“Fascinating and alarming” trends (and 2 high conviction stock picks)

A combination of macro and geopolitical influences and company-led performance dominated our recent discussion with Australian equity investors from Solaris Investment Management and Firetrail Investments.

We asked their key decision makers – Firetrail’s Patrick Hodgens and Solaris’ Michael Bell – to review market performance in the year so far, but also their outlook from here.

On the macro front, we asked them to name the biggest risk on the horizon and how they’re positioned for this. They also delved into their portfolios to each discuss one of their highest conviction stock holdings. Here’s what they had to say.

What was the market standout in the first half of 2024, and what are you watching most closely from here?

Zeroing in on Australian equities, the teams at Solaris Investment Management and Firetrail Investment emphasise two distinct trends they’ve observed in 2024 so far.

Firetrail Managing Director and Portfolio Manager Patrick Hodgens highlighted the tipping point we saw for Australian consumers, as elevated interest rates started to bite.

“But it’s not one size fits all. There is a widening divergence in spending patterns between younger, lower socioeconomic consumers – who are suffering from rising mortgage and rental costs – and older, wealthier consumers with plenty of cash in the bank enjoying the highest interest rates we’ve seen in over a decade,” he said.

Hodgens expects this trend to continue while rates stay high.

A "remarkable re-rating"

At Solaris, CIO and Portfolio Manager Michael Bell pointed to the “remarkable re-rating” of price-to-earnings ratios, especially across companies within the banking, retail, real estate and software industries.

“Traditionally, earnings and share prices for companies are closely correlated, but this principle has seen a notable breakdown in these sectors recently,” Bell said.

“While the performance of the software sector aligns with trends in global indices, the performance of banks, retail, and REITs is both fascinating and alarming.”

He noted large-cap companies’ dominance across these sectors, calling out the examples of the big 4 banks, Goodman Group (ASX: GMG) and Wesfarmers (ASX: WES) – which have grown PEs by 29.4%, 68% and 36% respectively.

“Interestingly, only Goodman Group has seen an increase in earnings expectations, up by 4.0%, over the past eight months,” Bell said.

Looking forward, he suggested some key drivers of this include a shift away from China, moves by large Australian industry super funds. “This indiscriminate buying is likely to end, but it remains a critical trend to watch over the next 6-12 months.”

Hodgens is watching Australian small-cap stocks, where he still sees “extremely compelling value today.”

“Over the next two to three years, I believe the selective investor in Australian small caps will generate very strong returns,” Hodgens said.

What is the biggest risk ahead – and how are you prepared?

For Firetrail, Australian banks are one area of the local market on which Hodgens and his team remain wary.

“There are significant risks to earnings over the coming years, with competition elevated and costs inflating,” he said.

“The market is factoring in a very benign outlook for bad debts, despite significantly higher interest rates and elevated household debt. At the same time, the banks are trading at the top of their historical valuation ranges.”

This view is reflected in Firetrail’s portfolio, which is “materially underweight” banks, preferring insurers such as Suncorp and QBE for its financial sector exposure.

In a broader sense, it’s the continued outlook for tough macroeconomic and geopolitical conditions that pose the biggest risk in the eyes of the Solaris team.

“We strive to ensure that the majority of risk and return in client portfolios originates from the companies we hold, rather than from large sector or macroeconomic positions,” said Bell.

What is one high conviction holding in your fund?

The two asset managers named very distinct companies in response to this question – one a US-based tech firm that listed just five years ago, the other a global healthcare conglomerate that listed on the ASX in 1994.

Life360 (ASX: 360)

Bell is confident the location services company has substantial earnings growth ahead, emphasising its recent shakeup of its advertising platform for free users of the app. “Combined with expansion into Europe and beyond, Life360 is set for substantial growth in earnings,” he said.

Bell also highlighted the firms other strong credentials including:

• Ranking among the top 5 social networking apps on iOS
• 66 million monthly active users, only 5% of which currently generate revenue.

“Despite doubling its subscription prices in the USA with minimal churn on both iOS and Android devices, its market capitalisation remains under $4B. Life360's "Land and Expand" strategy offers free features that attract users, who can later be converted to paying customers,” Bell said.

Managed Fund

Solaris Australian Equity Long Short Fund

Australian Shares

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Managed Fund

Solaris Core Australian Equity Fund (Performance Alignment)

Australian Shares

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CSL Limited (ASX: CSL)

Firetrail’s Hodgens believes now represents a rare opportunity to buy CSL at a discounted price.

“We see 50% upside which is very rare for such a large, liquid, defensive stock,” he said, with a view the market is overly focused on its most recent acquisition of specialty pharmaceuticals business Vifor. Conceding this “has not proven to be a great acquisition so far,” Hodgens emphasised this is only a small part of the overall business.

In contrast, he reminded investors that CSL’s plasma business, CSL Behring, accounts for 70% of group revenue. “We estimate this division can grow revenues at double-digits for the next three years, supported by the return of immunoglobulin supply and the launch of new products,” Hodgens said.

He also noted that gross margins from this core business are yet to fully recover from the COVID downturn, with the downward pressure tighter economic conditions since then have placed on plasma donor fees.

“We estimate gross margins can return to pre-COVID levels over the next four years, driven by lower donor fees and other internal initiatives,” Hodgens said, anticipating earnings growth of 20% a year over the next few years.

Managed Fund

Firetrail Australian Small Companies Fund

Australian Shares

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Managed Fund

Firetrail Australian High Conviction Fund

Australian Shares

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Attend the 2024 Pinnacle Investment Summit

If you’re a financial adviser or qualify as a wholesale investor, you can hear more from Michael Bell and Patrick Hodgens at the 2024 Pinnacle Investment Summit in Sydney on Wednesday July 24 and also receive CPD points for your attendance. Register to attend and see full event details here

You can also register to attend the Summit in other major cities across the country here: