The opportunities in volatility
Elevated volatility is providing endless opportunities. Matthew Haupt, Lead Portfolio Manager at Wilson Asset Management, explains how the WAM Leaders portfolio is constantly adapting to data and news flow to take advantage of mispricing in markets. In this interview Matt discusses his positive views on gold, oil and why he thinks the banks are offering value in the market.
We are very constructive on oil. I think it’s shaping up to be a great trade, and I think it might be a touch early to get in now for most people, but we’re adding it to the fund and slowly, progressively building it up.
I still think industrial share prices are too expensive, but when the economy does turn, we’ll be switching a lot of the portfolio into industrials and trying to capture some of the upswing in economic activity through the more leveraged names there too.
- Why Matt thinks there is value in the banks
- The Us dollar shortage and how this impacts Australian mining stocks
- His thesis on oil and the companies he likes for exposure to this thematic
- Active trading opportunities in Australian large caps
- Gold and how he is managing exposure via mid-tier Australian gold producers
- The stocks Matt likes for an improving domestic economy
- The one lesson he has learnt from the recent sell off
I think on the curve of emotions, James, we’re sitting around hope. We’re getting a lot of share market performance coming back in, but I really think there is more legs to this downturn.
I’m seeing value in the banking sector, which is probably contrarian. ANZ (ASX: ANZ), NAB (ASX: NAB), Westpac (ASX: WBC), all look relatively cheap. They’re almost at GFC levels. If we go back to the crisis scenario, you go long gold. So we’re keeping a very fluid situation in gold. You could be in a position where the oil market becomes incredibly tight and you get prices rising. That is a real clear trend, and it’s quite mechanical; if the economy’s opened up again, oil usage goes up.
With what’s played out, where do you see value in the market?
I’m seeing value in the banking sector, which is probably contrarian. At the moment the banks are very much hated across the market. The institutional funds are very much underweight. The reason why I like them as a sector is everyone’s banking on this long-drawn-out recovery in the economy and a credit cycle coming through. I think if the credit cycle isn’t as bad, the banks look like really good value here. It’s going to take a few more months to work this trade out. We’re just initiating this trade, but I think there is some value in the banks.
And if I look in other sectors, the oil sector would be one. I think the oil sector looks okay. And again, if you’re banking on a recovery in economic conditions, then oil stocks look really good value here.
Okay. We’ll dig into banks in a little more detail further on. Just on the oil market, it was a recurring theme and a point of interest for investors. What do you see as the recovery path for oil and potential timeline?
Oil at the moment, my best guesstimate is about 20 million barrels of demand that has fallen away. There’s a big surplus in the oil market. We’re seeing the OPEC cuts coming in May, that’s around 10 million barrels a day. We need that gap between that 20 and 10 to close. And that will close when the economy is open again.
Aviation is around 8% of global demand for oil. That’s going to take a while to come back. Transport is a big one, when people start driving again, that oil gap will start to close and I think you’ll get an increase in oil price over the next few months.
I’m a little bit wary about the June contract of oil, the futures contract. There may be another episode like we saw in the May contract where near the end of expiry, it fell away and went negative. That’s just a financial impact. Producers aren’t getting negative prices, that’s a financial futures event, that may happen again, but post-that, I think oil is really set up for a long-term trade here.
I’m keen to get your assessment on what some of the lesser followed, but really important macro trends are.
Well, I think the key one here is around emerging markets. When the crisis happened, you saw a really big US dollar shortage, and that means people couldn’t get their hands on US dollars as trade flow decimated. People trade in US dollars, and a lot of emerging markets sell goods to the US and they weren’t getting their hands on US dollars. And there was a big rush for US dollars in the crash.
I think that the key thing now is emerging markets. If this virus stays around for longer, their economies are going to be a lot softer than people are expecting. And they are going to be in a US dollar shortage situation where they won’t have US dollars to pay their US dollar debt. For me, that is a real big concern. And that could be the next wave, if we do get another wave of market turmoil, is really around emerging markets and their shortage of US dollars.
Explain to me, how is there a shortage of US dollars when the money printers are working overtime to print more money?
In the US the supply of dollars has gone up, but for the reserve currency, they’ve got to run a really large deficit to service the rest of the world’s appetite for US dollars. With trade falling away, their deficit is flipping back the other way. Trade is a lot of how US dollar is spread. And at the moment that is contracting at record levels. For me, that is the key here that, despite the printing of US dollars and injecting liquidity, it’s not finding its way to these emerging markets. The Fed (Federal Reserve) have opened up the swap lines where major central banks can participate in repurchase agreements to get US dollars, but emerging markets can’t access these swap lines. So for me, that’s the key here.
Okay. One of the themes is potential for shortage of US dollars having an impact on emerging markets. How does that play through to the WAM Leaders (ASX: WLE) portfolio? What are some of the implications for Aussie large-caps?
At the moment it’s really a risk we are watching. We’re not acting on this yet, but if we see evidence of this happening, we will have to adjust our positioning and adjust our positioning through resources because emerging markets are big users of resources versus developed economies. For us, we’ve got to look at each company, where their exposure is, and also some of the commodity exposures as well, particularly copper and oil, again, would be a big emerging market theme too.
So that would be lightening up of your resources, correct?
You definitely have to lighten if emerging markets went into a crisis, definitely.
Okay, great. What are some of the other macro trends? You’ve got shortage in US dollars. What else is catching your eye?
I think that we touched on it before. I think the big one to me is oil. The oil market is quite simple. When the economy is running, globally, there is about a hundred million barrels a day consumed. When the economy is contracting like it is now or shut down, you are losing about 20 million barrels a day. There is a big build-up in storage of oil. There is a glut of oil that is sitting in tankers. The tanker rates, which are holding oil, the price for a tanker has gone up 300%. Everyone is trying to find a way to store oil because it’s not being consumed. My theory and the theory of most people is the economy is going to improve. For me, it’s quite clear cut. If the economy improves, oil usage is going to improve. Even if we get up to 90 million barrels a day with a 10 million cut from OPEC, we should be in a position to start clearing some of these shortages.
And then I guess the big term picture is around the CapEx. CapEx has been reduced by 30-odd percent from the majors. And also you’ve got shale, US shale, which is uneconomical and you’ve had companies already go bankrupt. Shale could potentially lose four to six million barrels a day. So you could be in a position where the oil market becomes incredibly tight and you actually get prices rising. And I don’t think people have got 50, 60 dollar oil in the current valuations of some of the Australian oil companies. I think that is a real clear trend and it’s quite mechanical, if the economies open up again, oil usage goes up. I’ve approximated a 1% decline in GDP is equal to about 1 million barrels a day. When we look at the fall in oil it’s saying about 20 million barrels, so GDP is contracting by about 20% at my best guess.
So is it fair to say you’re constructive on oil?
Yeah, very constructive on oil. I think it’s shaping up to be a great trade, and I think it might be a touch early to get in now for most people, but we’re adding it to the fund and slowly, progressively building it up.
Do you have a preferred exposure, a preferred way to access it?
At the moment it’s Santos (ASX: STO). Our biggest position in the portfolio in oil is Santos. And then it’d be Woodside (ASX: WPL). Woodside is more steady, not as much leverage as Santos recovering the oil price, but we quite like that company too, as it’s quite solid and has a good pipeline of opportunities.
One of the real features of this market has been just how quickly things have changed. It’s been really volatile. There’s been new information to react to. How has that impacted the way that you’ve been managing money?
The sell-off was incredibly fast and vicious, and it was a real unwinding of all the leverage that had been built up over the past decade. That all unwound in about two, three weeks. You had massive deleveraging, the Fed had to intervene. Almost like a LTCM (Long Term Capital Management) scenario where that failed. The Fed had to intervene and bail out these leveraged ‘risk parity’ funds. They had to go in and bail these guys out initially. So volatility was extreme.
From my perspective, the volatility creates opportunities. For about three or four weeks, I was up every night, probably getting about four hours sleep, just watching European markets, US markets, watching the Fed speakers, trying to work out what was going on so we could shape our portfolio back in Australia to try and take advantage of this. And thankfully we could get on top of a lot of these trades early. The volatility creates opportunities. We like volatility, and we found incredible opportunities in the midst of the crash.
Crashes happen in stock markets. It’s nothing to be scared of. It feels bad at the time, but it creates great opportunities if you hold your nerve and get in the market.
Could you maybe just talk us through an example of a trade that worked out really well? I’d be interested to know, I’m sure a lot of shareholders probably don’t have an insight into how actively you trade and what some of these opportunities. Could you just run us through a quick example of one that worked out?
Sure. I guess I’m thinking of at a stock level, Scentre Group (ASX: SCG) was a really interesting one. Scentre Group, they own the Westfield shopping malls, that price was at all-time lows at a point. We’re not necessarily a believer in shopping centres long-term, but every now and then the market throws up these incredible opportunities and we bought Scentre Group. And now it’s put on about 40, 50% from its lows.
Another one, Star Group (ASX: SGR), the casino operator, was trading well below net tangible assets. Again, the stock market had discounted their future, was trading well below net tangible assets. So we purchased Star as well. And again, that’s put on about a dollar from its share price from we’re buying it. A dollar sixty it’s, now two dollars sixty.
You get great opportunities in this market if you can hold your nerve. The market on the upside, overreacts but also on the downside overreacts. You just really got to have a long-term position and a view on these stocks if they’ll come out of this.
We have moved out of the period of what seemed to be peak volatility. Are you still finding those trading opportunities?
Peak volatility, when we measure it from a stock market point of view, the VIX is an index we look at. That was over 80 during the crisis and by Fed and through central bank intervention they’ve suppressed risks. The valuation opportunities have disappeared, but on a daily basis, we’re trading around a lot, because you’ll get really different scenarios in the same sector.
One day BHP (LON: BHP) might be up two percent and Rio’s (NYSE: RIO) down a percent. And there’s no reason there should be a gap there. And we will trade that. There might be a day where Woolworths (ASX: WOW) and Coles (ASX: COL), there’s a two, three percent spread on the price and we’ll trade around in that too. So despite the valuation opportunities having disappeared, the relative trading opportunities are still around. Myself and Johnny, we’re trading around in these things daily. We don’t leave the screens because there’s all these opportunities still presenting themselves.
One of the longer-term themes that seems to be emerging is obviously the debasing, or the money printing that’s going on. And I know you’ve got a decent exposure to a number of gold stocks. You mentioned that that was an area you’re interested in on the most recent investor call. Could you talk us through your thesis on gold, and how you’re playing it in the portfolio and why you’re doing it through some of those mid-tier producers that you’re holding?
Gold is a really interesting topic. And one that has many believers and non-believers. For us, it’s just, how can we make money and where will money flow to and post the sell-off. In the initial sell-off gold was sold down. That happened during the GFC too, as we talked about the US dollar, everyone was trying to access US dollars. So gold became a funding source. Post that gold, we had to wait for the sell-off in gold. Then we purchased a lot of the mid-tier gold producers. And the reason why we purchased the mid-tier is they’re Australian based and they have growth opportunities. Whereas the bigger company like Newcrest (ASX: NCM), which we do own as well, we don’t have as big a position in that because they have operations offshore, and they don’t have the growth profile as the smaller mid-tier ones. For us, the Saracens of the world and Northern Star (ASX: NST), they have growth opportunities and we quite like those stocks. So, that’s the reason.
Thematically gold, I still think has got some upside, but I’m a little bit wary now. It’s very much a long-term consensus long. That always worries me when everyone’s thinking the same thing. Again, we have to make our decision now, will gold improve from here? Gold will improve if interest rates stay low and volatility stays elevated. If interest rates start going up and the economic conditions improve despite the money out there, I still think gold has some short-term downside if that scenario eventuates. If we go back to crisis scenario you go long gold, so we’re keeping a very fluid situation in gold. It’s around 4% of the portfolio at the moment. I’d probably be reducing that down to about three over the next few weeks and then see how we go. And if we get another flush of volatility, we can move back (to long) gold. It’s very fluid at the moment.
Well, you touched on it in our introduction. I know it’s going to be a big question for a lot of your shareholders. Let’s dig into the banking sector a little bit more. As we sit here in mid-May, we’ve seen a number of the majors defer paying their dividends. NAB reduced their dividend drastically. Yet you still remain constructive on the sector. Is it that point of peak bearishness that has got you interested?
Exactly. You want peak bearishness but you also want a fundamental case that has a probability of playing out. And I think the stock market for me, banks look relatively cheap versus the rest of the market. For me, either the rest of the market falls toward the banks or the banks go up towards the rest of the market.
For me, I think the big question now is will the profits of the banks be socialised too much? And well, what I mean is will the banks bear too much of that pain? The government are trying to make them bear a lot of the pain. The real question is how much pain will they bear as far as interest payments and the like, and delaying and fees and the like?
My base case is why I’m constructive, I think the economy does improve. I think jobs come back. I don’t think the credit cycle will be as long and as deep as people think. And therefore, I think the banks will come back and there will be a great opportunity to buy over the next few months.
The downside scenario obviously is you get a second wave of the virus. We go into an extended lockdown again. Then my view would change quite dramatically. My view at the moment is the economy opens up again. The credit cycle isn’t as bad.
And the way the accounting works with the banks now is they’ve changed the accounting. When you get a credit event like now, all the provisioning is front-end loaded, but when the credit environment improves, the unwind is just as quick. You get all these write-backs, which underpin their profits too.
For me, I think the banks are well capitalised. If we’re in a scenario where things improve, you’ll get the write-backs. And if the Reserve Bank of Australia (RBA) also step off the yield curve, because they’re holding the yield curve down their three year rate at 0.25, they’ve actually stepped off that and allowed to go up to market rates, which may be 75 bps or 100 bps. The banks will start earning good money on their replicating portfolios. The unwind trade would be quite powerful. So that’s why I’m interested.
We’re not betting a lot on the banks at the moment, but it’s still something I think could be a great opportunity in the next few months if it plays out.
CBA’s (ASX: CBA) been forever the stronger of the banks, the standout. Do you have a preferred way of accessing them or are there nuances within the big four that are catching your eye?
There’s always differences between the big banks as far as quality goes. The valuation is what we look at. CBA looks incredibly expensive on valuation, but arguably the best bank and well capitalised. When I look at the banks, ANZ, NAB and Westpac all look relatively cheap, they’re almost like GFC levels. I don’t think it’s going to be as bad as the GFC. I think when we look at valuation, they are a standout, and as far as quality goes, we really like National Australia Bank. I think that’s a great company, has a chequered past, but it feels like it’s got the most potential to unlock value. And finally, we’ve got a great CEO and a great chairman at the same time. So I think NAB looks the best. It has the most embedded opportunities. For me NAB is the clear standout.
Now one of the sectors that people are really interested in is, and this is from a longer-term perspective, is what is the flow-on impact for property? What is the future of REITs and how does that endure after COVID-19?
It’s a really in-depth question when you cover it off. Like you mentioned, REITs have a lot of different categories, office, retail. And if we look at office, this work from home, is that a theme that will carry on for a long period of time? I think it will. It feels like people have worked out they can actually achieve a lot from home. Maybe office space, over the next few years, isn’t as high as expectations were previous to this. Office is an area I think that probably will come under pressure.
Looking at the retail space valuation makes me attracted to it. Long-term, that’s a debate for another day, but valuation in the short-term makes retail look attractive. And like I mentioned, Scentre Group and Vicinity (ASX: VCX) look okay at these levels if you believe the shopping malls are going to be opened up again with all the retailers. For me, retail looks okay.
Commercial looks good still. We like Goodman Group (ASX: GMG). Goodman Group, great company, global company, can access funds and maintain their guidance we just saw recently too.
James MarlayWhat are some of the key attributes of the portfolio right now?
The key attributes of the portfolio, we’re sticking around iron ore. Iron ore we think is a great trade to happen still. We think China will hit a run rate about 1.1 billion tonnes of steel production from April to December. And that will underpin the iron ore stocks in Australia. Fortescue (ASX: FMG) have got net cash now. The balance sheets are great of BHP and Rio. We think that trade in this uncertain world is quite strong. So we like that trade.
I like the oil trade. We’re building positions slowly at the moment, hoping to bring that higher over the next few months if we get some clarity around the economies coming back on.
We like copper as a cyclical play. Copper is very much an industrial metal. They call it Doctor Copper, the copper price, because it gives you a good indication of underlying conditions. So, we quite like copper at the moment.
The other key trades, we really look in the industrials when to turn positive on those. I still think industrial share prices are too expensive, but when the economy does turn, we’ll be switching a lot of the portfolio into industrials and trying to capture some of the upswing in economic activity through the more leveraged names there too.
I’d be looking at companies like Qantas (ASX: QAN). Qantas obviously the share price has been decimated as you would expect. Qantas is one that looks really attractive to us, long-term. We’ve taken a small position early. We’re not confident enough to build it up higher at the moment due to the potential for second waves and more shutdowns and longer shutdowns. So Qantas is one.
Transurban (ASX: TCL) is another as traffic comes back on, but like we touched on, that work from home is a really interesting one too. And Transurban, their toll roads, a lot of them are coming off airports. So until travel comes back, those toll roads really won’t ramp up to what they were before. Transurban is another one.
And then a lot of consumer discretionary would be on our radar too, as you would have expected, they’ve traded poorly. Consumer staples on the opposite end have done really well. Consumer discretionary is another one we’ll be looking towards as things got better.
Well each crisis is different. What’s a useful lesson that you’ve picked up from investing through this period?
Well, I think this crisis is different because this was an event-driven crisis. It wasn’t a normal business cycle crisis. I think the biggest lesson from this one is the front-end loading of stimulus and rescue packaging. Normally in a crisis, it will take a few months to unwind. Then you identify you’re in the crisis, then there’ll be a response and it might be six months down the track before we get all the stimulus and rescue packages. This time it was immediate. You had the immediate response of policy. And I think that’s why the stock market has performed like it has.
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