By WAM Leaders Lead Portfolio Manager Matthew Haupt
The WAM Leaders investment strategy is based on picking inflection points and positioning the portfolio ahead of those changes. We spend a lot of time thinking about how the economic environment will look over the next six to 12 months. Therefore, in the lead up to the local reporting season, we adopted a defensive posture, rather than going for higher-risk stocks.
We believe sticky cost inflation is going to create a significant margin squeeze for corporate Australia this year, which means we are backing firms with proactive management teams that are actively looking for efficiency and productivity gains, especially in labour.
Focusing on companies with cost-out strategies
Reporting season themes correlate to the economic cycle. In boom times, strong revenue growth shines, and cost bases inflate. In uncertain times, margins are the focus. This season the markets were students of the latter.
This trend was seen across all sectors, from media such as News Corp (ASX: NWS) to toll roads such as Transurban Group (ASX: TCL) as diligent management teams reported stronger-than-expected margins. In a rising inflation environment, the price lever can be pulled aggressively. However, as inflation normalises, the companies actively implementing quantified cost-out programs will thrive.
In this vein, banks have substantially reduced their headcounts in 2023. This strategic move, coupled with equity market flows from China to Australia has driven the surge in the banks’ share prices. We have a contrarian view on China, and expect incremental measures to be deployed through the year to strengthen its economy. There is potential for a reversal of these market flows, which could turn into a headwind for valuations of the Australian banks. While fundamentals have held together better than expected, the environment overall is soft and we are sceptical that market valuations accurately reflects the true earnings reality of these stocks.
Australia’s economy remains resilient
The market is fixated on whether reported earnings beat the consensus of analysts’ expectations, while missing the bigger story. Across the retail sector, we are seeing signs of top line revenue growth shrinking at the same time as the cost of doing business has risen.
Competition has seen prices fall, and it is difficult to pull the price lever at this point in the cycle. There is no escaping the fact that the cost of doing business is going up for almost all companies. We expect consumer discretionary stocks could give back some of their 2023 gains even as interest rate cuts look likely at some point in the year.
Geopolitical considerations
There are also significant geopolitical risks to the outlook, especially given the US presidential election. Generally, markets do not run up into elections; they run after the result is clear. The biggest issue is the prospect of presidential candidate Donald Trump’s re-election. The policy levers he had to pull in the past – tax cuts and spending – cannot be pulled this time. This could force him to look at trade measures, such as imposing tariffs, creating more uncertainty for global trade. How he navigates America’s relationship with China and Russia will also be critical.
Such an outlook gives good reason for caution. The world is set up for more geopolitical disturbances. While we believe it is going to be a tough 12 months ahead, the defensive positioning we have adopted ensures the WAM Leaders investment portfolio can navigate any scenario we may face. We remain excited on the mispricing opportunities that will inevitably surface in this environment, identified through WAM Leaders’ active investment process.