Thematics with Kate Thorley, Oscar Oberg, Catriona Burns and Matthew Haupt

Kate Thorley: In this edition of WAM Vault, we are going to address some of the questions that our shareholders sent in. We surveyed our shareholders and over 70% are overwhelmingly positive on the Australian economy and even more are positive on the global economy.

Catriona, starting with you, how are you positioning your portfolio and what has changed since we did the last edition of Vault in November 2020?

Catriona Burns: In terms of the WAM Global (ASX: WGB) portfolio, since the last edition of Vault, we have transitioned more of the portfolio towards reopening winners. We have obviously since then had the vaccines announced. We have added a number of stocks in terms of sectors such as travel, media and housing out of the US, for example. We still retain a number of those long-term structural winners as well in areas like health and wellness, digitisation of payments, and automation.

We are taking a balanced approach in terms of the portfolio. However, we are expecting as economies reopen, there will be a lot of those shorter-term wins to come from those reopening plays.

Kate Thorley: Matt, how about you, from a large-cap Australian perspective?

Matthew Haupt: The big change we have had was we went overweight resources last year, as China put its foot down for the credit cycle. That has played out and now we are back towards financials. Energy, we still think that has some legs in it. We are very much along Catriona’s lines of positioning for the recovery from the recession. Economies coming back and that output gap closing, that is where we are really positioned at the moment.

Kate Thorley: Oscar, what about you?

Oscar Oberg: Pretty much the exact same. In the first half of the year, we did quite well out of some sectors such as ecommerce, agriculture, healthcare and those companies that were benefiting from coronavirus. Then, of course, the Pfizer vaccine was announced in November and we had to quickly change the portfolio. The team did a great job in shifting to those cyclical sectors such as financials, aged care and construction services.

From my perspective, what we have seen is there has been a rapid shift away from growth to value, but still, the valuation difference between these companies is the highest it has been in 50 years. There is still a long way to go, particularly if we start to see rising interest rates.

Kate Thorley: That is great. Matt, looking slightly more long term, one of our shareholders is asking about inflation, what are your thoughts around that?

Matthew Haupt: I think the market is pretty well priced in correctly at the moment. In the US around 2.5% is the break-even rate. What we are looking for now are events to change those expectations.

We are looking at the closing of the output gap. That is the difference between where the economy should be and where it is now. If that closes faster, that will push up inflation expectations. Also, generally, the stimulus out there at the moment, that is a real driver. Unless there was an inflation shock, which I do not think there will be, I think the market has it correct now.

What we are focusing on now is any event to change those expectations. Not around ‘will inflation hit 2.5%,’ that is not the conversation. It is around events now which will shape the shift in that either down or up and that is what we are focusing on at the moment.

Oscar Oberg: It has been fascinating in the small-cap part of the market. We have done the rounds and been across Australia for the last two or three months. It does feel like every company you speak to has cost pressures at the moment.

I think the best example we have seen is Tassal (ASX: TGR), which is a salmon producer. I did not know this until coronavirus happened, but it used to export 90% of its salmon in a passenger jet. With international flights effectively stopping, the company had had to go to the sea, and that is a cost of 11 times higher than normal freight costs. From our perspective, in small caps looking to small cap industrial companies, we really need to pick those companies that have the ability to raise prices to offset these cost pressures.

Catriona Burns: That really is a phenomena that we are certainly seeing globally, every day when we are talking to a company, whether they are in the US or Europe or the UK. We were talking to one this morning that was complaining about polyethylene pipe, we have seen lumber complaints and freight issues as Oscar was saying. It is daily they are talking about these pressures.

At the moment, most companies are saying it is totally fine in terms of passing that on. A lot are taking the view that it is transitory. It is a key watch point and it is a factor we are considering and really thinking about with companies, in terms of whether they have pricing power if it does not prove to be as transitory as the current assumptions are.

Matthew Haupt: That is the important thing. Inflation will dictate monetary policy. So, inflation is very important to watch, because that will ultimately determine the interest rate hiking cycle. That is why it is so important.

Kate Thorley: Thinking about the tech sector now, it has obviously had a fantastic run up until more recently. Oscar, starting with you, what are you seeing in this sector?

Oscar Oberg: Speaking from the Australian perspective, we have really been able to differentiate the winners and losers in the technology sector. There was a period for a number of years where if you were a company that had ‘pay’ at the end of your name, you would seem to get a huge rerating and you would trade at 20 times sales. It does feel like those days are coming to an end, but there will always be opportunities.

If we look at the technology sector in Australia, the best example of a company that has done well throughout this period is Xero (ASX: XRO). It has such a high level of recurring revenues, it is a Software-as-a-Service-based business, and it had very low levels of churn. I have been surprised at how resilient the business has been through here and really confident around its market share growth that it can get in the United Kingdom, Australia and the US over time.

Kate Thorley: Great. Catriona?

Catriona Burns: I think back to the point around interest rates, it is obviously a key issue for tech stocks. You have had interest rates coming down for a decade, inflating prices of some of these tech stocks, particularly in that concept end of the market where they do not generate any earnings.

As Oscar said, they trade on enormous multiples of sales. We have seen some of that hype come out of those share prices. When we are looking for opportunities, it is really in businesses that actually do have valuation support. Certainly, we can see a number of pockets that are interesting and a number of plays in the tech sector when we look globally. It is certainly not at all in those concept stocks where they do not generate any earnings and it is really whether it is in automation, digitisation of payments. These are trends that we think have some longevity, but also you can buy stocks with significant valuation support. It has become a lot more nuanced and you really have to pick those individual stocks, not just buy any tech stock, as Oscar said.

Kate Thorley: Matt, there have been a lot of headlines around resources and a so-called resources super cycle. What are your thoughts, is there a resources super cycle?

Matthew Haupt: I would argue no. The primary driver of resources is China, it consumes over 50% of world’s copper and 70-80% of iron ore. What happened last year when coronavirus hit, obviously that was the centre of it, the Chinese Government immediately went and ramped up credit origination and infrastructure investment. It was huge, the amount of stimulus China put into the market. So, that drove commodity prices. Then you had supply issues around, especially in copper – Latin America has been hit hard by coronavirus. So, you had supply-side issues and then stimulus within China driving this cycle.

It is not a super cycle, in my view. It is really the boom-bust cycle we see in China all the time. They put the foot down and then they pull it back, and they are pulling it back at the moment. I think if you are going to play resources from here, you have really got to be specific around different commodities. Iron ore I think is pretty well done now. It still will be elevated, but I think that trade is very much over. Things like manganese and alumina, aluminium, those things have not rallied yet, but the spot prices have. I think if you are going to position, you have got to play in that space.

Kate Thorley: Catriona, we have had a few questions from shareholders about the US market. You have just come through reporting season, what has been interesting out of that market?

Catriona Burns: Speaking to companies on the ground and seeing the earnings they reported, certainly demand is coming back strongly. A lot of companies were pretty conservative in terms of willingness to put out guidance, and you saw approximately 88% of companies beat. There was a significant level of beats compared to conservative guidance.

What was interesting was some of the share price reactions were pretty muted despite this. In some cases, that gave us opportunities in companies where we thought ‘that is a cracking result’, the share price had not moved, and we were able to buy more.

I would say talking to management teams, there is no doubt demand is coming back. There are some temporary supply constraints, but generally on the demand side, companies are very positive. Supply, despite those hiccups, is starting to come through. Then, you have this backdrop of consumers generally being pretty cashed up in a lot of cases because they have been locked down, unable to spend their money, and so there is a lot of pent-up demand. The backdrop for the economy there is pretty strong.

Kate Thorley: That is great. Matt, over to you on the banks. This is always a common question from our shareholders, what are your thoughts on the Australian banks?

Matthew Haupt: The banks actually traded really well through coronavirus. It was predominantly through government support. The Reserve Bank of Australia (RBA) and The Australian Prudential Regulation Authority (APRA) came in and gave them support, gave them cheap funding and the cheap funding is still in place now. Last year, it was in March/April they struck huge provisions on the basis of coronavirus deteriorating the economy to a state where there was a lot of defaults. That has been wound back now and the banks are well capitalised. They are going to release provisions over this year. There is going to be a lot of capital management too. We were fortunate enough to catch up with a few of the bank CEOs, something very much on the table is ‘how do we return some of this capital to shareholders.’

I think Commonwealth Bank of Australia (ASX: CBA) will do big off-market buyback, hand back franking. National Australia Bank (ASX: NAB) will do an on-market buy back. They are in a great position. Also the headwinds, which are low interest rates, are starting to unwind now. The big effects are being felt already, and in 2022/2023 they will start to turn to tailwinds. It is actually a very good spot for the banks at the moment, but the easy money has been made.

Kate Thorley: That is great. Oscar, what are your thoughts if interest rates start to rise?

Oscar Oberg: Very similar to Matt. The banks are not traditionally a sector we hold in WAM Capital (ASX: WAM) and WAM Microcap (ASX: WMI), but the outlook for the banks is very strong. Interestingly enough I caught up with one of the largest non-bank lenders yesterday in Melbourne. They were saying that the number of impaired or problem loans that they have on their books right now is actually lower than what it was pre-coronavirus, which is incredible when you think about it. The rising interest rate environment, that should boost net interest margins, for these reasons we have got large positions in the portfolio in MyState (ASX: MYS) and also Virgin Money UK (ASX: VUK), which really should benefit from an improving UK economy.

Kate Thorley: Thank you so much for your time and thanks to our shareholders for all your questions.