Last time we heard from Wilson Asset Management's Lead Portfolio Managers, the mood was decidedly bearish. We were in the midst of a correction, and they, like many others, were questioning whether it was ‘the big one’. Fast forward six months, and the mood has picked up. What’s changed? According to Chairman and Chief Investment Officer, Geoff Wilson, the change was primarily due to the Fed’s u-turn on monetary policy. With Quantitative Tightening (QT) off the table and China pumping stimulus into their economy, markets are poised for the return of growth.

In my summary of the recent Wilson Asset Management Shareholder presentations, we hear why the golden age for LICs is returning, the attributes that make a great investment, the three most important topics for the Australian market, and a range of investment ideas from across the various WAM portfolios.

Geoff Wilson: The return of the golden age for LICs

Admitting you were wrong can be hard, but especially when you’re standing on stage in from of hundreds of investors. Six months ago, Geoff Wilson AO was worried about a range of headwinds, including:

1. Global growth slowing
2. Rising US rates
3. The US Federal Reserve’s QT program

He could see the possibility of the market falling 30-40%.

“My prognosis was wrong.”

As has now been well-publicised, the Fed did a u-turn, paused QT, and rates now expected to fall.

Adding to this, China pumped 6 trillion RMB of “QE” into their economy.

While the risks now to earnings growth remain, QT is off the table, and the can has been kicked down the road a bit further.

LICs discounts and premiums

Many LICs began to trade at a larger discount to net tangible assets in the lead up to the Australian Federal Election, due to uncertainty around franking credit policies. Geoff says investors went on a “buyer’s strike” and many people adjusted their portfolios – people don’t like uncertainty.

With all this out of the way with the return of the Coalition government, he says the sector should go back to equilibrium and the ‘golden age’ of LICs that we’ve seen in recent years should return. 

Catriona Burns: Where to from here?

Back in November, Catriona Burns told us there were two factors that needed to change for them to get bullish…

1. An unexpected change to the QT program
2. Resolution of the US-China trade war

The first has of these issues has been resolved. Rate hikes are on hold and QT is being wound back. So, what changed the Fed’s mind? Global growth was slowing in major economies at the end of 2018, PMIs were decelerating, the US government shut down for a record period, and the yield curve inverted. Meanwhile, inflation was under control, which meant the Fed was under no real pressure to raise rates.

What about now?

The Fed has a dual mandate: maintain maximum employment and stable prices.

With unemployment at 48-year lows, the labour force is tight – there are less workers than jobs. Employers are finding it harder and harder to get workers.

“Paypal are having to pay software engineers, straight out of university, the equivalent of $280kpa as a starting salary, plus bonuses and equity options.”

Inflation remains benign at 1.6% p.a. in April. This is still consistently below target. If it ticks up above 2%, the Fed’s position might change.  

What about the yield curve?

The yield curve inverted on 22 March. An inverted yield curve is when short term interest rates are higher than long term interest rates.

Of the last 8 times the yield curve inverted (since 1968), there was a recession within 18 months on 7 of those occasions. September ’98 was the only false signal.

But 18 months can be a very long time for equity investors, and staying out of the market can be expensive.

“Some great equity returns have been made between the inversion and when the economy entered a recession.”

Can China reignite global growth?

In 2018, China cracked down on shadow banking and P2P lending. This saw growth start to slow, which was only exacerbated by the trade war.

More recently, the Chinese government announced tax cuts and infrastructure spending, while also cutting reserve requirements for banks. All in all, 8.2 trillion RMB of stimulus was pumped into Chinese economy in Q1. There is usually a six to nine-month lag before import demand picks up. So, countries like Japan, Germany, and Australia should see benefits from this in the second half of the year.

Despite the recent uncertainty around the trade wars, Burns says that Trump is incentivised to get a deal. China is in a stronger negotiating position now though due to its strengthening economy. If it needs to add more stimulus, it will. 

Inside the WAM Global portfolio

The combination of the Fed pause and the Chinese stimulus have made them less cautious and bearish. As a result, they have put some cash to work. Cash levels are down from ~30% to ~11%. 

As always, Burns says they're looking for companies that have:

1. Strong industry positions
2. Highly comptetent management teams
3. Strong earnings growth potential
4. A valuation that doesn’t reflect the opportunity
5. A catalyst to change the share price

Some current examples

Eventim: The Ticketek of Germany, Austria, and Italy. The company has up to 90% market share in some markets. It ticks all of of the WAM boxes (see above). The CEO/Founder owns 43% of the company, so he's highly incentivised to succeed. The company has a net cash balance sheet, and earnings growth potential from margin expansion due to digitisation.

Bandai Namco:  A Japanese toy and entertainment business with a huge IP portfolio that includes Pac Man and Dragon Ball, among many other Japan-focused brands. Catriona sees a huge opportunity for licensing in China where mobile gaming is growing 20% p.a. The company has a conservative management team and a net cash balance sheet. She sees a potential earnings beat as an upcoming catalyst. 

They also used the sell-off to add to positions in Alphabet and LVMH and reduce cash levels.

Matthew Haupt: The three most important topics for the Australian market

1. Macro variables: Watch the cycle

Matthew Haupt says there are three key macro variables that drive equity markets. 

First, the liquidity cycle. This includes both the cost of money and the availability of credit. Currently, things are looking pretty rosy on this front. 

Second, the business cycle. This includes how the economy and businesses are performing. China is driving the business cycle and it looks to be picking up on the back of their recent stimulus. 

Finally, the political cycle. This is about the stability of the political regime. While we have some stability locally now, following the recent elections, Haupt says that global politics are becoming both increasingly important, and increasingly unstable. 

Trade wars ain’t trade wars

While the current battle between the US and China might appear to be about trade, Haupt says it's actually a battle between a rising power and a ruling power.

When Athens was worried about the rise of Sparta ... it ended in war. And this was no isolated example. Sixteen times over the last 500 years, a ruling power has been overtaken by a rising power. Twelve of those have ended in war. This will go on for decades as China threatens to surpass the USA.

Usually it's a third party, not either of the two powers, that causes the war. The current characters:

1. Trump, the “self-proclaimed ‘stable genius’”
2. Xi Jin Ping, fairly moderate
3. Kim Jong Un ... the third factor. Could he cause a conflict?

 2. China

So why is China so important? Apart from being a huge country that accounts for an even bigger portion of global growth, primarily, it's their thirst for metal. 

So of course, China has a big impact on the Australian budget. When China does well, Australia runs surpluses, which leaves more cash to be spent on services and tax cuts locally. 

Matthew believes that China will stimulate again in the next few months, so his base case is for global growth to return.

 3. How to position for the current market

Assuming the return of global growth, which he says is their base case, the places to be invested are:

• Emerging markets
• Global cyclicals
• Commodities
• Financials

Some current examples from their portfolio include:

Rio, BHP, Oz Minerals, Western Areas, QBE, Amcor, South32, Iluka, Fortescue, Woodside, Computershare.

Fortescue Metals Group 

The Vale tragedy has taken 98mt out of the global iron ore market. Steel mills substitute for low grade iron ore when margins are under pressure, which they're seeing now. This reduces the discount on FMG's low grade iron ore, and supports their margins. The iron ore market remains tight and inventories are decreasing. Miners expect these trends to continue for two to three years.

If we’re wrong…

Of course, one must always consider the possibility that they're wrong. If global growth stalls and PMIs begin to fall again, equities will underperform, while defensive assets do well.

If this plays out the portfolio positioning should be for developed markets, gold and yield-sensitive stocks, long duration assets, consumer staples, and health.

Some current examples from their portfolio include:

Northern Star, Saracen, Evolution Mining, CSL, Telstra, Sydney Airport, Newcrest, St Barbara, Transurban, GPT Group, Goodman, Dexus.

Evolution Mining 

Matthew says the gold price is determined primarily by four factors:

1. US interest rates
2. USD
3. Oil price
4. Volatility

In September last year when they began buying, all four factors pointed towards a rally for gold. Positioning was heavily oversold too. They lightened their position in January, but began purchasing again recently as the macro factors began to line up again. 

Two more stocks he really likes

Western Areas – supported by the strong thematic around EVs and nickel. BHP was very positive on nickel in their recent strategy update. Nickel in WA needs to consolidate and he expects Western Areas to be a big part of that.

Aristocrat – the fundamentals are in place for continued growth. They recently published a strong result and rallied 8%. The company appears to be undervalued and is kicking goals. 

Oscar Oberg: Get me out of Australia

This February was the weakest reporting season since the GFC for the ASX, said Oscar Oberg. The economy is weak, so Aussie investors are looking offshore for growth. Offshore earners like IDP Education, Altium, and Appen have performed strongly.

However, the most expensive companies in the ASX trade on an average forward PE of around 34 times. This is 40% higher than the 25-year long term average. Valuations of these companies are now higher than at the time of the tech bubble in the early 00s.

Infomedia - is a rare thing; a tech company trading at a reasonable valuation. It's a global leader of software for automotive parts. Most of its revenue is offshore and recurring. 

The company has a new management team, which has invested heavily to take market share.

They expect it to beat expectations again in August reporting season.

Myer – is a turnaround with significant earnings growth potential over the medium term.

*gasp*

Oscar says they expected profit above analyst forecasts, but under the guidance of a new CEO, earnings surpassed even their expectations. For the first time in eight years, Myer delivered earnings growth. 

There are more cost savings ahead through store closures and reducing the footprint of existing stores. He also says that the shopping experience has improved significantly in recent times. 

Over the next 3-4 years, he thinks Myer profits could reach $55m, once cost savings have been implemented. 

Martin Hickson: A market-driven approach

Many investors and fund managers have lamented the increase in intraday volatility when companies report results. But when your strategy includes trading results around earnings season, this volatility might not be such a bad thing.

Clearly, volatility has been increasing in recent years. But why? Martin Hickson says there's two reasons. 

First, the number and experience of sell side analysts have been decreasing. This means the gap between market expectations and reality is likely to be higher.

Second, there's been a large increase in quant funds that use automated strategies to trade "beats" and "misses". 

Appen - this company is already up 100% this calendar year. It helps companies like Facebook and Google to improve their algorthims by providing the data to improve their AI.

It listed four years ago at 50c, and now trades at $25 – a 50 bagger.

Appen's revenues don’t just recur, their customers actually spend more with the company the longer they’re clients.

PWR Holdings - is a microcap that can continue to outperform the market. It's a manufacturer of performance parts (specifically, intercoolers, for all the rev-heads out there), primarily for motorsports. 

This Aussie-founded company is based in Brisbane and the founder still holds 30%.

The company has a dominant position in motorsports. For example, it holds an 80% market share in Formula 1, the world's premiere racing series. 

PWR is pushing into the OEM market (large global car companies), which is significantly larger than the elite motorsports market that they already dominate. They’ve won contracts with companies like Jaguar and Rolls Royce.

With earnings growing at 20% and an attractive valuation, Martin believes this little Aussie world beater can continue to re-rate. 

Well, that's it from this year's WAM forum. Watch the Future Generation Investment Forum, or read the wrap-up from Alex Cowie after the event.