Jonas Daly:
Hello, and welcome to our podcast for September 2022. My name is Jonas Daly, Head of Distribution of Bennelong Funds Management. And I'm joined here today by Bennelong Australian Equity Partners CIO, Mark East; and Neale Goldston-Morris, who is Senior Analyst and Macro Strategist. Today's podcast has been set up to provide investors with an overview of the global macro landscape and then an update from the interim reporting season that we just had.
Gentlemen, thank you for joining us today. Neale, I might just start with you if I could. Just on the global macro side, inflation's obviously the big gorilla in the room. How much further do you think we've got to go here? Are we at peak inflation at the moment?
Neale Goldston-Morris:
It is the big gorilla in the room. And no, we are not at peak inflation. Not at least as far as core inflation. Let me just quickly differentiate there. Headline inflation will come off in the coming months because all prices are settling, and a lot of the other commodity prices are settling, and supply chains are normalising. But for central banks, it's not the headline that matters, it's the core inflation, which takes out those cyclical elements.
And in core, the two big bits are rents and healthcare costs. And both are going up strongly and both will continue to go up strongly for well into next year. That's the challenge for central banks. And that's why rates will go up further. The Fed will continue to tighten over the next three or four months and so will the RBA. And of course that will pressure mortgagees in particular. Economies will slow.
Jonas Daly:
Great, thanks for that. And now are we at the bottom yet for equity markets?
Neale Goldston-Morris:
I don't believe so. And from this perspective; yes, the markets have been derated. PEs have come down. And they probably need to come down a bit further. The big adjustment to come is in earnings forecasts. Bottom up earnings by the analysts right across the market, and virtually ignoring the downside risks of the economy at this stage. They're almost backward looking as to what was occurring in the June quarter, when things were still buoyant. But the turn is occurring in the September quarter. And they'll have to start making some significant adjustments over the next three to six months. That's where the adjustment comes from.
And when you look at our portfolio, we are very much away from the economic sensitive big sectors. We have no banks. There will be bad debts on back of a large fall in house prices. And they are going to occur, but you can guarantee that one.
And we have firstly, no resources apart from a small position in BHP, because commodity demand will soften over the next six months, quite sharply. We're already seeing it in copper and we’ll see it in a lot of the others as well. Retailers, now bricks and mortar retail; the only economic sector that we think, that the area we still have exposure to, is the COVID reopening stocks. That is those that were virtually shut during COVID and are now reopening.
In other words, the entertainment, travel, education categories. Or if you simply boil it down to, the households are saying, "Let's cancel the curtains and go to Cairns." That's where you're seeing the spending. Pubs are full. Casinos are filling up. Obviously airplanes are pretty full as well. Through a number of stocks there – Corporate Travel, IDP Education, Aristocrat; we're maintaining an exposure to the reopening trade.
Jonas Daly:
And that's good. And look, obviously you held a few of those names through that recovery as well. But just in regards to turnover, you touched on avoiding some of those sectors, but is that why your turnover is so low? You're also avoiding banking and technology?
Neale Goldston-Morris:
We've been pretty happy with the stocks we've got, but there's a few that we have sold down because we think the economy will slow. Seek is one we've sold out of, because we think that employment is now peaking or job ads will fall away over the next six months. We're trying to avoid those that will have to cycle very high comps because of very buoyant numbers last year and the first half of this year. But the portfolio is very strongly emphasised towards those non-economic sensitive, long-term growth stocks like CSL in healthcare, ResMed in healthcare, Endeavor in the staples; as three examples.
Jonas Daly:
Okay. Thanks, Neale. Just before we move on to a bit more on the portfolios, just in regards to reporting season, how do you think the feeling was? And how are we looking, going into the next reporting season? Do we have a bit more pain to come?
Neale Goldston-Morris:
Thanks Jonas. Look, the reporting season per se was actually okay. The actual earnings came in broadly in-line with consensus bottom up forecasts, which was good. And it reflected companies putting up prices in particular to offset their cost increases because of the rising inflation.
Our concern is that the turn in the economy really didn't start to slow until around May. So those results included very little, if any, of the economic slowdown now underway. And our concern is that the next two reporting seasons are going to be pretty tough by comparison with a lot of earnings downgrades, particularly in the economic sensitive areas. And that will accelerate over time.
In addition to which the notable feature in that reporting period was, even though the results were quite good, managements were very reluctant to give outlook statements because they were basically uncertain as to what was occurring, because they could see rates were going up. Rates only started to go up in May, and then you had another one in June, so that was just one and a bit rises in those two months.
And now of course you've had another four since then, and you’re really into the meat of the increases since then. It's almost regarded as an interregnum between a very strong economy and a turn and the slowing economy to come.
And within that, the dynamics of our portfolio, when you're in high quality growth stocks, they always get hit as in the anticipation of rate rises to come, because your discount rate goes up. Yes, the CSL and so forth will underperform in that period. But once your earning downgrades start, then those sort of stocks outperform on a relative basis because your economic sensitive areas start to get the earnings downgrades – banks, resources, retailers, and the like, compared with healthcare and staples and other defensive categories.
The first half of that cycle if you like, hits quality growth, Pes come down. The second half should help quality growth, cause the E in the earnings comes down.
Jonas Daly:
Great, thanks Neale. That’s a really good summary there. And what we’ll do now is just, Mark, pass over yourself to talk about the portfolio in a bit more detail and a couple of stocks and your positioning.
Mark East:
Yeah. Thanks Jonas. I can sort of run through some of the key stocks and how they fared in the results season. Firstly CSL, it announced the result at the top end of its guidance range. And set guidance for the year ahead, the FY23 year, of 10 to 14% growth. And with plasma collections looking to be on an upward trend and a pretty positive outlook for their flu business, we're pretty comfortable that the company can achieve this earnings guidance range.
In terms of upcoming news flow for CSL, they're hosting an investor day in mid-October on its recent large acquisition of the Vifor business. And we hope that this will give the equity market a better understanding of the upside to come from this business.
Another sort of key stock is ARB, the four wheel drive accessories supplier. They reported a result in line with market expectations. There may be some short-term headwind for the company just in relation to the slow supply of new vehicles into Australia. But we think the medium to long-term outlook for this business is positive. And that view is partly based on some new relationships the company has. Just in the last year or so, it’s announced a relationship with Ford in Australia and the US. And also just very recently have announced a new relationship with Toyota in the US. We're also hoping that the company will release a number of new products over the next sort of six to 12 months, which also should help to drive growth in the future.
Breville is another key position. They reported a result in line with expectations, the company's businesses in Australia and the US performed really well. And the company's European business understandably sort of struggled in the last few months of the year, following the Russian invasion of Ukraine. Over the sort of medium to long term, we think the company's outlook is positive. And although there is sort of clearly some uncertainty in the short term about the European business and what happens there. Again, we're expecting some new product releases over the next one to two years, which should help to drive growth sort over the medium term.
One other sort of key position is James Hardie. They reported a third quarter result which was slightly below the market's expectations. And the company adjusted their full year earnings guidance range slightly, just by moving the top end of their guidance range down. And market forecasts currently sit right at the bottom end of that guidance range. There's clearly a fair bit of uncertainty about the outlook for the US housing sector at the moment. James Hardie's mostly exposed to the R and R sector, the repair and remodel sector. So it is somewhat protected from what happens in US new housing, but that outlook for US housing will have some impact on the company over the next sort of year or so.
Our analyst has been in the US in the last week or so and visited James Hardie, and met with new CEO, and met with the line management. And he's come away positive on the company's medium-term growth prospects. And just finally, I think Neale mentioned IDP Education, they reported a really strong result above market expectations. And I guess with the movement of international students appearing to be sort of recovering strongly, we're pretty positive on the outlook for IDP.
So that's some of our key stocks and how they fared over that reporting period.
Jonas Daly:
Fantastic. Thanks, Easty, that's great. And some good examples of good quality businesses with strong fundamentals that will keep moving along and have strong pricing power regardless of what's going on the global macro side. Look, some really good insights there, gents. And thanks for your time today. And thanks for everyone who joined the podcast and have a great day. Cheers, bye.
