banks is well above the existing inflation rate now. It's more about the fact that the US has seen its economic growth accelerate when it's defied all logic and all forecasts. When rates have gone up, it was supposed to slow, but for the moment, the US economy's chugging along and rates have gone higher and equity markets don't like that.

When we talk about bond yields being high, just explain why bond yields matter so much because they kind of set the benchmark, don't they?

When we talk about bond yields being high, just explain why bond yields matter so much because they kind of set the benchmark, don't they?

Yeah, it's interesting. Two things set the valuation for the stock market or equities as we call them. One is earnings. How much can a company earn and how quickly those earnings grow. So if you've got a fast- growing company, that's earnings are going up every year, we'll pay a lot for that. But the other side of it is the bond yield and the 10- year bond yield's important. Why do we always quote that part of it? Because that's the standard that we use for discounting earnings into the future. So the higher the yield, the quicker we've got to discount it. So $ 100 in three years' time, if you've got to discount it with a bigger number, it's worth less today. If it's a smaller number, say if the 10- year bond yield was 1%, we discount it at a slower rate. So the valuation's higher today, if that makes sense. So it's a critical element. It's 50% of the equation.

Yeah, it's interesting. Two things set the valuation for the stock market or equities as we call them. One is earnings. How much can a company earn and how quickly those earnings grow. So if you've got a fast- growing company, that's earnings are going up every year, we'll pay a lot for that. But the other side of it is the bond yield and the 10- year bond yield's important. Why do we always quote that part of it? Because that's the standard that we use for discounting earnings into the future. So the higher the yield, the quicker we've got to discount it. So $ 100 in three years' time, if you've got to discount it with a bigger number, it's worth less today. If it's a smaller number, say if the 10- year bond yield was 1%, we discount it at a slower rate. So the valuation's higher today, if that makes sense. So it's a critical element. It's 50% of the equation.

Okay. So given what's happening in the market, and yesterday was a bit of a horror date for the market, is the market oversold, I'm talking about the local market, do you think there are opportunities? What's your take on the ASX?

Okay. So given what's happening in the market, and yesterday was a bit of a horror date for the market, is the market oversold, I'm talking about the local market, do you think there are opportunities? What's your take on the ASX?

I think we're getting to that stage. As I said, keep a close eye on that US 10- year bond yield. Back in October last year, it got to about 4.2, 4. 25 and, this is a year ago, everyone saw a slowdown coming in the economy and we saw inflation coming down. So the bond yield actually started to go down. It went back down into the threes and the equity market rallied. And we thought, well, this is the beginning of a rally, but more recently that growth spiked, economic growth, and the bond yields have gone back up and they've gone right past that 4. 25. It sat there for a while and went to 4.7, 4. 75, around that level. Equities have come off. But I get the feeling that there's a little bit of a spike, a little bit of adrenaline in that bond market. Everyone's selling it off, and it might be just reaching a short- term high. Just keep an eye on it, but I think you're right. And once, if it does come back down, if it drops away from, say it gets to 4.9 maybe in the next week, then drops away, then you want to be back in the equity market because as we said before, that discount rate changes and it would turn around again like it did last October.

I think we're getting to that stage. As I said, keep a close eye on that US 10- year bond yield. Back in October last year, it got to about 4.2, 4. 25 and, this is a year ago, everyone saw a slowdown coming in the economy and we saw inflation coming down. So the bond yield actually started to go down. It went back down into the threes and the equity market rallied. And we thought, well, this is the beginning of a rally, but more recently that growth spiked, economic growth, and the bond yields have gone back up and they've gone right past that 4. 25. It sat there for a while and went to 4.7, 4. 75, around that level. Equities have come off. But I get the feeling that there's a little bit of a spike, a little bit of adrenaline in that bond market. Everyone's selling it off, and it might be just reaching a short- term high. Just keep an eye on it, but I think you're right. And once, if it does come back down, if it drops away from, say it gets to 4.9 maybe in the next week, then drops away, then you want to be back in the equity market because as we said before, that discount rate changes and it would turn around again like it did last October.

Are there certain sectors that you're better, that have safer plays at the moment?

Are there certain sectors that you're better, that have safer plays at the moment?

Well, that's an interesting one. On a day where markets are down, 1, 1.5% a bit earlier in the day, then everything gets hit a bit. And so not really, but over time, obviously you want defensive earnings. If interest rates are going up, you want companies that are defensive because higher rates in the long- term means that economies slow down, earnings slow down, so you want those defensives. But I would argue that that's not a great place because a lot of the Australian defensive stocks, whether it be in healthcare, whether it be in food or telcos, those things that we've got to spend on day by day have probably got a little bit expensive and not that attractive. So I think the play is to maybe go the other way and assume that once rates come back down, buy those higher growth stocks and higher multiple stocks that do better when rates are lower. What does that mean? The technology stocks that have been sold off, the quality end of the market, whether it be the healthcare growth, things like a Cochlear or a tech platform like an REA, stocks like that, when rates come back down, they will rally because they are higher growth stocks and they get hit harder when rates go up.

Well, that's an interesting one. On a day where markets are down, 1, 1.5% a bit earlier in the day, then everything gets hit a bit. And so not really, but over time, obviously you want defensive earnings. If interest rates are going up, you want companies that are defensive because higher rates in the long- term means that economies slow down, earnings slow down, so you want those defensives. But I would argue that that's not a great place because a lot of the Australian defensive stocks, whether it be in healthcare, whether it be in food or telcos, those things that we've got to spend on day by day have probably got a little bit expensive and not that attractive. So I think the play is to maybe go the other way and assume that once rates come back down, buy those higher growth stocks and higher multiple stocks that do better when rates are lower. What does that mean? The technology stocks that have been sold off, the quality end of the market, whether it be the healthcare growth, things like a Cochlear or a tech platform like an REA, stocks like that, when rates come back down, they will rally because they are higher growth stocks and they get hit harder when rates go up.

Stay with me, Matthew, we'll be back in a minute. My guest this morning is Matthew Kidman, Principal at Centennial Asset Management. Banks are such a big part of the market. How's all this work with the banks?

Stay with me, Matthew, we'll be back in a minute. My guest this morning is Matthew Kidman, Principal at Centennial Asset Management. Banks are such a big part of the market. How's all this work with the banks?

I'm so glad you've asked me that, Sean, because every time we've ever spoken, you've got to ring up the banks and I know that's right in your wheelhouse. You've got a long history following Australian banks. Look, I've said all along that I don't think the banks represent great value, and I stick by that. There's a number of ways we can measure the valuations of banks, but typically professional investors look at book value and that's all the loans out there they lend out and what they've got to pay to lend that money. And the difference is effectively the book value. Typically, book values in Australia among the big four banks should be 1.3, 1. 4, 1. 5 times. If it gets down to one times, that's a buy. Typically, if it gets above 1. 5, it's probably getting expensive. CBAs a little bit different. It's the quality end. It gets a better return than everyone else on the capital that it deploys. So it sits closer to two times book. And nothing screams cheap in that area at the moment. And, of course, they've remodeled themselves over the years away from business lending, much more towards home lending, and the housing market's still in the midst of a slowdown. It could turn around quite quickly, don't get me wrong, but at the moment it doesn't stand out to me as a great place to be in the market.

I'm so glad you've asked me that, Sean, because every time we've ever spoken, you've got to ring up the banks and I know that's right in your wheelhouse. You've got a long history following Australian banks. Look, I've said all along that I don't think the banks represent great value, and I stick by that. There's a number of ways we can measure the valuations of banks, but typically professional investors look at book value and that's all the loans out there they lend out and what they've got to pay to lend that money. And the difference is effectively the book value. Typically, book values in Australia among the big four banks should be 1.3, 1. 4, 1. 5 times. If it gets down to one times, that's a buy. Typically, if it gets above 1. 5, it's probably getting expensive. CBAs a little bit different. It's the quality end. It gets a better return than everyone else on the capital that it deploys. So it sits closer to two times book. And nothing screams cheap in that area at the moment. And, of course, they've remodeled themselves over the years away from business lending, much more towards home lending, and the housing market's still in the midst of a slowdown. It could turn around quite quickly, don't get me wrong, but at the moment it doesn't stand out to me as a great place to be in the market.

What about small caps? Now we have spoken about the fact that small caps have been discounted against other sectors of the market over time. Is that coming back? Where's that up to? Would you buy small caps, particularly given yields are so high and there is uncertainty about the economy?

What about small caps? Now we have spoken about the fact that small caps have been discounted against other sectors of the market over time. Is that coming back? Where's that up to? Would you buy small caps, particularly given yields are so high and there is uncertainty about the economy?

I think it's the place to be, but you've got to have a timeframe. It's definitely underperformed. The XSO, the small ordinaries as we call them, which covers the whole sector, all the different industries from industrials through to resources, has underperformed dramatically over the last year and a half, two years. I think underperformed by about 20%. There's definitely better value there compared to the big end of the market, but at the same time, it's more exposed to domestic conditions and we know domestic conditions are slowing, not falling off the edge of the cliff, but slowing. And of course there's still inflationary environment here. So I think valuation wise, it's the place to be. If you've got a two- year time horizon, start looking over your small caps options that are out there because I think you will win over that timeframe. In even the last five weeks since you've been away and you've come back, they've underperformed again. And that is mainly around this fear about rates going higher, economies slowing, lack of liquidity. It doesn't feel right to be there, but I think over that broader timeframe, that's where the value sits.

I think it's the place to be, but you've got to have a timeframe. It's definitely underperformed. The XSO, the small ordinaries as we call them, which covers the whole sector, all the different industries from industrials through to resources, has underperformed dramatically over the last year and a half, two years. I think underperformed by about 20%. There's definitely better value there compared to the big end of the market, but at the same time, it's more exposed to domestic conditions and we know domestic conditions are slowing, not falling off the edge of the cliff, but slowing. And of course there's still inflationary environment here. So I think valuation wise, it's the place to be. If you've got a two- year time horizon, start looking over your small caps options that are out there because I think you will win over that timeframe. In even the last five weeks since you've been away and you've come back, they've underperformed again. And that is mainly around this fear about rates going higher, economies slowing, lack of liquidity. It doesn't feel right to be there, but I think over that broader timeframe, that's where the value sits.

Any that you particularly like?

Any that you particularly like?

There's lots of sectors that we keep looking at and we'd love to buy, but we're lucky in the sense that we haven't got a massive fund and we don't have to move too early, but there's a lot of bombed- out sectors and we will move in because that's where we like to hunt. There's a handful of different retailers that have been sold off. There's a handful of different finance companies that have been sold off. There's media, there's even car retailers and so on. So there's a whole section of the community that, probably one way to sum it up, is exposed to the consumer because we keep hearing about the mortgage cliff, everyone's fearful of it. We're going from fixed rates to variable rates, switching back, those who have got a mortgage, and that's a lot higher rate than you're going to pay on your house and it hits you overnight. We're a fair way through that, so I'm not as fearful as others, but that's what's keeping everyone away. But at some stage there'll be a trigger. And when you can buy companies that are decent operators for nine, 10 times earnings, if those earnings can hold in there and then accelerate over a two- year period, then they're the place to be.

There's lots of sectors that we keep looking at and we'd love to buy, but we're lucky in the sense that we haven't got a massive fund and we don't have to move too early, but there's a lot of bombed- out sectors and we will move in because that's where we like to hunt. There's a handful of different retailers that have been sold off. There's a handful of different finance companies that have been sold off. There's media, there's even car retailers and so on. So there's a whole section of the community that, probably one way to sum it up, is exposed to the consumer because we keep hearing about the mortgage cliff, everyone's fearful of it. We're going from fixed rates to variable rates, switching back, those who have got a mortgage, and that's a lot higher rate than you're going to pay on your house and it hits you overnight. We're a fair way through that, so I'm not as fearful as others, but that's what's keeping everyone away. But at some stage there'll be a trigger. And when you can buy companies that are decent operators for nine, 10 times earnings, if those earnings can hold in there and then accelerate over a two- year period, then they're the place to be.

Just one final question, a little removed. We have a new Reserve Bank Governor, Michele Bullock, do you expect that the fact that there is a new governor will make much difference to how the bank operates then vis- a- vis what that means for investors?

Just one final question, a little removed. We have a new Reserve Bank Governor, Michele Bullock, do you expect that the fact that there is a new governor will make much difference to how the bank operates then vis- a- vis what that means for investors?

In one instance, no, she is cut from the same cloth. She's worked with the old governor for a long time, thinks a similar way, assesses the data and monetary policy in a similar fashion. And that's the way you would like it, because Phil Lowe was a very good governor and she's cut from the same cloth. And so when she gives these press conferences now post the results, you would expect her to give a similar... Like she did yesterday. She said, " We're on hold for the moment, but expect higher rates if inflation doesn't come down. And we reserve that right to lift rates." And that's what Phil Lowe was saying. I think where it could be different is the overhaul of the Reserve Bank, which has given more power to the actual Reserve Bank Board and the committees that are within that board where it has to get consensus. I have no idea how they will be thinking and what message they will be telling the governor to go out and tell the public. Previously, as we know, the governor and his team or her team would present something to the board, they'd discuss it, but they normally back the experts, the economist. That's been turned on its head and now it's the committee who makes the decision and the governor's got to sell that decision to the public. And I don't know how that's going to play out. It might be the same. I don't think she's any different, but the process has changed, and so we've just got to watch it carefully what it means in the longer run.

In one instance, no, she is cut from the same cloth. She's worked with the old governor for a long time, thinks a similar way, assesses the data and monetary policy in a similar fashion. And that's the way you would like it, because Phil Lowe was a very good governor and she's cut from the same cloth. And so when she gives these press conferences now post the results, you would expect her to give a similar... Like she did yesterday. She said, " We're on hold for the moment, but expect higher rates if inflation doesn't come down. And we reserve that right to lift rates." And that's what Phil Lowe was saying. I think where it could be different is the overhaul of the Reserve Bank, which has given more power to the actual Reserve Bank Board and the committees that are within that board where it has to get consensus. I have no idea how they will be thinking and what message they will be telling the governor to go out and tell the public. Previously, as we know, the governor and his team or her team would present something to the board, they'd discuss it, but they normally back the experts, the economist. That's been turned on its head and now it's the committee who makes the decision and the governor's got to sell that decision to the public. And I don't know how that's going to play out. It might be the same. I don't think she's any different, but the process has changed, and so we've just got to watch it carefully what it means in the longer run.

Matthew, thank you for talking to Fear and Greed.

Matthew, thank you for talking to Fear and Greed.

Thanks very much, Sean.

Thanks very much, Sean.

That was Matthew Kidman, Principal of Centennial Asset Management. This is the Fear and Greed Business Interview. Remember, this information is general in nature and you should seek professional advice before making any investment decisions. Join us every morning for the full episode of Fear and Greed, Australia's best business podcast. I'm Sean Aylmer. Have a great day.

That was Matthew Kidman, Principal of Centennial Asset Management. This is the Fear and Greed Business Interview. Remember, this information is general in nature and you should seek professional advice before making any investment decisions. Join us every morning for the full episode of Fear and Greed, Australia's best business podcast. I'm Sean Aylmer. Have a great day.