The bubble has burst: Here are 5 stocks to keep you afloat

Hans Lee

Livewire Markets

Are equities in the last stages of a decade-plus long bull run? Treasury yields are soaring, inflation remains stubbornly high, and just about every asset class bar the US Dollar couldn't catch a break in August. But for every selloff, there is an opportunity and value stocks are now enjoying a time in the sun that they have not had for years. 

For Aaron Binsted and the team behind the Lazard Defensive Australian Equity Fund and Lazard Select Australian Equity Fund, it's been a chance to accumulate high-conviction positions in select stocks and sub-sectors. 

It's a strategy that has worked big time. The Defensive Australian Equity fund was the second-best performer in FY21/22 among Australian equity-focussed products. Its defensive mandate, combined with a high-conviction income focus has served it well in times when investors were looking to protect capital rather than chase it. But if defensive is the name of the game, why not have more of the portfolio in cash until uncertainties shake out?

In this fundie Q&A, I ask Binsted about his views on the broader market landscape here and abroad. We'll dive into two of his favourite sectors and the top companies within those sectors. Finally, we'll discuss China - and why he says there is good reason to be underweight the Big Three iron ore miners.


Livewire: You're going to hit 20 years at Lazard in December. What's the biggest lesson that you've learned in all that time?

Aaron Binsted: There are probably two things that really stick out. The first is that great saying that the lesson of history is that we don't learn from history, and why do I say that? Our view was that we had a massive equity bubble build-up from 2019 to 2021, that was just a huge unjustifiable distortion and was going to unwind. And that's in the process of happening now. 

And why do I say we don't learn from history? Because there were just so many similarities to the TMT boom in '99-2000. 

Both periods were speculative bubbles that were not based on earnings or cash flow growth. It was based on multiples going up and up.

Noted American economist Hyman Minsky's definition of speculation is buying an asset, expecting someone to buy the same asset for you for a higher price, without a change in income.

The other thing I've just noticed from these cycles is that if something persists long enough, people just suspend disbelief. It's very difficult to keep your rational convictions when something persists for a long time. 

The practical insight from that is the need to be patient, and I think that that is something that everyone knows in theory, but in practice, it can be much more difficult. 

By buying good quality, secure cash streams for sensible prices, you're going to make good returns over the long run, but you need to be patient.

I think that's now come through, particularly in the last 12 months.

LW: From a macro perspective, where do you think we currently sit in the inflation and interest rate tightening cycle – what’s your base case for where we’ll be this time next year?

Aaron Binsted: Inflation and interest rates are two really important variables. However, I think it's incredibly dangerous to say I have a forecast that inflation will be X, and building a portfolio around this prediction. You should have a view, but you have to manage a range of outcomes and make sure you've got a portfolio that's robust in different scenarios. 

That said, I think clearly, particularly after Jackson Hole, you've got to expect that rates are going to go up and be higher for longer. 

We started writing about inflation risk during 2020 when I don't think many people were. This is a risk that we've been alive to, and we've been managing that risk in the portfolio. Headline inflation obviously is going to start coming down. I think that's not really debated, but core inflation does look like it's got some momentum. It's too high to stay within inflation targets and we really need to watch what happens with wages. 

Everyone is now getting on the same page in terms of the need for rates to be higher for a longer period. There's been some reflection of that in asset markets. I think it's important to note, that there's been almost no impact felt in economies yet from higher interest rates. In terms of that side of the equation, that hasn't even started yet. 

LW: If you're saying that wages are a very important factor, how does that inform any consumer-centric stock calls?

Aaron Binsted: We have been generally underweight consumer discretionary and overweight consumer staples for a period of time. We have been very mindful that rates are going to have to go up more than people expect. We are cognisant of the fact that people, and consumers took on a lot of debt through housing. We've been underweight discretionary for that reason.

Particularly in the domestic economy, the interest rate increases have not flown through yet at all. We are probably going to start to see the first impact towards the back of this calendar year. Then depending on how hard the RBA goes, increasing into 2023. It has not really played out in terms of the actual economy yet.

LW: Let's turn to two sector exposures that I know that the Lazard team looked at really closely, financials and energy. Let's start with financials - what parts of that sector are looking appealing right now?

Aaron Binsted: Basically, we are quite underweight the banks and we are very overweight insurers and there are a couple of different dynamics there. 

One, we've talked about our view that interest rates needed to go higher. As a general rule, insurers benefit from higher bond rates. We are also now in the midst of a strong premium cycle, which will drive earnings growth into the future. It's a delayed impact on the P&L but it's a very strong impact when it arrives. That's our key reason that we like the insurers and the fact they are at very modest valuations. 

Take one stock, for example, QBE Insurance (ASX: QBE) which is the most leveraged to the insurance premium cycle. On next year's earnings, it's trading on less than nine times earnings.

It's a very modest valuation when they've got significant earnings tailwinds, both from the premium cycle and interest rates. 

For the banks, We've had a view that house prices were very high and were likely to come under pressure for some time, and we increased our bank underweight through the first six months of calendar year 2022.

Furthermore, if we do get inflation problems, that has implications for banks on a longer-term basis, that's still a question mark for us, but it's a risk we have in mind.

LW: Energy is your second-biggest portfolio weighting currently. What parts of that sector still look attractive despite the big run-up we've seen?

Aaron Binsted: In the middle of 2020 we went out very publicly and said that energy was the most attractive it had been on a multi-decade basis. I don't think many people from an equity market perspective were talking about energy then, but we were very positive and we had an 18% overweight in energy at that point in time - , which is by far the highest we have ever had.

Energy has subsequently performed very well and our overweight today is about 12%. You can see what is happening with Europe and spot gas prices. We have seen prices in Europe and in Asia for spot LNG that no one thought they would ever, ever see.

We have structural demand growth with Europe needing to replace Russian pipeline gas, and that obviously is pushing up coal prices because people are now substituting gas for coal. That all plays into the backdrop dynamic of an incredibly underinvested energy complex.

We have been under-investing for a long period of time. Energy is a long cycle. It takes a long time to bring supply on. 

For example, Woodside Energy (ASX: WDS) reached the Final Investment Decision for its Scarborough LNG project in 2021. They are expecting the first gas at the end of 2026. So clearly there is quite a bit of lead time to rectify supply shortages. You're talking about five years. We obviously do have a bit of cyclical pressure on the economy right now. That is something we're very mindful of, but we think energy is still a good place to be invested.

We have our biggest position in Woodside. We also have Santos (ASX: STO). We do have some Whitehaven Coal (ASX: WHC), but we have sold down those shares recently as they have risen hard. We also have Worley (ASX: WOR) which is obviously related to energy through CapEx. We also like them for their role in the green transition through offshore wind and carbon capture and storage and green hydrogen.

LW: Talk to us about your cash position and whether that is likely to change near-term.

Aaron Binsted: For the Select Australian Fund, in particular, most of our strategies typically are fully invested portfolios, but our Defensive Australian Equity Fund, does have the ability to increase the cash weighting. That fund has been around for 10 years and from 2012 until 2017, it was fully invested. Cash steadily increased from 2017 to 2020. And, in February 2020, it was about 35% cash. 

That's not because we knew COVID was coming, we absolutely didn't, but just valuations were incredibly stretched. 

As equity markets fell, cash actually peaked at just over 50% of that fund. Given valuations came down, we steadily invested those funds over the subsequent 12 months, and by about June 2021, it was 7% cash. So again, almost fully invested. And today, we are at about 18% cash. Particularly in calendar 2022, we have realised some gains and the cash weighting has gone up again. 

LW: What’s your view on China, particularly amid deepening fears of a slowdown from that economy – and how is this reflected in your portfolio?

Aaron Binsted: We have had concerns about China's property sector for some time. The key way we're expressing our China concern is through being underweight iron ore. We do have exposure to some metals, even though they are obviously cyclical. There's also the dynamic of supply cuts due to energy constraints.

And we really like the long-term growth story with the green transition and the metals that are going to be key utilisation, key enablers for the green energy transition. 

Valuation is our primary starting point, but obviously, you've got to be incredibly mindful of the sector and cyclical dynamics. We do think there's a risk to iron ore prices given what we're seeing in the Chinese property sector and global economic weakness.

LW: And for companies like maybe Treasury Wine Estates or a2 Milk, those same kinds of risk, those same kinds of concerns apply?

Aaron Binsted: Treasury Wine Estates, officially at least, isn't selling to China anymore. That's not an issue. They’ve done a good job reallocating those volumes. For A2, China is their business. That's where the value is. They're still going through the SAMR registration process for their brands. That has not been resolved. It's an obvious risk and for that business, it's clearly material. 

Learn more

For further information on Aaron's funds and Lazard's capabilities, please visit the fund profiles below.

Managed Fund
Lazard Defensive Australian Equity Fund
Australian Shares
Managed Fund
Lazard Select Australian Equity Fund (W Class)
Australian Shares
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Hans Lee
Senior Editor
Livewire Markets

Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.

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