Beaten down large caps to lead the recovery

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As borders reopen and Australians return to a new-normal, our economy moves from a pandemic to a recovery stage. Matthew Haupt and John Ayoub, large cap specialists at Wilson Asset Management, identify the beaten down sectors offering significant value for investors.

"The thing to note is that over the last six months markets have been very dislocated. We have had a lot of volatility however that has created a lot of opportunity ... From that standpoint we are more excited as this presents more opportunities to make money for our shareholders."

Insurance, mining, and infrastructure are sectors they see as offering outstanding value, while technology valuations look excessive. In this interview, the pair explain why they disagree with the consensus view on low rates moving forward and how this is influencing the large-cap ideas in their portfolio.

Discussion points

  • Impacts of the low interest rate environment and the introduction of QE
  • Strategies used to profit through the global recovery
  • Why the fund is staying away from Australian tech
  • The most compelling plays in Minerals and Insurance
  • Where the fund sees exciting opportunities in Australia
  • What the market is missing right now

This video is part of the WAM Vault series filmed in November 2020. Click here to access interviews covering Aussie small caps, global equities and alternative assets.


James Marlay: It is a really interesting time to be having a chat. There has been a huge amount of stimulus in the market. We have also had some news that caused a reaction around the prospect of a vaccine. Matt, you have talked about common sense starting to return to the market. What does that mean? What is that common sense that is coming in?

Matthew Haupt: Well James, I really believe it is around the unprecedented response to monetary supply, sending the rates down to zero, negative, the long duration assets bid up, pulling forward expected returns to today, and the valuations were getting out of control. What you are seeing now is hope of some normality coming back into the market. You are getting certain rates moving up. A vaccine may cause monetary policy to be eased in the future, and all those expected returns will be diminished over time. It is very sensitive at the moment as the rates are so low and we have probably obtained that sweet spot at the moment while economies are shut down. Any change to those dynamics causes a massive impact.

James Marlay: What have been some of the impacts of all of this money that is flowing through the system and particularly in the market where you are investing? Where is this flow of money headed?

Matthew Haupt: It is those long duration assets, infrastructure, anything with interest rate sensitivity. As we know, monetary policy does not really fix the economy, it simply boosts the asset prices and that is what we have seen that at the moment. Anything to do with duration or interest rate sensitivity they have gone up a lot. However it really has not helped the economy as we have found over time. Monetary policy does not help the economy. Fiscal policy does.

John Ayoub: The other thing to note is that over the last six months markets have been very dislocated. We have had a lot of volatility however that has created a lot of opportunity. What we have seen is that for a period of three to six years it was a one directional market where people were just buying long duration tech to generate earnings and returns. Today we have more opportunities in the market and there is more dislocation. From that standpoint, from a day-to-day basis, we are more excited as this presents more opportunities to make money for our shareholders.

James Marlay: We are going to definitely dig into some of the opportunities in a second, however while we are on the bigger picture story, the Reserve Bank of Australia (RBA) has lowered rates again quite recently and announced our own quantitative easing (QE) programme. What is your take on that decision and the impact that it has particularly in the large-cap space?

Matthew Haupt: The RBA’s move initially was very good. They were very quick to respond to the pandemic, lowering rates, the funding for the banks was great. I believe the QE is a mistake though. It is at the end of the lockdown period, our economy was reopening and you have a vaccine coming now, so I think the QE will distort some of the market prices in Australia. It is very good for property, however, I really believe it is bordering on a policy error. They have gone too late, they should have gone much earlier and holding down yield curve control hurts financial companies. It is quite interesting the market interpreted the QE announcement from the RBA probably in the way the RBA didn’t want things to happen, the dollar shot up. The long end of the yield curve is up because I think the market is looking at this response as being too late and now it is actually going against what the RBA was trying to deliver which was lowering the Aussie dollar, therefore the policy is too late. It should have been earlier and I believe it could cause some areas of concern around some of the valuations in Australia as well.

John Ayoub: The thing to remember is Australia is ahead of the rest of the world from a recovery phase perspective. We are almost already out of the coronavirus phase and with a vaccine coming to the rest of the world we have been able to manage and mitigate a lot of the risks a lot earlier. As Matt said, the RBA and policy makers in Australia were ahead of the curve early on with JobKeeper and JobSeeker, stimulus and whatever else was required, however they are doubling down at the wrong time and by doubling down at the wrong time it will likely back us up a little bit compared to the rest of the world.

James Marlay: Interesting. Maybe we could have a quick chat about a recap from the conversation we had from May. You guys were being very active in the market, trading opportunities and you spoke about sort of being “chained to your desks”. Some of the themes at the time were, you were bullish on banks, you talked about having held some gold, and you saw an opportunity in oil. I was wondering if you could maybe give me a recap of some of the views and how the portfolio has evolved and what has worked for you over the past six months?

John Ayoub: The biggest thing we focused on was the sequencing of the recovery. From a portfolio construction standpoint we tried to position ourselves from a sequencing standpoint; who is going to come out first, second, third, and then we constructed the portfolio with backdrop. If you consider, as Matt would have said in May, we were very positive around China being the first ones out of the coronavirus and the recovery phase therefore we were very heavily positioned to resources at that time. Following that we decided to tilt the portfolio to banks and a lot more of the domestic cyclicals as we thought Australia would be the next country to come out of it. Therefore you go from a flow perspective, our money would flow from China to Australia, to other markets where we thought the recovery would be taking shape.

James Marlay: You didn’t mention the technology sector which has been a huge beneficiary. I know you have alluded to some lofty valuations. How have you managed not having exposure to technology and why haven’t you had that exposure?

Matthew Haupt: It is valuation for us. We struggle trying to comprehend the market caps of these companies. Obviously the conditions are ripe for them to go up. How we managed is by picking companies, which John alluded to, we look at the phases of this recovery and we were quite early on in the recovery phase domestically and companies like Star Group (ASX: SGR), Scentre (ASX: SCG) and a few of those, they were at depressed levels trading below net tangible asset (NTA), and people were thinking balance sheets were a risk and we never thought that was the case because of the controls within Australia. That is how we have kept up by picking these really depressed companies that are actually generating good cashflow and have good asset backing. The real important area now is we are entering a different phase with the market, we are in the recovery phase now. With the potential vaccine we are going to have to look forward to how this economic output gap closes and that will benefit real companies so we are looking towards those.

James Marlay: Can we dig into some more specifics? I’d love to hear about what is in the portfolio and I know you talked about sequencing the phase of the recovery so that is a bit of a retrospective. Talk me through what is in now and how you are thinking about playing the next phase of this recovery?

Matthew Haupt: The next phase is moving, like I touched on, closing the output gap in the economy which has got potential gross domestic product (GDP) sitting way higher and you have this huge output gap therefore we really need to close that output gap and that closing of the output gap is consumer spending and economic activity and as that returns you have got to be leveraged to those companies. For us, that is where we really do well in that environment because we are looking at these companies making good cash flow. Balance sheets will be rewarded finally, they were punished before, therefore good balance sheets will be rewarded in this environment and you have got to be positioned for anything linked to economic activity or recovery. In the area for us at the moment things that stand out is the insurance sector and again that is very much out of favour at the moment however that is a sector that will benefit from rising yields, also the premium cycle is incredibly hard at the moment and has been ignored. Anything paying a dividend as well, dividend payers have been punished in this environment which is quite bizarre. They will be the next beneficiaries as well so you have got to find companies with good dividends as they will be the next beneficiaries.

John Ayoub: The insurance names are Insurance Group Australia (ASX: IAG) and QBE Insurance (ASX: QBE), other aspects that we like to focus on are the companies exposed to government spend, stocks like Lendlease (ASX: LLC) and Downer (ASX: DOW) should continue to do well over the next 12 to 24 months. Elsewhere what coronavirus has provided is an opportunity for companies to refocus on their cost base, reposition and restructure, what we can see when we come out the other side is more profitability in corporate Australia. If you take Qantas (ASX: QAN) for example, what they were able to achieve during the coronavirus period, they wouldn’t have been able to achieve previously. They were able to readdress their cost base and as you come out the other side their domestic earnings will probably be greater than their peak earnings for the group in totality from 2018. We are very positive around corporate Australia and how they have been able to restructure their cost base and refocus on growth in the future.

James Marlay: You have mentioned a few stocks there. I would love it if one of you could take me a little bit deeper inside the thesis of a really core position where you have a lot of conviction about how you want to play?

Matthew Haupt: One I can touch on is IAG, the insurance company. With IAG there is great debate around the exposure with business insurance. Again, what we like to do is to find companies where the market has got an opinion, and then we try to find the opposite, and work through that. We’ve worked through it with different analysts, also lawyers, and talking about business insurance, and we believe the market’s impact or the perceived impact will be a lot less than that perception. We believe IAG’s exposure will be much less and the market sort of factoring in over a billion, a billion and a half, which we believe is very wrong. IAG is a specific example of a company in which during the pandemic there was liability, which could have a lot of people thinking is unlimited however we think it is very much contained, that is a company that has been caught up in the hype around the pandemic and that is a very specific case. You’ve also got the potential of interest rates rising, which is a small portion of their earnings, but the real key is the premium cycle is incredibly hard. You’ve got tailwinds coming out of this and once business intelligence (BI) is released we think there will be an incredible upside for this company.

James Marlay: Materials has been a sector that has held up pretty well. There has been some strengthening commodity prices. John, you mentioned China came out early. It’s been supportive for that part of the market. How have you guys played the materials sector? Is it a core part of the portfolio now?

John Ayoub: It remains an overweight key sector. For the last two or three years bulks, so BHP (ASX: BHP), Fortescue (ASX: FMG), Rio (ASX: RIO), have been the main driver of our material overweight and they have been massive beneficiaries from China’s stimulus and supply shocks from Brazil, however as we sit here today a lot of that has taken shape and taken place thus we’re looking more at the growth commodities. Oil, we are looking at nickel, we remain positive on copper. We are starting to rotate away slightly from the bulks and starting to look more towards the base metals and the oil stocks and consider as recovery takes shape they should be well positioned looking forward.

James Marlay: Is there a core or a lead position that explains that rotation or that you can use as a case for that rotation?

Matthew Haupt: The most obvious one for us has been Oz Minerals (ASX: OZL). Again there were company specific areas such as the company upgrading its production and the capital expenditure very much on target for their expansion which was under question for a period, yet it’s really around the coronavirus knocking out a lot of the copper output in South America. That was a beneficiary that we played and we have been riding into this recovery phase. For us copper, like John said, is a very much activity led commodity, and we sense in the next phase it will be positioned to do well.

James Marlay: We talked a lot about sort of the core parts of the portfolio. I know you guys have a tactical way of thinking about the market as well. How is that balanced between core and the tactical trading opportunities sitting at the moment? Where are some of the opportunities that you are thinking about from that shorter term trading perspective?

John Ayoub: The market provided a lot of opportunities recently and as Matt pointed out and you mentioned earlier that we were glued to our desk, for a long period of time during the last six months. People react in certain ways to information and our job is to process the information and work out if it is an overreaction, long or short. If people have gotten a bit too aggressive on a stock and we own it, we have to capitalise on those opportunities one way or another. Where we sit today is a function of opportunities in the market. We have been presented with a lot more structural core positions within the portfolio over the recent past however as we look forward we are probably going to have to start to look towards some of the shorter term trading opportunities as they present themselves.

James Marlay: There has been all these big headline events in the papers. We’ve had the US election dominating, coronavirus, vaccine, government stimulus. What do you think has been missed while we have all been looking at these headlines? What has the market missed?

Matthew Haupt: What happens during a shock or event is people get used to the current situation and extrapolate it for a long period of time. We are actually in emergency settings globally on monetary and fiscal policy, the rate environment is incredibly low, and everyone is extrapolating this out for a long period of time. However this won’t happen, this is a shock and during a crisis normally it is a structural crisis, you have to deflate a bubble. This is a shock event so everything has been put on hold but there is no essential bubble to deflate. If you can get fiscal policy kicking things along, monetary holding up asset prices, and we can recover out of this, that base case everyone is factoring in now will be wrong. The low rate environment forever that will be proven to be wrong and that will cause big shocks through the stock market. We are starting to see a bit of a glimpse of that now as we move out of phase one which is the pandemic, phase two recovery and a return to normality. We are in phase two, if the vaccine is here, but everyone is caught in phase one still so that transition will be quite painful for a lot of people.

James Marlay: I was going to ask you where value is because that is where we started our last conversation and you gave us a great answer but I am going to flip it on its head and say where don’t you see value given you are talking about coming from phase one to phase two?

Matthew Haupt: It is anything to do with interest rate sensitivity and high valuations and again we look to the tech sector as overvalued. If the vaccine comes, I mean it is all contingent on the vaccine, as we are actually looking pretty terrible globally on the coronavirus situation, it is accelerating to the negative side. Excluding the vaccine you would be piling into that trade as policy will have to meet coronavirus however if coronavirus is contained policy will change therefore the tech sector looks over valued, that is a stand out still. Prices could fall 30% to 40% and I would not be surprised if we go into this next phase.

John Ayoub: A lot of those beneficiaries as we mentioned early the coronavirus, the stay at home trade so to speak, you can’t put a multiple on this year’s sales or this year’s earnings and we heed caution on that because they will not be able to comp these as people start to return to normal life. Although people have suggested structural change has happened a lot more rapidly, as we know in the past things don’t happen that quickly, and by human nature we like to go back to what we know. As soon as borders open up and as soon as people are able to dine out and travel again you will see that nuanced.

James Marlay: We are in the situation where you are not able to get face-to-face with your investors which is obviously disappointing. This is the way that we are doing it in 2020. What’s the message that the two of you have got to your shareholders and investors in WAM Leaders?

Matthew Haupt: The next 12 to 18 months is incredibly exciting. I think we are going to go into this recovery phase. This will be more our market, even though we’ve actually performed well in this very dislocated market. We are very excited about the good companies coming back to decent valuations from the depressed levels they are now and we think we can position the portfolio incredibly well over the next period as it plays out. We are very excited about the opportunities, very excited about select companies that we are able to purchase at discounts to what we believe they are worth. This environment is great for us.

John Ayoub: Lastly, we are living through history and it is an exciting time to take note of how people react and how markets are moving. We will be reading about this in 20 years and look back and say: this is what happened. It is a great time, and we have to stay glued to markets and enjoy the ride.

James Marlay: Thank you both for you time.

Matthew Haupt: Thank you.

John Ayoub: Thank you.

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