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The Market
Trump – Liberation Day?
Trump’s announcement of tariffs yesterday sent shockwaves through global markets.
The shallow dive
- Ignore the preposterous comments in Trump’s announcement. Parse the underlying message.
- Trump is willing to sacrifice short-term market and economic disruption for political and economic gains.
- There is much to understand.
- We are not convinced of a permanent loss of value.
- Clients’ Australian shares sub-portfolios are well positioned already with many stocks that are ‘adaptable’ to change, and with most holding over 10% cash. We will be patient.
- Critically, the long-term challenge will be how to respond to what is a changing world order. Again, the winner will be those countries and companies that can adapt.
The deeper dive
In early March, US Treasury Secretary Scott Bessent suggested that “access to cheap goods is not the essence of the American dream”. With an eye to this week’s announcements, he noted that trade policy must be about more than just obtaining low-priced items from other countries.
So clearly, if you find Liberation in the form of high company profits and cheap plastic from China, this week wasn’t liberating. Much of Trump’s announcement was preposterous, and elements of basic economics were wrong, but our experience of Trump forces us all to parse the underlying message from any speech.
This week, Trump was willing to sacrifice a small (<5%) portion of the stock market’s value, risk higher inflation, and prepare to navigate short-term economic disruption for several political and economic aims – many of which he has outlined over the past forty years.
The impact on markets was a spike in risk and a fall in price. Falls in the oil price and risks around short-term economic growth in the US compounded these falls.
The concept of “cheap” moved from Chinese plastic (which is now 60-70% more expensive landed in the US after tariffs) to a set of hardest hit shares. But cheap alone doesn’t make a bargain.
We spent the latter part of the week looking at:
- What constitutes a buying opportunity in the current environment, versus
- Where and for how long will patience on the sidelines be further rewarded? Cash levels, ready to be deployed, in our clients’ Australian equities sub-portfolios are typically higher than 10%.
Readers and clients will be aware of our rotation away from the most exposed stocks and towards more affordable international markets, including Europe and Japan. This has continued to assist clients’ portfolios.
A framework for analysis
To appreciate this, if any of Trump’s underlying claims and motivations are relevant in the medium term, our analysis has synthesised views from many sources.
Trump claims regarding trade deficits on a country-by-country basis represent one nation’s ”stealing from another” isn’t valid, nor would using such a calculation to generate the level of tariffs appears more than directionally relevant.
But highlighting the impact on genuinely fair trade of market access regimes, non-tariff restrictions, differences in VAT, and straightforward economic subsidies has merit. Equally noteworthy is the idea that the US economy needs to be reorganised to generate more widespread social benefits from its huge household consumption capacity.
Within this context, we categorize the tariffs into four groups.
1. Motor vehicles
Automobiles have particular impacts due to the cultural history of US manufacturing, the legacy of the sector as part of NAFTA, and the US- Japan relationship since 1990. US auto has minimal impact on Australia.
2. The 10 percenters
This is the 10% from all “other” countries, a group that includes Australia. This baseline of 10% serves two purposes: revenue growth and the capture of tariff avoiding behaviour.
- Despite Trump stating that tariffs are taxes on other countries, there is no doubt that tariffs are a tax on domestic households and companies; who pays, producers or consumers, depends on the product and the level of tariffs
- The US has limited political capacity to raise taxes; raising a tariff has the advantage of not being perceived as a tax, and the US government need more revenue
- We own a few companies that export to the US, and companies like Reliance Worldwide tend to mix production from multiple sources
- The use of a base global tariff of 10% also reduces the incentive for China to send goods to the US via minor modifications through a third country
3. Reciprocal tariffs
Reciprocal tariffs, including the most significant changes, such as those with the European Union, are all about negotiations.
- For the share market, this increases uncertainty and extends the timeframe for resolution to beyond many market participants’ investment horizon. We believe that ongoing negotiation in this area has the potential to add considerable value, also with increasing confidence.
- There will be early wins announced by Trump for nations such as Vietnam and Israel.
4. China
A separate issue, China was intentionally the recipient of the most punitive increases.
The new China tariffs are the natural extension of the same geopolitical contest that has been waged under the guise of co-operation for the past two decades. Countries in conflict don’t tend to trade with each other, and a tariff at the envisaged level almost requires trade between the US and China to be curtailed.
The impact of the tariffs on China is wide-ranging for our portfolio and Australia. The compromise solutions are more complex, will take longer, and will need to be more comprehensive, encompassing discussions of security and monetary policy.
The company impact
With the framework outlines above, the impact on the portfolio is the company level impact of a changing world trade order. The uncertainty surrounding the durability of tariff changes and a general increase in risk premia due to uncertain global responses contributed to this week’s increase in markets’ risk.
The market impact could have been more muted if the motivations and future tactics of Trump were more apparent. Are the tariffs just being used to leverage future deals on a country-by-country basis, as we believe?
The direct impact of the tariffs on individual companies will be worked through in the coming weeks. In the short term, the problem appears more straightforward than the opportunities. But both will emerge in time.
General US economic weakness is also a concern for markets with the outlook for weaker growth, reduced real incomes from higher inflation, and uncertainty on the scope of the US economy to invest in change relevant to the market.
A long-term view – adaptability
As we step back from headlines and knee-jerk reactions, we remain confident that investing in companies, especially in Australia, which is less affected, retains its critical feature: adaptability.
Companies can adapt to changing circumstances, especially those with intellectual property, pricing power, excellent customer relationships, and products in high demand.
Does it mean profit can’t change in the short term? No. Does it mean uncertainty around future investments is now higher, of course. But does it fundamentally change the prospect for companies’ post-adaption? Rarely.
Today’s falls on the ASX were compounded by falls in oil prices in response to OPEC production changes. Whilst lower fuel prices are supportive of the Trump agenda, they came as a dramatic surprise to the market.
Opportunities
We are not convinced of the loss of permanent value following the Trump trade shock. Opportunities will take different forms, and we rarely acquire companies with expensive future growth already factored in. In this respect we circle back to Treasury Secretary Bessent’s note that trade must deliver more than cheap goods.
Our Australian Shares sub-portfolios instead include, as examples
- Domestic supermarket franchise
- Global insurance brands and domestic healthcare companies
- Building supplies and infrastructure companies
- Global supply chains in copper, metal and battery materials
- Companies that undertake or serve the local production of food
We also try to avoid overinvestment in companies that purely profit from the exploitation of global cheap labour (retailers and companies such as Apple) or are too heavily reliant on single countries for clients.
The long-term challenge for Australians in coming weeks and years will be how we chose to respond to the changing world order. We will apply patience to find new opportunities amongst this change.
Challenger Limited (CGF)
Given the expensive investment fundamentals of the Australian major banks and the concentrated position these companies represent in the Australian share market indices (>20%), we elect to find other ways to invest in Australia’s financial services market.
In addition to banking positions in Macquarie and Judo Bank, we have exposure to several insurance-focused companies. These include QBE, NIB/NHF, Steadfast and Challenger.
This week, we direct reader attention to the latter of these names.
Challenger Limited – Market leader in a long-term growth industry
In today’s note, we outline some of the opportunities that Challenger will have to grow its retirement income products.
In the middle of 2024, the company entered clients’ Australian Shares sub-portfolios at a moderate weight, and we anticipate the position could grow.
What does Challenger do?
Challenger operates two core investment businesses: an APRA-regulated Life Insurance division and a fiduciary Funds Management division.
Challenger Life Company Limited (Challenger Life) is Australia’s largest provider of annuities. This business focuses on the retirement phase of investors. As the population ages and with the concentration of wealth amongst baby boomers, we think this business is strategically well-positioned for the near and medium term.
It’s Funds Management division, known as Fidante, is an equity investor and incubator of a range of Investment Management firms in Equities, Fixed Interest and Alternative Assets. It typically provides distribution and administrative support for these firms. Some of the brands in its stable are Equities – Alphinity, Greencape, Wavestone, Fixed Interest – Ardea, Kapstream and Bentham and Alternatives – including Apollo and Elanor
What is an annuity?
An annuity is a financial product that provides a regular and guaranteed income stream over a specified period or for the remainder of an investor’s life. Essentially, it’s a contract between the investor and an insurance company whereby the investor makes a lump-sum payment or series of payments (premiums). In return, the investor receives a series of regular cashflows/payments that begin immediately or at some future date.
A discounted valuation
Despite improving profitability and consistent EPS growth in recent years, Challenger has failed to capture investor attention and has suffered a sizeable de-rating.
The stock trades at a prospective P/E of close to 9x earnings, which is less than half the P/E of CBA, despite having superior forward earnings growth projections, according to market consensus.
Its relative value can be seen in two charts: one compares its P/E to its history, and the other compares its P/E to the market (a ratio) through time. On both measures, it is cheap today.
Figure 1: CHF P/E multiple history
Source: UBS, FactSet
This leaves the stock trading at a significant discount of ~50% to the broader ASX200 PE multiple, itself the low end of the historical range for which the stock has traded in the past 20 years.
Figure 2: CGF P/E versus ASX200 ratio
Source: UBS, FactSet
The relatively low price compared to both the current market and historical prices paid for Challenger is despite the improving returns on equity (ROE), as shown below.
Figure 3: CGF Price to Book and Return on Equity – should be correlated
Source: UBS, FactSet
Additionally, the stock offers investors an attractive, fully franked dividend yield of around 5% (equivalent to 8% pre-tax).
Figure 4: CGF Historical dividend yield
Source: UBS, FactSet
Higher ROE the result of management’s improved execution
The company has established an impressive recent track record of operational performance, marked by consistent improvements in earnings.
Figures 5 & 6: CGF Steady improvement in key metrics
Source: Company reports
Significantly, returns generated on shareholders’ capital have been improving and are well above the cost of capital. The recent 1H25 result also saw the company meet its stated target ROE of the RBA cash rate plus 7% for the first time in 3 years.
Source: Company reports
The improvement in returns has been driven, in part, by an increased focus on cost efficiency, but without cutting into ‘muscle’ and capability.
We also feel positive about the recent decision by management to ‘take its medicine’ and mark its property portfolio assets to more realistic valuations.
Figure 7: Outlook and opportunities – Favourable backdrop for their key annuity products
Source: Company reports
The popularity of annuities, which currently account for just 3.5% of assets held in pension accounts, is poised for a significant boost, with the Federal Government, superannuation funds, and annuity providers all looking to introduce more appealing products to ensure more successful retirements.
The main superannuation regulators – the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission – wrote to funds in June, asking them to introduce better retirement income products.
Annuities could be a suitable option, provided they are less complex and more appealing, offering retirees a guaranteed income for a set number of years or life.
APRA making life easier with proposed capital changes
That opportunity could arrive this year, with the APRA recently outlining in its new corporate plan that it will “support life insurers in increasing the availability of retirement products for retirees” this financial year.
Part of that will be to examine what works in offshore markets to see whether it can be applied to Australia. This could include some relaxation of the capital requirements for annuity providers, allowing for greater flexibility. Currently, Australian requirements for annuity providers are perceived as overly burdensome compared to those in established markets such as the US and Europe.
More flexible capital rules announced in late February are helpful and could result in significant savings in the level of capital required by Challenger to operate its annuities business.
In simple terms, assets are marked to market while the liabilities, which include the present value of future payments, are valued using risk-free rates plus an allowance for illiquidity.
Nobody wants to see a situation in which any annuity providers go bankrupt, given their crucial role in providing a safe and reliable form of retirement income. However, under the current rules, the test is viewed as too stringent compared to offshore regulations.
If a larger allowance could be made for illiquidity, it would enable annuity providers to offer more appealing products, potentially increasing the popularity of annuities.
Changes to the capital requirements would also reduce some of the volatility in annuity underwriters’ business operations, potentially leading to more attractive returns for customers and shareholders and a larger and more competitive annuities sector.
We view Challenger as the most obvious beneficiary of any relaxation in the capital rules around annuities.
Figure 8: Other opportunities – Several, including partnering with large superannuation funds
Source: Company reports
Annuities distribution
The superannuation industry has been effectively focused on delivering wealth creation opportunities for retirement. Still, industry participants acknowledge that the drawdown and post-retirement phases of the cycle are not given due consideration.
We anticipate that Challenger can be a successful participant as a manufacturer of high-quality post-retirement products for large investment platforms, such as Netwealth, and also provide products for clients of the large industry superannuation funds.
Summary
We consider that Challenger offers an attractive balance for investors to access:
- A market-leading position in a profitable, long-term growth market (annuities)
- A solid recent track record of management execution with clearly identified opportunities for further operational improvement and higher returns
- Attractive valuation and investment fundamentals
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.