Finding the market leaders

QUESTIONWhat is the WAM Leaders investment process and how the team apply it to identify opportunities?

MATTHEW HAUPTAt WAM Leaders we use the top down process. What we are trying to do there is identify the operating environment;  the environment which will be positive for certain sectors. Within those sectors we are looking at the bottom up approach, trying to pick the best stocks within those sectors.

JOHN AYOUBAnd we are rigorous in our bottom up approach. We constantly see management, we try to identify companies that are going to be leading within their sectors and from that stand point we can pick the best stocks that will have the ability to withstand any headwinds and maximise tailwinds in all market conditions.

QUESTIONWhat is your outlook for the current macroeconomic environment?

MATTHEW HAUPTThe macro outlook for stocks is quite uncertain at the moment.  We are in a position of incredible financial tightening and what that means is, the environment is incredibly tough for stocks, but also the operating environment for companies is getting tougher and tougher. What that means is we are going to see earnings growth decline over the next 12 months in quite a significant manner.  There also is a chance of potential risk here that we push too hard and the consequences turn to a fairly big recession. That is a watching brief, not our base case.  We think the base case is that policy will start to pause, not pivot, but pause. That will still make the environment tight for companies and we will have to be cautious over the next 12 months.  We think that financial tightness is stressing the system, and we are starting to see that in pockets all over the world. The backdrop is tough and I think earnings growth will be quite a negative surprise over the next 6 to 12 months.

JOHN AYOUBWe are starting to already see the emergence of headwinds in a number of sectors and it is rapidly deteriorating, particularly in the consumer discretionary and the building sectors in the US.  What we can also identify is there is three separate different paths that central banks around the world are taking.  If you look at what the US is doing, they are steadfastly trying to keep inflation down, that is the primary focus of policymakers over there.  In Australia, the central bankers and Phil Lowe is too scared to aggressively tackle inflation. He is very conscious of the property sector ensuring that we do not have a property demise in Australia. China is trying to stimulate, they are doing quite the opposite of everyone else. What we can see is that the central banks that control the Australian Stock Market and the outcomes of the Australian Stock Market are taking three very diverse paths and our job is to try to navigate through those and try to predict the earnings of the companies that are affected by these various policymakers.

MATTHEW HAUPTThat is quite an important point, the divergence of policy now.  We have had the Fed, who are sticking with very tight policy versus Bank of Canada and the RBA which have relaxed policy because of the variable nature of the mortgage market. It is really going to create different pockets and different environments for stocks.

JOHN AYOUBAnd it is going to affect every country slightly differently and we are already starting to see the consumer in the US struggle.  They are already starting to tighten the belt.  Moving closer to home, the Australian consumer will still fake it until Christmas and they will continue to go about their way. As Matt said earlier, we are concerned around the shape of the economy next year when we have the full affects of the rate hikes, which is the lag effect of somewhere around 4 to 6 months, and that will take full shape next year.

QUESTIONWhat sectors are the team looking at for opportunities in the remainder of FY2023?

MATTHEW HAUPTWhen you look at the sectors, you have got to look at the operating environment which is incredibly tight.  The consumer is going to be put under pressure.  The policy actions of central banks is to make a tight environment and change behaviour of consumers. That is how inflation ultimately will be effective, by changing of behaviour.  With that as a base case you have got to look at what sectors will do well in this environment in the business cycle, but also the monetary policy cycle. When you look at that, they really have to have defensive characteristics.  When we look at sectors, we are looking at staples which obviously did well through COVID but should do well over the next 12 months.  You have got to look at telecommunication companies.  Companies like Telstra, with very defensive characteristics. Some of the rates are quite interesting although the debt markets are pretty tight and the cost of interest rates has definitely gone up. We still think there is value there as they have some defensive characteristics too. I think those three sectors are probably your best bets over the next 6 to 12 months.

JOHN AYOUBI think it is the end of speculation.  Companies for a long time have survived on hope.  Free money allowed companies to over achieve on ambition but what we expect now, is that it is a return to the old economy, the real economy of sorts, where cashflow is king to control your bottom line costs. With inflation running rampant we are going to be able to focus on which management teams have the ability to crimp that cost line as the top line slows. It is the old world economy where we are returning.  We continue like all stocks. We continue like insurance companies as they have the ability to pass on inflation to their end customer. It is the old world versus the new world and our preference is the old world.

MATTHEW HAUPTThat is a very good point.  The year of speculation or the bubble of everything is over.  The cost of capital has made the hurdle a lot higher for investment.  You are not going to get that silly investment.  You are not going to get cash burn and quality is the absolute most important quality to have over the next 12 months.

JOHN AYOUBDefensive quality, will be the term we would coin, to focus on coming out the other side. As Matt deluded, if we have tightened too aggressively and central banks have to respond by loosening somewhat, we must find the market leaders. That is what we will be trying to identify towards the middle of next year, finding those market leaders that have the ability to absorb and withstand all the shocks that we will be facing over the next 6 months and they will come out the other side stronger.

MATTHEW HAUPTThank you to our shareholders for listening to WAM Vault today. We really appreciate your continued to support over the life of WAM Leaders and we hope to keep delivering good returns for you.