A quality company that actually benefits from rising rates

For all the hubbub of inflation being the kryptonite of markets, very few of us realised that it would be rising rates that would really do the trick. 

Since the RBA announced it would be lifting the cash rate in May - the first time in more than 11 years - the S&P/ASX 200 has taken a wild ride south. In this time - the bourse's former darlings, its growth stocks, have wiped out most (if not all) of the gains they made over the past two years. 

And yet, when the yield on US 10 Year Treasuries peaked on June 14, markets changed their tune. The ASX 200 has lifted more than 6%, with many of these growth names supporting the benchmark on its leg higher. 

But Michael Maughan of Tyndall Asset Management warns investors to be wary. In fact, he believes there's still some pain for these high P/E names to go. 

Instead, he brings along one sector (and one stock) that he believes can truly benefit in this new environment, a quality name with a strong franchise, providing investors with some much-needed insurance when they need it most. 

Note: This interview was recorded on Wednesday 27th July 2022. You can watch the video or read an edited transcript below.

Edited Transcript 

Ally Selby: Hello, and welcome to Livewire Markets. I'm Ally Selby, and today we're very lucky to sit down with Michael Maughan of the Tyndall Australian Share Income Fund. Today, we're talking about interest rates and how that impacts valuations, but we'll also be talking about one exciting company that actually benefits in this new environment. Thank you so much for joining me today, Michael. It's a pleasure as always. 

First up, let's talk about interest rates, central banks around the world are lifting them. What does that mean for equities over the long and short term?

Michael Maughan: I think that rising rates are a good thing when you're coming from a stimulatory position to a neutral position. I think that's a positive. 

The cash rate is only 1.35%. It's not necessarily something to be worried about. Where it's had the most impact on markets is that it's been the trigger for a paradigm shift in terms of how we think about value in the market and who the leaders should be, and maybe how we value some of the higher growth stocks.

Ally Selby: The market's already talking about cash rate cuts next year. It's crazy to think that we're already talking about cuts. Do you think that these high P/E names or these highly geared names could rebound in that time or is there more pain on the horizon?

Michael Maughan: As I said before, we're going through this paradigm shift, so we need to work out what's normal. So, if we go back to when interest rates were very, very low, $1 of future cash flow was valued similarly to $1 of cash flow today. So, that meant that companies with profits way out in the future were valued more highly than maybe they should have been. 

If you think about the growth premium in the market, it went from 1.5 times to four times, partly accelerated by COVID. That really needs to reset, and we're nowhere near getting back to that base level.

Ally Selby: I'm really excited for this. You've brought along one sector today that you think can really handle interest rate rises. What is it?

Michael Maughan: Well, the classic beneficiaries are financials. And while, yes, the banks are benefiting with their net interest margins improving as deposit rates have increased slower than mortgage rates have, the bigger beneficiary is something like insurance. Insurance companies earn a return on the book of assets that is there to pay claims down the track. That's how insurance works. And so they're going to benefit from the increased returns on that book. So, we expect that they'll be massive beneficiaries of that at a time when the industry itself has been improving anyway. A lot more discipline has come to the market in terms of globally insurance companies pricing risk correctly and putting their premiums up as they should.

Ally Selby: You've taken us through a sector that looks promising in this rising rate environment. Is there a stock that you think looks particularly exciting within this new paradigm shift?

Michael Maughan: Yeah, as exciting as insurance can be, I think Suncorp (ASX: SUN) would be that name. If you think about it, they're selling the bank, so they're going to get pure exposure to those positive industry factors we talked about before.

Suncorp's proven to be the strongest franchise in terms of the way they have done reinsurance, premium increases and managed claims cost.

They're leading the market, so now with the bank being sold, you're getting more exposure to those positive factors and it's the quality name in our preferred sector.

Ally Selby: Suncorp is your number one pick in this rising rate environment. I hope you enjoyed that video as much as I did. If you did, remember to give it a like and subscribe to our YouTube channel. We're adding awesome new content every week.

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Michael and the team at Tyndall AM invest in income-generating stocks to put money in your pocket. To learn more, visit their website here.

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Tyndall Australian Share Income Fund

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