Time for the scalpel rather than the sledgehammer

Where dispersion in markets is set to rise, stock picking and making active and well-researched calls will be as relevant as ever
Dion Hershan

Yarra Capital Management

We all know that averages can be absolutely useless in periods of significant dispersion. And while it’s tempting to look at aggregate numbers in Australia and be seduced into believing we are in ‘normal times’, this clearly neglects the key point: dispersion is back with a vengeance.

The dispersion we’re already seeing will be evident across the board: in economic outcomes, corporate earnings and in turn share price performance. Pockets of resilience will coincide with localised/niche recessions.

A summary glance at aggregate numbers for Australia would be comforting (based on consensus).

  • GDP is forecast to grow at 1.7%
  • Unemployment is expected to rise just 0.1% in 2023 to 3.8% before rising to a still low 4.4% in 2024
  • The federal budget is in surplus in 2023, a sharp recovery from a pandemic low of - 12.5% of GDP
  • Resources and rural goods remain buoyant, and for the 12 months to March 2023 were $427bn above their 2020 pre-COVID levels (17% of GDP)
  • Inflation is set to trend down to 2.7% by 2025, a decline of 510ppts (from a starting point of 7.8% in Dec 2022)
  • ASX 200 EPS earnings are forecast to hold flat for FY24-25

However, the devil is always in the detail, and it is apparent that the forward experience will be very uneven in Australia. It is worth noting:

#1. The proportion of earnings upgrades to downgrades is currently the worst since the COVID-19 pandemic impacted period of 1H20 

50% of companies missed EPS expectations during the last reporting season. This is despite reporting season overall being fine, with F23 consensus only moving by -1.6% in March 2023

#2. Consumer pressure will be pronounced at the bottom end 

The $270bn saving buffer is heavily skewed to wealthier households over the age of 45. Indeed, the impact of the shifting fiscal and monetary stance will have sharply different impacts by age groups and by income distribution. We estimate that the discretionary cashflow for the bottom 20% of Australian households will plummet 24% in 2023

#3. Almost 900k Australian households have a mortgage buffer of less than three months (9% of total mortgage holders) 

This is despite the often-cited reference that Australians are well ahead on their mortgages on an overall basis

#4. The 12-month decline in Australian household wealth is the largest fall since the GFC

Despite property prices being 12% higher than pre-COVID levels, the combination of falling asset prices (financial assets and housing) has driven a 3% decline in household wealth over the past 12 months (equivalent to $605bn). Meanwhile, household debt increased a further 5% over the past year which, when combined with the lagged impact of interest rate rises, will see total debt servicing hit record levels in 2H23

#5. Australian commodity prices, while elevated, have fallen 20% in the past year 

This includes a 23% decline in both rural commodities and base metals and an 18% decline in bulk commodity prices 

#6. Earnings dispersions are widening

The industrial sector (37% of ASX 200) is set to grow earnings by 10% in FY24, however 100% of that can be accounted for by 10 companies, and 70% by just four companies (Xero ASX: XRO, CSL ASX: CSL, Transurban ASX: TCL and NextDC ASX: NXT).

With both the opportunity set and the risk profile clearly elevated in this environment, it’s time for a scalpel rather than a sledgehammer. In a period where dispersion is set to rise from depressed levels (refer Chart 1) and volatility will widen further (e.g. IT and Resources) (refer Chart 2), stock picking and making active and well-researched calls should be as relevant as ever.

Chart 1: Alpha available from stock picking

Source: Goldman Sachs, May 2023.

Chart 2: Sectors with the largest opportunities for stock picking

Source: Goldman Sachs, May 2023.

In our large cap portfolios, we have recently added to holdings in Iluka (ASX: ILU) (niche commodities) and Tabcorp (ASX: TAH) (industry structure improving) for micro rather than macro reasons. 

Learn more

The Yarra Australian Equities Fund offers investors exposure to a differentiated, high conviction portfolio of ASX listed companies that we believe have strong capital-growth potential over the medium to long-term. Visit our website for more information. 

* Performance at 31 March 2023 and measured as excess return (before fees) compared to benchmark. Yarra Funds Management Limited (ABN 63 005 885 567, AFSL 230 251) (‘YFM’) is the issuer and responsible entity of a range of registered managed investment schemes, which includes those named in this document (‘Funds’). YFM is not licensed to provide personal financial product advice to retail clients. The information provided contains general financial product advice only. The advice has been prepared without taking into account your personal objectives, financial situation or particular needs. Therefore, before acting on any advice, you should consider the appropriateness of the advice in light of your own or your client’s objectives, financial situation or needs. Prior to investing in any of the Funds, you should obtain and consider the product disclosure statement (‘PDS’) and target market determination (‘TMD’) for the relevant Fund by contacting our Investor Services team on 1800 034 494 or from our website at www.yarracm.com/pdsupdates/. The information set out has been prepared in good faith and while Yarra Funds Management Limited and its related bodies corporate (together, the “Yarra Capital Management Group”) reasonably believe the information and opinions to be current, accurate, or reasonably held at the time of publication, to the maximum extent permitted by law, the Yarra Capital Management Group: (a) makes no warranty as to the content’s accuracy or reliability; and (b) accepts no liability for any direct or indirect loss or damage arising from any errors, omissions, or information that is not up to date. No part of this material may, without the Yarra Capital Management Group’s prior written consent be copied, photocopied, duplicated, adapted, linked to or used to create derivative works in any form by any means. YFM manages the Fund and will receive fees as set out in the PDS. To the extent that any content set out in this document discusses market activity, macroeconomic views, industry or sector trends, such statements should be construed as general advice only. Any references to specific securities are not intended to be a recommendation to buy, sell, or hold such securities. Past performance is not an indication of, and does not guarantee, future performance. Information about the Fund, including the relevant PDS, should not be construed as an offer to any jurisdiction other than in Australia. With the exception of some Funds that may be offered in New Zealand from time to time (as disclosed in the relevant PDS), we will not accept applications from any person who is not resident in Australia or New Zealand. The Fund is not intended to be sold to any US Persons as defined in Regulation S of the US federalsecurities laws and has not been registered under the U.S. Securities Act of 1933, as amended. References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. Holdings may change by the time you receive this report. Future portfolio holdings may not be profitable. The information should not be deemed representative of future characteristics for the strategy. There can be no assurance that any targets stated in this document can be achieved. Please be advised that any targets shown are subject to change at any time and are current as of the date of this document only. Targets are objectives and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any asset or asset class described herein. If any of the assumptions used do not prove to be true, results may vary substantially. These targets are being shown for informational purposes only. © Yarra Capital Management, 2023.

6 stocks mentioned

Dion Hershan
Executive Chairman and Head of Australian Equities
Yarra Capital Management

Dion is Executive Chairman and Head of Australian Equities. He is responsible for leading the Australian Equities team, and is a Porfolio Manager focussed on large cap equities. Prior to transitioning to Yarra Capital Management, Dion was the...

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