It’s becoming increasingly evident among Livewire readers and contributors that a new bull market has been forged in the depths of one of the worst event-driven crises in history. Day-by-day, the conversation is gravitating towards how high the market will rise as opposed to when it will re-test the bottom.
In this extended discussion, Anthony Aboud of Perpetual Investments and Simon Shields from Monash Investors Limited discuss how they’re navigating a market that’s so difficult to price given the level of economic uncertainty. They debate topics including the bearing of interest rates on stock prices, the downside and upside risks investors aren’t pricing in, and the types of companies to own in this environment. They cap off the discussion with 4 stock ideas they like right now.
Notes: You can access the video, podcast or edited transcript for this Buy Hold Sell episode below. This episode was filmed on 6 May 2020.
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Matthew Kidman: Welcome to our thematic, brought to you by Livewire Markets. I'm Matthew Kidman and today we're going to talk about has the market actually got it wrong? It's rallied since March 23, the economy's terrible, everything shut but we keep rallying. So is it wrong, or is it right? To join me to talk about it we've got Simon Shields from Monash, and Anthony Aboud from Perpetual, welcome gentlemen. Let's start with you, Simon. The market's never wrong, is it? It always gets it right. We've had a rally of a bit over 20% since March 23 but as we know the economy's shut, is it wrong?
Has the market got it wrong?
Simon Shields: Well, in times like these with a lot of uncertainty around, the markets start to look pretty near-term. It's not prepared to look out too far at all. And so right now in fact there's a bit of a double whammy going on. In the first instance, the brokers and the analysts are making forecasts that are pretty conservative and understandably so. They're faced with a pretty horrible set of revenue conditions for the different businesses. At the same time, because people are looking more near-term, and because their risk appetite's lower, and because the uncertainty of itself requires a bigger discount, the PEs have come back even more than usual, so it's a double whammy. It's much lower pricing multiples on lower earnings forecasts, and as a result, even though the market's recovered somewhat, it's still got 30-odd per cent to go to get back to the levels it was pre-COVID. I think that right now it hasn't recovered too much yet. I think it's actually got a fair way to go.
Matthew Kidman: Okay, Anthony, there's a bullish case for you, but everything's closed. The economic numbers are terrible. Today we got Germany's industrial production down 15%, they thought 10%, every number's worse. We've never been through this before, but on the other side we've got reserve banks or central banks around the world putting a lot of money into the system and governments, zero interest rates. The market got it wrong or is it on the right track, bouncing back?
Anthony Aboud: Personally, I think trying to predict the next week, month, market is a bit of ... I think it's a bit of a fool's game. I'm going to probably be the one fund manager comes on this and say I don't know where the market is heading in the next month, six months, I'd say twelve months, and it's not something I really spend a lot of time focusing. On the positive side you are seeing a lot of ... I guess the consensus view is that everyone's sort of become a bit of an expert on the virus and that consensus trend seems to be that this is a bit of a head fake and that we're going to be heading lower. You see a lot of talking heads talk about how much cash they've got and that they're going to pounce on new opportunities.
That's again a bit of a bullish sign and you've also ... also obviously there's a concern about a second wave of the infection, but I do believe the psychology of most people, both from a health perspective and an economic perspective is probably a little bit stronger and we'll be able to handle it a little bit better this time around. You combine that with ... we probably got 0% interest rates for a long period of time. You put all that together and you can paint up a not-negative argument.
Everyone's going to go back to work in the next little while. Everyone's sort of going to go back to the mall - you look at America now - go to cinemas, whatever. And I think there'll be a general positive sentiment. But once we get off the help from the government, whether it be JobKeeper, the banks giving a holiday to loans, the landlords having no eviction and yeah, the benefits that the tenants are getting both from a residential, but also from a small to medium enterprise perspective, which is going to be sort of September, October, that's when we're going to really see the health of the economy.
That could be back to reality. We could be in a situation where demand ... I mean, the question I'm asking myself is when all that happens, will demand be lower? Will we start thinking about what we need rather than what we want?
Navigating the uncertainty
Matthew Kidman: Now what I'm hearing Anthony is maybe in the shorter term we might have a couple of bulls in the room, which is against consensus. So, Simon taking it back to you, we kind of know where the environment is now. It's very confusing. We've never been through this. So, you're trying to get returns for your investors. How do you navigate this extremely unusual period?
Simon Shields: Well, every stock we look at we price, and so that's what we're doing. We're trying to think what these companies are going to earn over time. And yes, the earnings forecasts have come back somewhat for what's going on. But that is one to two-year effect for the most part. There are some companies that have permanently been hurt, sure, but for the most part it's a one to two-year effect and you've got a price that. It's not like the companies earnings are going to be 10% below what they would have been forever.
Matthew Kidman: So taking Anthony's point, zero interest rates for an extended period, that seems to be consensus. Do we have to say with that environment we're happy to look two to three years out where company earnings will be?
Simon Shields: Well I am. I'll get back to the interest rate issue in a moment, but I think if we roll the clock forward six, nine, twelve months, when people are forecasting what the next twelve months and two years earnings are, they're not forecasting them from today. They're forecasting them from a year's time, and it's going to be a lot clearer then, what those numbers are going to be than what it is today. So you're going to be getting probably better higher numbers because people are less uncertain, they can be less conservative, they're closer to the fact. And secondly, there's going to be less discount for risk in the pricing multiples as well. So I think that I actually can't predict what's going to happen in the next month or two or three months, but on a twelve-month view, I'm very confident we're going to see a higher market.
Interest rates and earnings
Simon Shields: Now as to interest rates, interest rates are really important because they set the price of all the assets in the market. So, if people are out there looking to invest, to get an income, well cash is not going to do it for them, they're almost getting zero from that. Bond yields are incredibly low. That's not going to do it for them either. And they don't grow. So earnings yields are the only game in town. They're much higher than bond yields and they grow. So I see multiples of 18, 20 times in this market at the moment. It's actually been cheap relative to what the other alternatives are. And as unpalatable as that is by historical standards, that's the only game we've got. I don't see interest rates lifting anytime in the foreseeable future.
Matthew Kidman: Okay. So you're as long as you can be?
Simon Shields: That's right.
Keep an open mind
Matthew Kidman: And Anthony, as fund managers, you can't afford to wait. You've got to move ahead of the curve, otherwise it's too late. So, how do you expose yourself here? How do you navigate it because you can be both long and short in your game? What's the game right now?
Anthony Aboud: You've got to keep an open mind. You can't be an uber bull or an uber bear, you got to keep an open mind at all times and, for example, even from a stock-specific perspective, I'll give you an example. Flight Centre (ASX:FLT) as a company, I've always thought there's been structural headwinds. I like the management team but I've just never got into it. It was $35 in February.
But when it comes to a cap raising at $7.20 where the company is taking $1.9 billion worth of the fixed costs out of the business, mid-cycle earnings of about a dollar a share at $7.20 ... we invested in that, you know what I mean? So for me, it's about ... the key is about keeping an open mind. I don't usually go, "I want my net exposure to be here because I think the market's good." It goes to where the opportunities are. I've got to say mid-March there were a lot of good opportunities, it's probably not as exciting now.
Has the market priced it all in?
Matthew Kidman: Okay. Simon, what's the market ... given you're a bull, what's the market mispricing? Has it got a bit ahead of itself? Is there something that it's not factoring in or even more so, is there something on the positive side it hasn't affected in yet?
Simon Shields: I think that the market's fully pricing in what's going on with COVID, or as best as it can work out what's going on with COVID. I don't think there's anything that it could reasonably be pricing in, that it's not pricing in. I just think that in times of great uncertainty like we've got at the moment, everybody pulls their heads in. The forecasts come back, the discounts go up, and that's where the opportunity is. Now, as Anthony said, you've got to be really stock-specific because different stocks face different environments, and equities are inherently risky even though they're giving you a better earnings yield. And we're making our decisions in an environment of uncertainty. But that's the challenge. Get as much information as you can, assimilate as well as you can, and make the call. But it's sort of unacceptable to sit here and do nothing. Otherwise you end up just being a passive investor and riding the markets up and down.
Portfolio positioning and stock ideas
Matthew Kidman: Terrific. Now we can talk about a couple of stock tips. Anthony, you're a stock picker both on the long and short side. You gave us Flight Centre as an example. What's a couple of other stocks, but probably just as importantly, where do you want to position yourself given everyone's at a different stage as we go into ... or we're in the middle of this crisis and will come out at a different stage? So a couple of names that might help us make money in the future.
Anthony Aboud: There's got to be a little bit of balance in the portfolio. I mean there is some sort of a ... you got to have a little bit of some companies which aren't leveraged to a cycle, like your supermarket, like your Woolworths. IPH (ASX:IPH) is a company like that for me, where it's a patent attorney company, the largest one in Australia. I typically don't like roll-up type companies, but these guys have consolidated the industry and done a very good job at it. It's a very strong cash generator. Despite having just bought Zenith, it's still earning about 75-odd million dollars of the net debt so less than one times gearing and so Australia, it's a very stable industry. They've got a very strong market share.
Australia doesn't grow that much, but there's not much volatility in the amount of patent filings. Where they get their growth is up in Asia. Singapore, they've got a 25% market share, but they're growing across Southeast Asia and that is typically US, European companies wanting to get exposed to the Southeast Asian consumer and these guys file the patents for them. So for me, this is a company which is growing. It's about a 4% yield undergeared but it's not heavily leveraged to the overall cycle. That's something which excites me.
Matthew Kidman: Okay, Simon, we'll give you the same shot. A couple of stocks and where should you be positioning yourself? Should it be something that's going to recover or something that's going to work its way through without too many blips?
Simon Shields: Yeah, well there's place for both in the portfolio, I mean I always like businesses that are structurally growing, and there are some businesses that really have been given a bit of a boost by what we've seen here in COVID. So Jumbo Interactive (ASX:JIN), it's an online lotteries seller and there was a trend anyway to online lotteries and penetration. Of course with so many newsagents being shut, this has really pushed more of the online sales and even though lotteries as a whole are down, because there's less bricks and mortar store open, Jumbo is getting a bigger share of that and it's not just in Australia, increasingly it's getting overseas lotteries as well.
Another company that we really like is Nanosonics (ASX:NAN). It was a bit too expensive for us previously. It's come back, but it's right in a medical device that is in infection prevention, and at the moment it's got one main product but they should be rolling out a second product shortly. But of course infection prevention is really a hot issue at the moment and it was a strongly growing company anyway, it seems now there's just absolutely going to be nothing in the way of that growth going forward and we've been able to get it at a much better price.
What do you do now if you're in cash?
Matthew Kidman: All right, Anthony, let's talk to the bears for a second. People, they've got cashed up, they've watched the market rally, they've still got their cash. What would you say to them that, given you're going to have zero interest rates for a while, have they missed the boat or should they be just longer term and this time is a good time to invest in the market?
Anthony Aboud: I look at it from a stock-specific lens. I didn't mind having a bit of cash although in the long short-term I haven't seen a lot of cash there because that's the nature of the absolute return type product. But no, there will be volatility. There's going to be opportunities, but my only advice would be when you're looking to invest, be very comfortable with the balance sheet, the liquidity of the company and be very clear of your angle. Be very clear on what it is that you like and where you see something different from the market.
Whether it be, yeah, the market's too short-term thinking, you're looking out through the cycle three, four years or you're seeing something which other people aren't, but as long as the balance sheet's in good stead, they can generate cash and the liquidity is fine and you've got your angle, then that's fine. The fact that you've got cash now, don't feel the pressure to buy something just because the market's gone up and there will be opportunities. You just got to be patient and find them.
Matthew Kidman: Simon, will we look back in two or three years and say, "That was a great time to buy equities?"
Simon Shields: I don't see how it's going to be otherwise, really. I mean we've seen that in every major crash that we've had. They seem to come around every seven years or so. The last one was the GFC and it was such a big one, 2007, 2008, it was almost like we had a double period without a crash. The one before that was the tech wreck about seven or eight years before that, and that was a huge one as well. So we get these big ones come along every so often, and we look back in hindsight and we find that they're just a small blip on the whole upward path of the market. And there's good reasons for that. Technology is improving all the time. Demographically, there are more people on the planet, they're wealthier over time. And we just build on that. So, I've got no doubt, whether it's two years or five years or 10 years, we'll look back and regret if we haven't been invested in the market.
Matthew Kidman: So it seems pretty bleak out there at the moment. But if you get out your binoculars, the sun will be rising. It might just take a couple of years.
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