Volatile and falling markets aren’t much fun for anyone. But Emma Fisher, portfolio manager at Airlie Funds Management, says investors who stay on the sidelines at times like this run a different sort of risk.

“It sounds counterintuitive, but you’ve got a better chance of making good money when markets are down. So, we welcome volatility, we welcome short-termism because it increases the chance that you’re going to be able to buy mispriced assets,” she says.

“Even though it doesn’t feel as good and it doesn’t feel as comfortable as when markets are making new highs, it’s actually a better environment for stock picking.”

And one of the best places to do that stock picking, Fisher argues, is right here in Australia.

Yes, interest rates have further to rise, which will put pressure on consumer spending and the margins of ASX-listed companies.

But the fact Australia’s housing market is dominated by variable mortgages should mean that rate rises have a bigger effect on the economy faster than in other countries, meaning the Reserve Bank may not have to go as hard as it otherwise might.

In addition to that, Fisher says corporate balance sheets in Australia are “in better shape than they’ve been in any other downturn that we’ve seen” providing local firms with no shortage of flexibility to navigate any downturn.

“We think if we are heading into a tougher period, that the Australian economy will probably do relatively quite well.”

Matt Williams, Fisher’s fellow portfolio manager on Airlie’s Australian Share Fund, says he was overall quite impressed with the results delivered through the August reporting season, nominating private health insurer Medibank, plumbing supply group Reece, and building products giant James Hardie as the firms that delivered the highest quality results.

While dividends were a little softer than Williams expected – arguably due to companies showing sensible caution about the outlook – he says the ability of companies to pass on higher prices and maintain margins was impressive, and the overall picture was one of an economy in rude health, despite all the concerns about rate rises hitting growth.

“We do a good job of talking ourselves into recession,” Williams notes wryly.

“We feel that things are going to get tougher – there’s no doubt they have to because the top line and the cost line is under pressure. But the consumer in both Australia and the US is looking pretty good in aggregate and corporate balance sheets are really good in aggregate.”

The Airlie Fund is down 2.9 per cent over the last 12 months, versus a 2.2 per cent fall in its benchmark, while over three years it is up 9.4 per cent, versus a 4.3 per cent gain for its benchmark.

Williams and Fisher are heading out this week on a national roadshow that will allow them to host financial advisers in face-to-face events for the first time since 2019.

The message will be simple: don’t let the dominant narrative of markets overwhelm you.

“The thing about the dominant narrative is we love it, especially when you’re in these really macro-driven markets like we’ve been in for the past year. Because if it’s driving the headlines, then it’s probably creating opportunities,” Fisher says.

“It’s not saying that the dominant narrative of, say, economic turmoil is wrong, and that it’s not going to happen. It’s saying it’s been more than priced into some stocks, in some sectors.”

The pair is wary of the sort of defensive stocks that have become very popular in recent months, a list that includes Brambles, Woolworths, Coles and Telstra.

“It can be tempting when you’re worried about where the cycle is going to want to hide in defensives,” Fisher says.

“The challenge you’ve got is the defensive, safe, boring part of the market has re-rated. So, you’re now facing this choice between, in some instances, eye-wateringly expensive, defensive companies and bombed-out consumer-facing businesses that look tantalisingly cheap, but where you recognise that the earnings are probably too high.

“You’ve got to have a playbook for how you navigate both sides of the market.”

The fund does have some of those defensive names, including Woolworths, Wesfarmers and CSL. But Fisher says investors need to think carefully about which defensives they back.

“If we are in a more inflationary environment than we have been historically, you want to look at the capital intensity of the business model,” she says.

“So, a lot of those businesses like Telstra or Brambles, they’re spending billions of dollars a year on maintenance capex and that’s going to cost even more each year in an inflationary environment.

“They’re sort of running harder to stand still and you’re paying more for them now than you did a year ago. That, to us, doesn’t scream good value.

“Medibank we’re happy to own that still, even though it has performed well because it’s got the kicker from high interest rates in terms of its investment income, and it’s a capital-lite business model. So, it shouldn’t be hugely hurt by inflation.”

But Williams and Fischer are also looking for pockets of value among more beaten down stocks, including in consumer-facing businesses, which the dominant narrative says are in for a tough time.

“Our playbook there is to really focus on the balance sheets of these companies. Because the market’s probably right that earnings are too high, but valuations have now priced that in,” Fisher says.

“If you’re looking at consumer discretionary-facing businesses, you want to own businesses that are pretty much net cash or that they own a lot of property.”

Williams nominates two companies that fit this bill: Nick Scali, which is down more than 30 per cent year to date, and Premier Investments, which is down 32 per cent.

One of the big concerns of the August reporting season was the build-up in inventory at retail businesses, which have spent much of the past two years scrambling to secure stock amid supply chain shortages.

Williams is confident top-class retailers will be able to navigate any inventory issues, but he’s watchful.

“If Christmas is not as good as maybe they’re hoping, the retailer’s then going to have to shift that stock and ship it at a price that may not be so attractive. So, that’s what we’d be looking out for,” he says.

Another consumer-facing business Fisher calls out is ARB, the four-wheel drive accessory maker that has long been a darling of fund managers. The stock is down 45 per cent this year, but for Fisher it’s an example of a quality business that is trading at a reasonable valuation for the first time in a long time.

Finally, Williams remains keen on the lithium sector, and particularly Mineral Resources. While there’s no shortage of speculation in the sector, Williams says demand looks strong.

“The OEMs (original equipment manufacturers) are telling you what they’re doing in terms of tooling up for EVs. But it’s also not so much China dependent.”

 

Disclaimer: This material has been prepared by AFR, published on 6 September 2022. HM1 is not responsible for the content of linked websites or content prepared by third party. The inclusion of these links and third-party content does not in any way imply any form of endorsement by HM1 of the products or services provided by persons or organisations who are responsible for the linked websites and third-party content. This information is for general information only and does not consider the objectives, financial situation or needs of any person. Before making an investment decision, you should read the relevant disclosure document (if appropriate) and seek professional advice to determine whether the investment and information is suitable for you.