Hugh Dive's blue-chip strategy to thrive in choppy markets

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The selloff of Australian large-cap stocks is overdone, investors are pricing in a sharper rise in interest rates than is likely, says Hugh Dive of Atlas Funds Management.

The ASX 200 is currently down about 11% for the year so far, a broad-based decline predicated on a view the cash rate could hit 3.75% by Christmas. But Dive is more sanguine in his outlook, expecting the rate to top out at 2.5% by the year’s end.

“With unemployment at the lowest level since 1974, inflation at 5% and house prices up 30% since January 2020, it’s hard to make the case that we’re in emergency settings. A normalisation of interest rates is to be expected but it’s causing a lot of angst in markets” - Hugh Dive, Atlas Funds Management

Many Livewire readers will be familiar with Hugh Dive, author of the well followed and widely read Dogs of the ASX articles. With the latest edition about to drop we took the opportunity to learn more about how he invests and to get more detail on how he is navigating the current investing backdrop. 

Rising inflation isn’t uniformly negative for stocks

Even if the local cash rate heads higher than he expects – given the persistent volatility and uncertain macro and geopolitical environment – Dive emphasises the fundamental effects are far less uniform than market behaviour suggests.

Rising inflation and the subsequent lift in rates have caused a pullback in discretionary spending, which is clearly negative for the likes of restaurants, cafes, and retailers of higher priced goods and services such as Harvey Norman (ASX: HVN) and Flight Centre (ASX: FLT).

But on the other hand, this rising inflation environment is potentially quite positive for supermarkets.

“When we've seen the tightening policies in the past, people tend to eat at home. They’ll shop at Woolworths and Coles, and at Dan Murphy’s for their bottle of Shiraz, but they're not eating out as much,” Dive said.

Regulated infrastructure firms such as Transurban (ASX: TCL) also benefit from rising inflation, its motorway toll prices increasing in line with this.

“Companies like that with long-term fixed debt and earnings can move. Inflation's quite positive, but the markets haven't really got around to that,” Dive said, suggesting the penny probably won’t drop until the upcoming August corporate reporting season.

Alongside parts of the energy sector, he named another motorway operator as one of the few other places for investors to hide during June, referring to Atlas Arteria (ASX: ALX) largely on the back of its upcoming takeover.

“But that's what we see often in these corrections, similar to what we saw in March 2020, when everything went down regardless of its fundamentals, and then things normalised when companies came out,” Dive said.

“It's actually quite positive for us and is just part of being an equity investor, dealing with the emotion than can often see everything fold at the same time and then throw up opportunities."

This environment also finally brings some good news for general insurers, who’ve seen record payouts on the back of claims for fires, floods, and business continuity coverage. The rising cash rate means insurers’ floats - the income they earn on the premiums they collect from policyholders – can finally earn some interest. QBE Insurance Group (ASX: QBE) alone has been sitting on a pool of around $30 billion earning less than 1% interest for the last several years.

The role of dividends and franking

Dive also remains upbeat on the dividend outlook, despite a more recent softening of iron ore prices that have buoyed mining company share prices and payout ratios for so long. He noted many of the lower-cost commodity producers maintained fiscal discipline during the boom, avoiding making “silly acquisitions at the top of the market”

“And many other big blue-chip institutions, including banks, are in much better shape than in previous downturns,” Dive said.

In the following interview, Dive discussed some of the signals his team uses to gauge company earnings quality and sustainability – including dividend franking – and named several ASX 200 companies his team regards as likely winners.

Dogs of the ASX

He also provided a sneak peek of how his “Dogs of the ASX” performed in FY2021-22 and some inclusions for FY2022-23. This is a 10-stock, equal-weighted portfolio of the worst ASX 100 companies, which are bought and held for an entire year and then resold.

“The strike rate has been very good, having won seven out of the last 10 years (relative to the index performance). But in each of those years there are some companies that look absolutely dreadful on 30 June that then end up looking excellent the following year,” Dive said.

“I’m looking forward to doing it this year because my picks from last year look pretty good and are streets ahead of where they were previously. With only nine days to go, it’s 9% ahead of the ASX 200.”

Hugh Dive's Dogs of the ASX for FY22 is now available here.

You can watch the full interview by clicking the player below.

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