12 stocks to bolster your portfolio right now (and how to position for a market pivot)

An old boss of mine once shared a horrific story about being stuck in an elevator (which in itself, would already be hellish). It stopped, before suddenly dropping several floors, lifting his feet off the ground with it. 

While the plunge itself had shaken him to his core - as it did the building manager - he luckily walked away injury free. 

Thanks to this story, I now have a fear of elevators. And while I can only imagine what that stomach-dropping, life-flashing-before-your-eyes feeling would be like, I assume it must be somewhat similar to the many emotions we investors face in this current market. 

After all, how many more bear market rally rollercoasters must we ride until that pit in our stomach dissipates? How much more bad news can markets (and our portfolios) take before we see a sliver of hope on the horizon? 

While my crystal ball doesn't appear to be working currently, long-term bond yields do seem to have peaked. 

So what does this mean for equity valuations? And which stocks are the experts backing to see them through the volatility ahead? 

In the last wire of this three-part collection on Aussie equities, Tribeca Investment Partners' Jun Bei Liu and Watermark Funds Management's Justin Braitling share 12 stocks they believe are attractively valued right now, the signals to watch out for to know when to pivot, as well as how they are positioned for the months ahead. 

Jun Bei Liu

Lead Portfolio Manager Alpha Plus Fund

Tribeca Investment Partners

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Justin Braitling

Chief Investment Officer

Watermark Funds Management

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The yield on US long-term bonds and the Aussie 10-year is expected to be in the 4.5-5% range in a year's time. How will these impact equity valuations?

While yes, cash rates are skyrocketing globally in the here and now, it's long-term bonds that investors need to pay attention to. 

That's according to Braitling, who explains that the discount rate used to value a company's future cash flows is the long-term government bond (i.e. the Australian 10-Year Government Bond or US 10-Year Treasuries), not next year's expected cash rates. 

"Long-term bond yields are peaking (bond values basing) as inflation peaks," he said. 

"This is taking longer than expected because inflation is proving to be more persistent than expected. Inflation will moderate but not as quickly as many would hope in the US, at least, because services inflation is far more relevant than goods inflation (which has been falling)." 

In addition, employment markets remain incredibly tight (in September, Australia's unemployment rate was only 3.5% - compared to the 6.71% it averaged over the past 44 years), putting upwards pressure on wages - which similarly, sustains inflation, he added. 

"This will continue until we get an employment recession, a key reason why a recession is inevitable - it kind of has to happen to rebalance the labour markets," Braitling said. 

"Bonds will rally (yields will fall) as advanced economies start to slow and slack returns to employment markets next year. At this stage, investors will be far more focused on falling profit estimates than lower yields - and one headwind for shares will be replaced with another." 

These high long-term yields have translated to lower valuations for companies, particularly, those companies with higher future cash flows (i.e. growth companies), Liu added. But with many stocks 50-70% off their highs, now could be the time to start scooping up quality growth at a discount. 

"We have seen a sharp sell-off across growth businesses over the last 12 months and this is a direct result of rising interest rate expectations," she said. 

"We have already seen many broker/analyst downgrades for the valuations of these companies and our view is that much of these downgrades or much of these share price falls as a result of higher interest rate expectations are now pretty much priced in." 

Which stocks are you backing to help keep your portfolio afloat as central banks continue to hike rates?

Over the past six months, Liu and her team at Tribeca have held overweight positions in some of the beneficiaries of inflation and rising rates, like Computershare (ASX: CPU). However, as she believes that interest rate expectations are now largely priced in, she recommends investors in these types of stocks take some profit. 

"I'm now gradually seeing more opportunity in some of the growth leaders that have been sold off, given my view that the valuation derating is pretty much done (of course, you'll still see some stabilisation and perhaps a little bit of volatility)," she said. 

"As long as the earnings are not downgraded for some of these growth names and they continue to grow their earnings, I actually think they look very reasonably valued." 

She points to the likes of NEXTDC (ASX: NXT), TechnologyOne (ASX: TNE), and REA Group (ASX: REA) as examples. More recently, Liu and her team have started to look at Domino's (ASX: DMP) as well. 

"A couple of these names just reached our valuation support," she said. 

"Over the long term, they will deliver very strong growth, but in the near term, there's a bit of earnings pressure. We are happy to take a long-term view to take a position in those quality companies." 

Liu has also been gradually picking up quality healthcare companies in recent weeks. 

"We do think healthcare will perform very well in an uncertain environment. These companies will deliver very strong earnings growth regardless of the economic outlook, and valuations look reasonable," she said. 

She points to companies like CSL (ASX: CSL), ResMed (ASX: RMD) and Ramsay Health Care (ASX: RHC) as examples. 

Similarly, Braitling believes that Ramsay is worth "revisiting". 

"The shares have collapsed since KKR walked away from their proposed deal in September," he said.  

"It is an excellent business that will recover once COVID passes and surgical procedures return to normal. I suspect the bidders will revisit the name in due course." 

He believes investors should be on the hunt for "cheap defensive shares", particularly those that have underperformed in recent years. 

"Telstra (ASX: TLS) and TPG (ASX: TPG) are both well priced here," Braitling said. 

"All the headwinds that have challenged TLS (NBN; mobile substitution, legacy deflation) are behind them. The business is growing again. Meanwhile, TPG is outstanding value here. The commitment of the founding shareholder is unclear, which I suspect puts this business in play at these depressed levels." 

Another sector that looks "very interesting" includes the general insurers, Braitling added, pointing to Insurance Australia Group (ASX: IAG) and QBE Insurance (ASX: QBE) as attractive opportunities. 

"Insurance margins have been under pressure with low interest rates (now reversing) and the insurance cycle has turned following a period of elevated claims," he said. 

"The shares are cheap, and we are moving into a hardening cycle for premiums-claims inflation on the other hand should start to ease." 

Meanwhile, within financials, the ASX (ASX: ASX) may also be worthy of consideration, he said. 

"The shares have fallen sharply with recent staff turnover and delays with the CHESS replacement, but at the end of the day, it is a valuable monopoly that should be resilient in a downturn," Braitling said. 

Do you think we are likely to see another rotation into growth stocks over the coming year? Or has the market intrinsically changed now that rates are well beyond zero? If not, which signals are you looking out for to know when to pivot? 

While Liu expects we will see a rotation into growth stocks over the coming year, she warns it won't be "growth at any price". 

"The previous frenzy of buying any growth company is not going to return. It will really be buying growth at a reasonable valuation," she said. 

And while Liu is picking up discounted quality growth stocks right now, Braitling believes investors shouldn't buy growth until the bear cycle has "completed". 

"Mega-cap technology shares, which led the last cycle, are only just starting to come under pressure," he explained. 

"While there is value emerging in emerging growth companies, don’t buy these names until we get the full wash out in mega cap technology (the NASDAQ)." 

This is because retail investors' funds flowed into mega-cap technology names like Apple (NASDAQ: AAPL) and Tesla (NASDAQ: TSLA) in recent years and are yet to fully flow out. 

"When this money comes out and the shares of these bellwethers finally collapse, the low will be in and then you search through the wreckage for the next crop of emerging growth businesses," Braitling said. 

So what will cause this outflow from these trusty mega-cap names? Well, Braitling believes the catalyst will be weakness in the economy. 

"When I started looking at technology shares 20 years ago it was considered a highly cyclical sector," he said. 

"Investors have forgotten this because COVID-19 has pulled forward demand. But when CIOs start cutting budgets in a downturn and consumers start slashing services, investors will be reminded of just how cyclical this sector is. 

"This will be the final straw for technology investors and represent the bottom of this bear cycle." 

Cyclical or not, Liu believes that profitless growth stocks will continue to struggle. However, the only thing that could potentially save them is a fresh round of M&A early next year. 

"The most obvious M&A target is the REIT and the Property Trust sector," she said. 

"The premium property players, such as Dexus (ASX: DXS) or GPT Group (ASX: GPT), are not going to remain at such low discounts to their net asset values. We also see value in Ramsay - we think it looks incredibly cheap, given its premium asset holding, as well as its expected earnings growth over the next few years." 

Within the tech arena, Liu points to NEXTDC and Megaport (ASX: MP1) as potential targets - particularly the former, given its "infrastructure-like revenue stream". 

In terms of the recovery, Liu believes that growth stocks will likely lead - but not those within the consumer discretionary sector. 

"Healthcare is the first sector that we see doing well and it's already started doing very well," she said.  

"The next leg will be the other companies that have earnings resiliency that will continue to grow." 

After all, we are yet to witness earnings downgrades in aggregate (the Aussie market is lagging in terms of its earnings cycle compared to other markets) - and as such, Liu believes we won't see as severe a downturn. 

"However, as we head into Christmas, there will likely be significant discounts as retailers are holding a lot of inventory. And there could be further discounts on negative news," she said. 

"We could potentially see some pressure across consumer names for the first half at the February results season. But post that, earnings will rebase and we will probably see a clearer economic outlook from there." 

Want more content like this?

This is the third wire in a three-part series featuring Justin Braitling and Jun Bei Liu. In case you missed it, check out this piece on how to navigate bear market rallies or learn why these experts are expecting a further sell-off in this piece. 

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