2 stocks facing headwinds (and the themes fundies are shorting in 2023)

Following the GFC, the world embarked upon a monetary policy experiment the likes of which had never been seen before.

Having read the history books and being aware of the economic and financial malaise that lingered for decades post the Great Depression, like a bout of long-COVID, central bankers were desperate to ensure it didn’t happen again.

So they pumped the system full of liquidity. Quantitative easing, loose balance sheets, low interest rates, you name it, they did it. Then, when the pandemic hit, they pumped even more liquidity and this time even governments got involved.

Well, the experiment is now well and truly over. Inflation has soared, recessions are imminent, and some of the distortions of all that liquidity are being reflected in the stock market. The tide is going out, and we’re going to find out just who has been swimming naked.

In that vein, Livewire’s Ally Selby sat down with the two Seans – Sean Fenton and Sean Roger – to discuss the long and short of it all, literally.

Fenton and Roger talk about hunting for shorts in the current environment, whether rate hikes are behind us and some stocks they like, both longs and shorts. 

Note: This episode was filmed on Wednesday 17 May 2023. You can watch the video, listen to the podcast or read an edited transcript below. 

Edited Transcript 

Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby and today we are very lucky to be joined by two long-short managers for their analysis of the ASX. Plus, we'll also be discussing some of the themes the market (and these fund managers themselves) are short right now. To do that, we're joined by Sean Fenton from Sage Capital and Sean Roger from Perpetual Asset Management. Two Seans today. I might mess it up, but hopefully, I don't.

It's been a volatile few years. Has the end of the era of cheap and easy money made it a really easy period to make money from shorts? I might start with you, Sean.

Today's market is a fertile hunting ground for short sellers

Sean Fenton: It's certainly an interesting period. We always look at longs and shorts in terms of relative opportunities. So what we look for in markets is things moving around a lot and changing. They're the market environments we like. Both shorting and being long on the other side works well, and what we've been through recently with COVID and lockdowns and big swings and money being thrown in and recoveries and inflation, recession, there's a lot of things moving around. There have been some great opportunities. There's been new trends and things changing. So I think it's generally been a good environment for active investing and we see that being maintained for a little while.

Ally Selby: Okay, over to you, Sean Roger. What do you think? Has it been a fertile hunting ground for short sellers right now?

Sean Roger: Absolutely, from our perspective. I think there was a large group of companies over the past few years whose success has really been built on a blue-sky narrative and that access to that free capital. And with interest rates increasing so quickly, a lot of those companies have had to pivot towards cash flow generation and profitability, which has inevitably brought down their growth.

Another aspect that we found a little challenging during the period of free money was the market de-emphasised fundamentals and earnings quality, which are two key parts of our process, and now with interest rates at more normalised levels, we can go into a short with more confidence that if a company misses earnings expectations or has pulled some earnings levers to hit that result that the shares will most likely fall.

Is the worst over for investors? The Seans don't think so...

Ally Selby: Okay. I want to move on to the bigger picture now. The RBA and the Fed have just hiked rates once again. Many are hoping that's the end of the rate hiking cycle for now. Do you think the worst is over?

Sean Roger: One thing I've learnt over the past few years is that it's good to keep an open mind with the macro and things can change very quickly. But in this circumstance, I think that there is still a bit more pain. Whilst I think we're towards the end of the rate hiking cycle, I think to see interest rates come back down at all, we're going to need to see a significant deterioration in the economy or a big increase in unemployment and at the moment, we're just not seeing that. So I think to get relief from rates, there is going to be a bit more pain, unfortunately for the consumer.

Ally Selby: Over to you, Sean. Do you feel like there are storm clouds on the horizon?

Sean Fenton: I think so. We might be near the end of the rate hiking cycle, but we haven't felt the pain yet. And the pain's definitely still to come. The sort of inflation we've got at the moment, it's different than what we've seen really since back in the '70s and '80s in that it's a lot more driven by tight labour markets and cost-push and feedback and historically you do need pain, you need higher unemployment to really fix that. So either that's going to happen or rates need to keep moving higher until we get there.

So we're getting towards the end game but we haven't seen the pain. Markets are at record highs, employment's full, and people are still spending. There are definitely a lot of early warning signs out there, but whether it's the second half of this year or into next year, we do see dark clouds gathering on the horizon.

A deep dive on consumer discretionary and tech 

Ally Selby: Let's go a little bit into some sectors now. Consumer discretionary and tech have been some of the most shorted sectors and stocks on the ASX for quite some time now. Why do you think that is and what are your thoughts on those sectors?

Sean Fenton: I think consumer discretionary is very much the Amazon effect. It's been in place for a while - ever since Amazon launched in Australia. They were always going to decimate the retail space and destroy margins and they've certainly gained some traction, but it hasn't really followed through. So a lot of those shorts in companies like JB Hi-Fi (ASX: JBH) and Harvey Norman (ASX: HVN) and the like, I think, are a bit of a residual from that broad global macro thematic of online sales and penetration, and Australia's a pretty small market. Those players have adapted and have their own omnichannel offerings. 

We are not into that short thesis and over the years we've seen some good opportunities to be long there. We're a bit cautious on consumer discretionary more because we see those storm clouds gathering and the risk of a consumer slowdown. 

And certainly, as Sean mentioned before, for a lot of tech companies there are big short interests because there's been a lot of make-believe business models and massive valuations without the actual profitability and cash flow to back them up. And a lot of those businesses have pulled back quite dramatically in the last year or so.

Ally Selby: What are your views on tech and consumer discretionary? A lot of those names actually have rebounded since the beginning of the year. I feel like it would have been painful for some short sellers. What's Perpetual's view on those sectors?

Sean Roger: I think that the tech sector obviously has had a very turbulent few years and I think at the bigger end of town the companies that still demand those high valuations have performed really well operationally. So I think any short angle there at the moment on something like a WiseTech (ASX: WTC) is largely valuation only. 

At the smaller end of town, you have seen some really big share price falls - down 70% to 80% and still with big short interests. And from our perspective, they can be quite risky shorts because you only need a little bit of good news or even just less bad news for those stocks to squeeze high. For example, recently Megaport (ASX: MP1) lifted 40% with their quarterly and even Life360 (ASX: 360) a couple of days ago is evidence of that.

On the consumer side, I think I agree with Sean's point around the Amazon thesis, but also more recently, there is a lot of concern about what happens to earnings in FY24. You're going to see a pullback in demand with COVID unwind and these pressures on the cost of living. But also from a cost perspective, you've got a big lag in rent increases coming through with CPI, and also just with wage growth where it is. So there are going to be some large earning declines, especially for some of the retailers.

Our view is that's probably captured in consensus expectations at the moment and especially in valuations, they're quite depressed as well. So we don't see significant downside from a share price perspective, but the outlook for the short term is uncertain.

Long-term opportunities: General insurers and healthcare 

Ally Selby: Where are you finding opportunities right now? Can you take us through some of your long positions?

Sean Roger: One sector to us that looks really interesting at the moment is general insurance in Australia. It's been a really challenging couple of years for the sector with elevated claims inflation, especially in motor and with a lot of natural hazard events. We're three years into a La Niña cycle and they typically have severe weather events for insurers. We think the sector's quite attractive, the structure there with IAG (ASX: IAG) and Suncorp (ASX: SUN). We think they've got really good pricing power, which you've started to see come through over the past six to 12 months with some of those strong rate increases.

So our view would be that as weather normalises, and we think it will at some stage, the outlook's quite nice for the insurers. We should see some margin expansion and some capital returns. My pick within the sector would be Suncorp at the moment. I think there's probably some uncertainty in the short term around whether or not the bank sale completes, but we think it looks really cheap even in the scenario that the bank sale doesn't go through.

Ally Selby: Okay. Over to you Sean. Where are you finding opportunities right now? Is there a stock pick that you want to call out?

Sean Fenton: We generally look for areas that have strong industry structures, so we actually like general insurance as well. Even cyclical areas where there are duopoly structures and pricing power, so airlines, for example. 

But going into a period of economic uncertainty, healthcare for us is always an area that's quite resilient - particularly if you can find stocks that have good long-term growth and even recovering from some COVID effects. CSL Limited (ASX: CSL) ticks the box for us. It's one of Australia's largest, most successful companies, so I don't think there's a lot of great insight there. 

They certainly were impacted by COVID with the collection centres being shut down, that takes a little while to move through the pipeline, so that's recovering now. Donor fees in the US are coming down, some margins are recovering. They've got a great pipeline of new product development coming through and they continue to deliver strong earnings growth. And it is actually trading at a multiple below its historic average. So we see it as a pretty good place just to sit there on the long side and get some steady growth.

2 themes and stocks facing headwinds

Ally Selby: How about the short side? Where are you finding shorting opportunities right now?

Sean Fenton: There's always a range of shorting opportunities across the board. One area that we've been looking at that concerns us a bit is China, where there's a lot of hope around COVID reopening and recovery, but what we're actually seeing is quite a lacklustre rebound and a bit of weakness coming through. 

In particular, the steel sector. We see a bit of risk from what happened last year. You'll recall their property development sector really crashed as credit was tightened and that's created some dynamics where new floor space sold really under pressure. There's some work going on to finish buildings, but China's now buying established apartments rather than taking the risk of buying a new one from a developer.

So we see a big hole actually coming through there for demand later on in the year and next year. A weaker global manufacturing environment. So we see downside risk for iron ore and something like Fortescue Metals Group (ASX: FMG), which is very much a pure iron ore play despite the hydrogen angle, has exposure there in terms of disappointment and weakness coming through in China, property and manufacturing.

Ally Selby: Okay. Over to you Sean, where are you finding shorting opportunities right now and can you take us through an example?

Sean Roger: You hear the term expensive defensives thrown around a lot. So I'm going to tweak that slightly and call it perceived defensives. Basically, with the uncertainty in the economy at the moment, you're seeing investors flock to companies with defensive earning streams and you're seeing that reflected in premium valuations. What we're looking for is companies where the market perceives the earnings to be defensive, but our view is that they're less defensive than what the market expects.

And I think in aggregate, as we move further through the cycle and you see demand start to soften, it's going to be harder and harder for some companies to pass through pricing. So we think there are some really good opportunities out there. 

One recent example of where this has played out is Amcor (ASX: AMC). They were very successful early on with cost of goods inflation, passing that through to their customers. But over the past six months with volumes declining and turning negative, they haven't been able to have the same success passing that price, and you've seen that play out in their margins. They obviously had some extra pressure with their balance sheet having a bit of debt and the extra interest costs. So that's one example that's probably almost played out now, but we think there are some other ones out there that we can take advantage of.

Ally Selby: Okay. Well, I hope you enjoyed that episode as much as I did. If you did, why not give it a like? Remember to subscribe to our YouTube channel. We're adding so much great content every single week.