How We Navigate Equity Market Volatility – Anton Tagliaferro

Since the start of 2022, we have seen inflation accelerating all over the world. The US reported 8.6% recently, the UK reported 9.0% last month and in Australia, RBA Governor Lowe warned last week that inflation would hit 7% by december.

Rising inflation led to massive bond sales around the world, led by US bonds. This saw Australian government 10-year bonds trading at levels not seen in a long time. In August 2021, yields were as low as 1.1%, then as low as 3% in early 2022 and now this week bonds have traded above 4.0% for the first time since 2014.

High inflation has prompted central banks everywhere to tighten monetary policy, leading to great uncertainty and a slump in stock markets globally. Central banks around the world – including the RBA – now find themselves in a situation where they must orchestrate a slowdown in demand to contain inflation, while trying to maintain economic growth and not plunge their economies into recession. recession.

Although the situation will remain uncertain for some time, it is clear that equity markets are slowly returning to fundamentals where earnings, cash flow and strong balance sheets matter.

What does this mean for the Australian equity market?

Given the many uncertainties, we maintain a cautious view of the overall stock. However, we continue to seek investment opportunities in profitable, well-established and attractively valued companies that we believe have a strong competitive advantage and are led by capable and experienced management teams. We believe these types of businesses are best positioned to weather the current economic uncertainty and grow over time.

Here are our current thoughts:

• We continue to steer clear of “growth” or unprofitable technology names, such as Megaport and silver zipperas we believe that most of these companies continue to look overvalued, even though many of them have so far fallen by 60 or 70%.
• We remain cautious on cyclical sectors such as those exposed to consumer spending, housing construction and media spending. That said, some of the higher quality stocks in these sectors, such as Nine Entertainment and Wesfarmers – have fallen very rapidly, so we are looking at the levels at which to buy these types of stocks.
• We remain cautious on many resource values. With very high prices for many commodities, markets are pricing in continued price and demand strength in what will be a weakening global economic outlook as we enter the second half of 2022. While many stocks of this sector look optically cheap on an earnings-based price, we don’t believe earnings will be sustainable for many of these companies once supply chains normalize and new capabilities come to market .
• We also remain wary of the big banks. While higher interest rates can potentially help banks as their net interest margins may improve, increased competition in the industry means these benefits may not be as high as they were in the scenarios. rising interest rates. Additionally, there are two other headwinds that banks have to deal with; rising interest rates which will also slow credit growth in the housing and business sectors, and bad debts could also increase as some borrowers grapple with higher interest rates in a slowing economy .

So where do we find opportunities?

We continue to like companies that have self-help initiatives they can undertake internally. Examples include:

• Brambleswhich announced a strategic review that we believe will create value across its divisions.
• willwhere over the next year or so, the company hopes to unlock value in its attractive InfraCo division, which generates substantial government-backed revenue.

There are also some companies that we believe are actually benefiting from the current turmoil in supply chains, but whose benefits the market has overlooked. Orica, for example, now faces less competition than before from imports due to explosives supply shortages and is also able to meet many of the cost increases it sees. Aurizon should also benefit as it must reset contracts with its rail network customers in mid-2023 and will be allowed to increase revenues due to rising inflation and bond rates.

We are also finding opportunities in the REIT sector, where we have been cautious for some time. It has fallen 25-30% fairly quickly, with many stocks now trading at substantial discounts to NTA. Although we need to adjust our valuation from earlier expectations, the falls we have seen are starting to provide a margin of safety and attractive yields for some names that we believe are defensively positioned, with low leverage, secure tenants and long-term lease profiles.

In conclusion, while markets are likely to remain volatile and uncertain for the foreseeable future, given concerns over rising interest rates, we will continue to stick to our style of quality and value investing which has provided attractive and less volatile returns to our clients for over two decades. While the current volatility has, of course, impacted our portfolios, we remain defensively positioned in well-established and profitable companies and look forward to investing in new ideas as market opportunities arise. will show up.

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