2 contrarian predictions (and the stocks to play them)

The first half of 2022 has been marked by a surge in safe-haven buying (namely, bonds and the US Dollar Index) at the expense of growth stocks. If you need any proof of how far that part of the market has fallen, just consider that EML Payments (ASX: EML) is down more than 50% this year, while Zip (ASX: ZIP) is down more than 77%... So far.

It doesn't help that the Reserve Bank of Australia raised the cash rate for the first time in 10 years earlier this month - and has flagged more hikes will be needed if it wants to bring inflation back into its target band. The Federal Reserve is also facing the same quandary - and all in all, that's making investors nervous. 

So is now the time to dip your toe in and buy quality stocks at bargain prices? Or could there be more pain at the trading desk if you decide instead to follow the crowd to cyclicals? 

We examine those themes and more in this thematic episode of Buy Hold Sell. Livewire's Ally Selby was joined by TMS Capital's Ben Clark and Tribeca Investment Partners' Jun Bei Liu to discuss two contrarian calls for the remainder of 2022 and the stocks they are buying to play them. 

Note: This episode of Buy Hold Sell was shot on Wednesday 11th May 2022. You can watch the video, read an edited transcript or listen to the podcast below.

Edited Transcript 

Ally Selby: Hey, how're you doing? And welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and with bond yields going through the roof in 2022, serious money has flowed in one direction (away from growth stocks). So what's the market missing? Well, to find out, we're joined by Jun Bei Liu from Tribeca and Ben Clark from TMS Capital for two contrarian predictions for the year ahead. 

We're only in May, and this year has been an absolute whirlwind. The RBA has just raised rates for the first time in a long time. Ben, I might start with you. How has your portfolio positioning changed compared to this time last year?

Ben Clark: Look, to be honest, it hasn't changed a great deal, Ally, which I know is boring. But we are big believers that if you own good businesses, you want to try and stick with them, particularly through these really erratic cycles and not try and chase the latest trends in the market. 

We think a normalisation of rates is a really healthy thing. There's been so much hysteria around it, but you have to remember, we're only at 0.35%, and rates were at 2% before COVID hit. And the economy's growing faster now than it was then. 

This is normal and good and probably should have happened some time ago. You want to still stick to your knitting and stick to the businesses you believe in.

Ally Selby: Ben's sticking to his guns. Jun Bei, has your portfolio changed at all over the past year?

Jun Bei Liu: Over the past 12 months, we have increased our exposure towards the stocks that will benefit from high interest rates, as well as inflation. However, I absolutely agree with Ben, that a quality company is a good quality company. 

The current market volatility just creates an enormous amount of opportunity for you to take advantage of sharp and quick sell-offs. Our portfolio has been gradually moving towards more healthcare; some of the structural growth leaders. But remember, these companies have delivered growth for decades and they will continue to do so for the next few decades. 

These companies are a really good opportunity for really investors to put into their portfolios. Which is what we have been doing over the last few months. 

Ally Selby: Which parts of the market are looking a bit crowded right now? And are you avoiding those sections of the market, or is this the kind of market environment where you should be following the crowd?

Jun Bei Liu: I think following the crowd is quite dangerous in any market condition, really. Following the crowd simply means, that if you are buying those companies, you're paying a big price for those businesses, even though they may look like they are trading on a small multiple. Remember, some of the companies at the moment that are currently quite hot are cyclical businesses. So that means their earnings can fall. They're not structural growth companies. 

Be very mindful of that and take profit - bank them and then take advantage of other companies that are currently out of favour.

Ally Selby: Over to you. Ben, which sectors of the market are looking crowded, in your opinion, right now?

Ben Clark: A couple of weeks ago, I would have probably singled out resources, but that's now had a pretty decent correction itself. 

AREITs are an interesting one. It's an area that's held up really well in our market, despite what are emerging headwinds to these businesses. 

We should see debt costs for a lot of the REITs will start to lift. I struggle to see commercial property prices continuing to rise in the environment that we are moving into. And the yields, which kind of look attractive today versus where cash rates are today, that gap's going to close really rapidly because rents aren't tied to inflation or anything like that. So that's probably an area that, to me, feels like it's been a safe haven and people have been happy to retreat there, but it might be a bit of a crowded trade.

Ally Selby: Jun Bei touched on it before. We've seen this massive sell-off in growth stocks. Are there any quality names that have been caught up in that sell-off that you've been buying recently?

Ben Clark: There's been quite a few, Ally. To me the safe area at the moment, just while you're trying to assess where bond yields do top out or where the terminal interest rate plays to is probably the more mature growth stocks that you want to look at, where you've got a lot of certainty around the earnings. Seek (ASX: SEK) might be a business that I'd single out there and the multiple compression isn't going to be too violent from this stage. 

You still want to avoid businesses that need the share market to fund their future growth. That is not where you want to be at the moment.

Ally Selby: Jun Bei, you talked a little bit about those healthcare growth stocks that you've been buying. Could you share some of the names with us?

Jun Bei Liu: Absolutely. So CSL (ASX: CSL) is an easy one. Its share price has been hit early in this calendar year on the basis that everyone else was buying resources and BHP became such a big part of the index. Its earnings were hurt by the pandemic, simply because the blood collection was quite tough over the last few years. Now in its most recent update, CSL actually talked to that - it's actually picking up quite quickly, which means earnings will grow quite significantly after that short term disruption. So to me, that business is trading on a very reasonable multiple for the growth it is going to deliver, and very similarly, the company is fully funded, generating really great cash flow. It's really helping you to future-proof your portfolio.

The bond yield, whether it's peaked now or whether it's in a month's time or whether it's further down the track, it doesn't really matter. This is a quality growth company. Soon the market will come back to those companies and realise that everywhere else growth is going to be hard to deliver. 

Ally Selby: Okay. I'm really excited about this. We asked our guests to come along with one contrarian prediction for the year ahead. Jun Bei, what do you have for us today?

Jun Bei Liu: My contrarian prediction is the market is going higher from here, especially the Australian equity market. Yes, we are going through a bit of volatility, worrying about high-interest rates. But it's now been priced into expectations, and the bond market will soon be stabilising, as we talked to before. 

The bond market is probably overshooting at this point. So that means equity markets are going higher. 

Corporate earnings will grow double digits and then we've got dividend yield pretty high, almost hitting 5% fully franked, including buybacks. So that creates a pretty good environment for equity returns over the next 12 months.

Ally Selby: Is there one stock that you think can really play the rising ASX market then?

Jun Bei Liu: There are many stocks. I think the one that you would buy is in healthcare, like CSL (ASX: CSL), which has been a laggard compared to the rest of the market, like resources and the financials.

Ally Selby: Okay. Over to you, Ben. What's your one contrarian prediction for the remainder of 2022?

Ben Clark: It's not so contrarian now because Jun Bei just singled it out as well. But I think the bond market has overshot itself, particularly locally. 

I really struggle to see the RBA pulling off 13 to 14 interest rate rises in this cycle, which is what the bond market has priced in. It would kill inflation. It would also do a lot of damage to the economy, and after several years of trying to protect the economy and nurse it through this pandemic, I really struggle to see them rising that aggressively.

I also think Jerome Powell and the Fed are talking up a big game. And I think if push came to shove, he would step back - if you saw some really nasty volatility in US equities and markets. A big part of the inflation issue is not going to be solved through interest rate rises. It's going to be through a normalisation of life after the pandemic. So I think bond markets, everyone's looking at it on a day-to-day basis. We all know rates are going higher. We all know inflation is an issue at the moment. But that is priced in. And markets often do what you least expect them to. So that for me is that we actually see bond yields come off, and we see parts of the market that have been hit by that start to move again.

Ally Selby: Okay. So with bond yields falling. Is there one stock that you're backing for the rest of this year?

Ben Clark: Well, I'm going to say Xero (ASX: XRO) on the back of that, I think where you want to look is good quality businesses again. Xero hasn't actually had an ASX announcement this year, but the share price has nearly halved. Its result is imminent. Most fundies would regard it as one of the highest quality businesses on the exchange. But it's been very expensive, and it's just got significantly cheaper. On face value, it still looks expensive, mainly because they pump about 80% of their revenue back into investment. That's the business that is at the tipping point of the overshoot that I'm talking about, that could run hard if we start to see that play out.

Ally Selby: Okay. Well, I hope you enjoyed that little bit of crystal ball gazing today. If you enjoyed that episode of Buy Hold Sell, why not give it a like? And remember to subscribe to our YouTube channel. We have so much great content coming over the next few weeks.