After a year in which Britain almost succumbed to a different sort of wide-ranging existential threat to survival, the words uttered by Winston Churchill in 1940 resonate loudly: "We're not at the beginning of the end but the end of the beginning."  

It was an observation that reset expectations soberly and sanely, summoning the blood and stiffening sinews. And all of us surveying the current economic moment to gauge precisely where we're at could probably use a bit of the same clear-eyed judgment.

Cue Airlie Funds Management's Emma Fisher and Alphinity Investment Management's Stuart Welch who both argue we are halfway through the economic recovery having clambered out of the pit of despair that gripped markets 12 months ago

In this episode of Buy Hold Sell, Centennial Asset Management's Matthew Kidman finds out how they are positioning their portfolios in the current environment. Plus, Emma and Stuart share one stock that they believe has emerged stronger from the COVID-19 crisis.

Note: This episode was filmed on 30 March 2021.

Edited Transcript 

Matthew Kidman: Welcome to the thematic discussion brought to you by Livewire Markets. I'm Matthew Kidman and it's been 12 months. Yes, that's right. We've celebrated the birthday of the bottom of the market post-COVID-19. And where are we in the recovery? Well, we started in intensive care, they moved us out of that, they got us into recovery. And now are we ready to check out of the hospital altogether and get back to normal? The government thinks so, it's stopped all its payments. And to help me discuss where we are in the recovery, we've got Stuart Welsh from Alphinity Investment Management and Emma Fisher from Airlie Funds Management. Let's start with you, Emma. Recovery, a couple of sentences, where are we at?

Emma Fisher: So I think in Australia, we're midway through the recovery. The recession's over, unemployment's back heading towards where it was pre-COVID-19, and then globally, I think we're still early days in the recovery. So this is the real world, but then there is markets. And markets will always move ahead of and anticipate what's around the corner. So I think we saw that last year; markets already anticipated the economic recovery that's underway this year. And so, last year when all the data coming through was really negative, markets were rallying. And today, when all the data is really positive, markets are a lot more volatile. So I think we're part of the way through the recovery, but markets had already priced it in.

Matthew Kidman: Stuart, we've done 48% since March 23 last year. It's been a pretty big birthday party, one year on. What do you think? Same question to you, are we halfway through that recovery like Emma says?

Stuart Welsh: I'd echo a lot of what Emma has just said. I think for any sort of crash and subsequent recovery, I think there's sort of three phases. There's the despair phase, the hope phase, and then the actual growth phase. And I think this time last year was definitely the despair phase and then there was a lot of hope in the market and anticipation of an earnings recovery. And I think we're starting to see that come through now. So the most recent earnings season we've just had was probably one of the strongest for the last couple of decades, but it needed to be because the market had anticipated that. But some of that hope has been realised, but it needs to continue to be realised for the market to push on from here.

Matthew Kidman: Emma, like all markets, you get over a bunch of problems, and guess what? We invent a few more. We've got inflation concerns, we've got the vaccine rollout, the stimulus programmes finishing. What's burning in your head as the big issue that gets us through that second half of the recovery that you're looking forward to?

Emma Fisher: Look, I think the number one issue facing investors globally is interest rates. And that's really talking about the FED because the FED sets the price of money globally. And ultimately the question that we're all grappling with is what is the right discount rate to apply to assets across the board? I think the market was very complacent last year because we saw all this stimulus and it was complacency around inflation because we've sort of seen this story before. We've seen QE, there's never been any inflation associated with it. But what's different this time is that combination of monetary policy and fiscal policy. Our own experience in Australia through the GFC tells us how powerful a tool checks are. It's a blunt, but it's a very powerful tool that's stimulating demand. So we think it's a powerful cocktail and it could potentially be quite inflationary. Now we don't know whether or not this is just a short term bump or whether it's something structural, but I think that's really what markets are grappling with right now.

Matthew Kidman: Stuart - inflation. Is that the burning issue or is it the fact that COVID-19's still ravaging parts of the world and vaccines haven't been easy to roll out? What are you thinking about at the moment?

Stuart Welsh: I think firstly, there's a lot of stimulus. So the governments are generally standing at the ready if need be. The vaccination rollout is occurring and while that's coming with some spits and spurts and at different rates in different countries, you would imagine that that's going to continue to roll. There might be delays, but ultimately that's probably going to come to fruition.

Matthew Kidman: So you can discount that?

Stuart Welsh: So I think you can have some sort of confidence that that will ultimately come to pass. So I think the key focus, as Emma's saying, is on rates. Just thinking about that a bit further in terms of, it's not just the direction of rates in terms of where they end up, but it's also actually how they get there. So ordinarily during this recovery phase, we would expect rates to grind higher, but if it does that in line with economic activity and in an orderly fashion, that's okay. If we see, like we had a bit of a glimpse into during the tail end of reporting season more recently, we see rates gap up. Well, that's a very different story and you could just generally say a bit of a risk-off trade. So I think the direction of interest rates is probably up, but it's the path that is quite important.

Matthew Kidman: All right. So we've seen a little bit of that risk-off in recent months. The Aussie market hasn't moved, even though it's done that 48%, hasn't done a lot since the end of November. That risk-off trade, the prospect of higher rates, how do you position your portfolio or how have you and what are you looking to do?

Stuart Welsh: In general, I think we're very dictated by earnings and we always look to see where the earnings upside is. Having said that, higher rates do impact the relative winners. So in a market where interest rates are increasing, long duration or yield top stories are ordinarily going to underperform, some of the more Value, sort of low PE, economically or cyclically exposed names in the portfolio. So you would generally think that that's where people would be moving in this type of market.

Matthew Kidman: Emma, same for you. You seem to be bullish. You think we're still got 50% of the recovery to go or something like that, as a round number. How do you position your portfolio given where inflation is, interest rates and so on?

Emma Fisher: Look, I think the part of the economic story that I think looks most attractive is the strength of the Australian consumer. We spend $65 billion a year overseas when we're allowed to. Right now, we're not allowed to, and that money has been trapped in our economy. That's been very good for retailers. We're seeing some of it's saved and you can see that in deposits at the banks. So I think one particular sector that looks interesting right now is retail. It's been put in this COVID winner bucket, that's now being sold off. Meanwhile, these businesses they've generated a tonne of cash over the last 12 months, so their balance sheets are in phenomenal shape. From a valuation perspective, I think it's very well understood that they'll have some difficult comps to work through. But looking longer-term, retail as a sector is a play on the health of the Australian consumer and the Australian consumer is very healthy right now. Some businesses I think will benefit if you add in the other layer, which is this economic recovery rolling into a housing recovery story. I think if you're a retailer selling anything in housing products. So Wesfarmers, Nick Scali, James Hardie, businesses like this really stand to benefit in this environment.

Matthew Kidman: So it sounds like you're not thinking we're going to go travelling overseas anytime soon.

Emma Fisher: Probably not this year. No, it's not looking that way.

Matthew Kidman: So if we take that and the consumer's strong. Is it the domestic recovery you're looking forward to and that's where we should put our money or is there global opportunities as well?

Emma Fisher: Yeah, look, I think it's certain that the economic recovery is more in its early stages globally. So I think the opportunities there look very attractive. But I also think you shouldn't discount the health of the Australian consumer, the health of corporate balance sheets in Australia, corporate balance sheets are in fantastic shape. If you have to get your crystal ball out and predict, I guess the next leg of upside for the ASX200, I think it's corporates really getting confidence in the pace of the recovery, going out and borrowing and investing in their businesses. A portion of that will come through M&A as well, and that could be the next leg.

Matthew Kidman: Stuart, we'll stick with that theme because our share market, we're celebrating the first birthday of the low. We haven't done as well as other markets, but we seem to have done a lot better on handling the Coronavirus and all the things that Emma said; the consumer's strong, corporate balance sheets are good. Is there upside in our market or is there something wrong that we're missing?

Stuart Welsh: No, I think there's certainly pockets of strength. And that's where we talked about following the earnings leadership and what companies are getting earnings upgrades. And I guess so far, this recovery has really been a manufacturing-led recovery. So the benefits of stimulus and low-interest rates have stimulated a lot of activity in things like housing, autos, capital goods. And so there are pockets, for example, in building materials where there has been a large increase in building approvals for detached family homes. And so some of the companies supplying into that, for example, are pretty well levered to the economic recovery that we're seeing coming through.

Matthew Kidman: Let's round the discussion out. You've given us sectors, give us the stock that you think has come out of COVID quite strongly and it's got a good flight path through the next couple of years.

Stuart Welsh: So I think one way the market's been looking at things is COVID beneficiaries and COVID recovery stocks, and there's been a bit of a rotation out of the COVID beneficiaries into the COVID recovery stocks. There's actually some opportunity, I think, on the other side of the fence where some of them have been thrown out and discarded, and one of those is Fisher and Paykel Healthcare (ASX:FPH). So they sell a lot of the humidified respiratory systems that have been treating a lot of the COVID patients. One of the key benefits of COVID was that the World Health Organisation recommended one of their treatments as a first-line therapy for COVID patients, but not only COVID patients, all respiratory patients. And given that they've been able to actually increase their instal base by 70%. And so what was a penetration story already has just sort of been accelerated by about five years, and that's a very positive situation for them and should position them well, coming out the other side to sell consumables to fill those machines going forward.

Matthew Kidman: Great. Now to Emma, I know you've mentioned a few stocks. Same to you. What's done well and what's going to come out of it nicely where we can make some money over the next couple of years?

Emma Fisher: A lot of our discussion today is focused on we're in recovery phase and we're early cycle. But I think what's interesting if that was a downturn, was it was very short and sharp and you didn't actually see the normal forces of creative destruction that you see in a normal downturn. So one of the businesses that I think actually got to see a proper cycle and benefit from those creative destruction forces was Credit Corp. So this is a business where two of its competitors actually had to feel the full brunt of their poor capital allocation decisions in the past. And they had to do emergency capital raises, sell assets and really going forward they're very hamstrung. So this is an industry structure that's come through a full cycle and has actually changed to really benefit the number one player and that's Credit Corp. So we think this is one where the industry structure has changed really dramatically in their favour.

Matthew Kidman:
Not only have we checked out of the hospital, but I reckon we can almost run home we feel that good. If you're enjoyed that show as much as me, go and subscribe to the Livewire channel on YouTube.

Where do you think we are in the recovery? 

It's been a pretty crazy few months. Just when we felt like we were out of the bush, Brisbane was shuttered back into lockdown. So where do you think we are in the recovery? Let us know in the comments section below. 

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