How to rotate your portfolio like a pro in 2022

COVID-19 was (and is) irrefutably a curse to the global society, but as it would turn out, it also became a blessing to many investors' portfolios. 

Who can forget the great rotation opportunities presented to investors over the past two years? For starters, there was the rotation into "stay at home" winners, with growth and tech stocks taking the lion's share of the world's investible dollars. 

Then, as we all know, the "reopening play" took centre stage, with many of the beaten-down stocks from the first few months of the pandemic enjoying their time in the spotlight. 

After that, there was a rotation into the "inflation beneficiaries" and a rotation out of tech. And now, what can only be described as genuine market panic, as investors rush to sell down stocks in anticipation of rising rates. 

So are rotation opportunities still alive and well in 2022, despite the volatility that we can only assume awaits? Our investing pros certainly think so (phew!). 

In this episode, Livewire's Ally Selby was joined by Elston Asset Management's Bruce Williams and Investors Mutual Limited's Simon Conn for a deeper look at their portfolio positioning over the year ahead. 

They'll share the sectors they are avoiding, the sectors they are overweight, and of course, a few stocks that have caught their attention as potential winners over the months to come. 

Note: This episode of Buy Hold Sell was shot on Wednesday 2nd February 2022. 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. 2022 has started off with a bang, but not in the way investors would've hoped. As many of you would know, the S&P/ASX 200 has slipped around 7% year to date, and with inflation abound and interest rates likely on the rise, we thought we'd invite two Aussie investing pros on the show to see how they are positioning their portfolios over the year ahead. Today, we are joined by Simon Conn from IML and Bruce Williams from Elston. 

Let's talk about COVID-19. It's the reason that we're filming from home today, but it also provided investors with plenty of opportunities to exploit mispriced sectors and stocks. Are those kinds of rotation opportunities available to investors in 2022 or are we more likely to see volatility and weakness from the ASX this year? Bruce, I might start with you.

Bruce Williams: I think we definitely will. We've got a lot of COVID-induced factors yet to play out. If you think about fiscal and monetary stimulus, if you think about consumer spending habits, if you think about the way we work, all these things, as COVID rolls through, have got to unwind. I think it will probably lead to a pretty volatile period and change the expectations for not only companies but what we pay for them as well.

Ally Selby: Over to you, Simon. Are there any rotation opportunities that are alive and well in 2022 or are you expecting volatility like Bruce?

Simon Conn: I think we're going to see quite a bit of volatility this year. 

I think January's been a precursor to what we shall see through the year. 

The most dominant factor on the share market has been the ultra-low interest rates that have been forced on the world by the US Federal Reserve and been copied by many of the banks around the world. As that ultra-low interest rate environment unwinds, and I think clearly the Fed in the US has signalled that, saying that inflation's not transitory. We'll see bond rates move up as they did quite strongly in January. And that will lead to a big valuation adjustment, particularly in those stocks that are high growth that a lot of investors have bid to valuations that just don't make sense for us. 

Ally Selby: Staying with you, Simon, I'd love to know, are you holding more or less cash than this time last year?

Simon Conn: Cash levels are about the same as this time last year, Ally, with a couple of per cent in cash, but we do have quite a lot of stocks under takeover. We've got about 7% and 9% of the fund subject to takeover. Companies like AusNet, API, Senex Energy, and Z Energy, which will turn into cash over the next six to eight weeks. That gives us quite a lot of firepower to reinvest into those stocks that we think still represent good value. And I can talk about those a bit later.

Ally Selby: Same question to you, Bruce. Do you have more or less cash in your portfolio than this time last year?

Bruce Williams: We have more, Ally. We recently got taken out of Sydney airports and we're yet to redeploy. Because of the environment we're in, the volatility, the unknown earnings season that we're going into, we thought we'd take the opportunity during that period to redeploy. We've got quite a few companies that we do like that we are just waiting for the opportunity to purchase.

Ally Selby: Bruce, staying with you. Is there a sector that you are avoiding or rotating out of in 2022?

Bruce Williams: If I was to choose one, it would be consumer discretionary, particularly retail. They've had a period of unbelievable demand because we'd had no other choice. We couldn't go out to dinner. We couldn't go on holiday. We couldn't do all those sorts of things that we're used to. In our view, it meant these companies are actually over-earning. As that rolls off, we think that consumers will spend more money on services as opposed to goods. And it's really difficult to work out what underlying demand will be going forward. You could potentially see that they've had earnings or they've had sales pulled forward into that COVID period. 

Ally Selby: What would make you re-enter the consumer discretionary sector or the retailers?

Bruce Williams: I think once we've got a feel for what normal sales look like and the growth rate of those sales. For us, it always just comes down to whether the valuation stacks up and we've got a margin for safety built-in there.

Ally Selby: Over to you, Simon. Is there a sector that you are avoiding in 2022?

Simon Conn: Like Bruce was saying, we've been very cautious on the consumer discretionary sector, especially the retail sector in particular. 

It was a perfect storm for them over the last 18 months with consumers locked at home, no overseas travel, and the JobKeeper stimulus providing effective wage increase for some people. 

Particularly omnichannel, pure online players, which we've been very cautious of. And those stocks, despite the pullback, we think still look pretty full. So we're pretty cautious on the retail sector. Margins look a bit inflated again and the valuations don't reflect more normal underlying running conditions for a lot of the companies in that sector.

Ally Selby: What would have to happen for you to start buying up retailers again?

Simon Conn: I think it comes down to a stock by stock basis. There are stocks such as Best & Less (ASX: BST) and Myer (ASX: MYR) in the discretionary sector where the valuations look very cheap - both stocks have been impacted by the shutdowns and lockdowns, having had stores closed and their margins haven't been artificially inflated by what's happened. So we think both those businesses on PEs of less than 11 and six times in Myer's case are good opportunities. We think the omnichannel way is a much better way to play the growing trend to online. The pure online players for us are pretty low margin businesses, really having to pay a lot of their margin away to Google to drive volume to their websites. So that's a sector we are very cautious of. 

Ally Selby: Staying with you, Simon. Looking at your portfolio, which sectors are you overweight right now?

Simon Conn: There are two sectors that we like - the consumer staple sector and the communications and telcos sector. Both have got fairly resilient demand. They're able to have some pricing power and particularly, the telcos are not subject to big cost of goods sold increases. And stocks in that sector look attractively priced for our money.

Ally Selby: What would have to happen for you to take money out of those sectors?

Simon Conn: It's a stock by stock situation. If the valuations were extreme, obviously, we would cycle out or move out of those sectors. But at the moment, we're finding good value in the consumer staples and in the media sector and the telco sector as well.

Ally Selby: Is there a consumer staples and a telco/communications player that you think could be a winner in 2022?

Simon Conn: We particularly like Bega (ASX: BGA) in the consumer staples sector. We really like the Lion Dairy acquisition. That's been something that's really enhanced the transition that business is making to a more branded consumer staples business. That generates a much higher margin, really driving the business away from their more commodity-based routes. The business is trading at about 19 times and an EBITDA multiple of eight times, which is a discount to international peers. Obviously, it's been impacted by COVID in the last six months, but as those unwind, the business has some pricing power and we think it's really well placed going forward.

In the telco sector, we really like TPG Telecom (ASX: TPG). It's the number three player. It's a fully integrated telecommunications business that has been impacted by COVID with the lack of roaming as people haven't been travelling and overseas arrivals haven't been coming to the country. But the merger between Vodafone and TPG really brings together and creates a real third force in the telecommunications market. So it's cost out opportunities, there's the fixed wireless opportunity, which we think can grow their earnings going forward. It's trading on about 13 times cash adjusted EPS, generally pays a good dividend, really good management team, and it's a business that just looks very, very cheap and under-owned for us.

And then one other thing we really like about it is the opportunity to crystallise the asset base they have. Telstra (ASX: TLS) just sold their towers business for 28 times EBITDA. TPG trades at eight times and they have a similar asset base, which they could then sell and stake in to crystallise some value and pay down debt and accelerate the increase in dividends.

Ally Selby: Okay. Over to you, Bruce. Which two sectors are you overweight in 2022 and why?

Bruce Williams: At the moment, Ally, we're certainly overweight energy. We think with the energy transition dominating headlines, there's been a real focus on the reduction in long-term demand for your traditional energy companies. But we think a more immediate issue for them is a lack of supply. Going back three or four years, we have very low prices that led to a real underinvestment in terms of CAPEX and sometimes, OPEX as well. Basically, there is a supply shortfall given the energy needs of the country. We think they will be sensible going forward in terms of how they spend their money. We think they'll run them very lean. 

The commodity price that drives them is very good, so excellent cash generation. And we think on undemanding multiples it's a really good spot to be at the moment. They also traditionally provide a bit of an inflation hedge, which we don't mind also.

Ally Selby: Is there a second sector that you're overweight in your portfolio at the moment?

Bruce Williams: We're not overweight at the moment, but certainly, it's something we're focused very heavily on and that's healthcare. Over the last couple of years, it really hasn't been the place to be from a price perspective. They haven't really changed over that period, whether it be COVID impacts, whether it be their defensive nature, or whether it be maybe a reasonably high multiple that they've since grown into. But certainly, that's an area we're really focused on at the moment.

Ally Selby: What would make you take money off the table in those energy and healthcare sectors?

Bruce Williams: I think it's the same that made me put the money in the first place. For us, it comes down to a reasonable rate of return, given the style of the company and that we are getting rewarded for taking on the risk.

Ally Selby: Are there two stocks within those two sectors that you're really liking at the moment that you think can outperform in 2022?

Bruce Williams: From an energy perspective, we very much like Santos (ASX: STO). It's got a lot of opportunities in front of it. They've been very disciplined and organised with how they go about it. They are reasonably low-risk opportunities. Obviously, the underlying price for oil and gas is very supportive. Lots of free cash generation. Post their merger with Oil Search, they're looking at getting rid of non-core operations and also palming down some assets. So the balance sheet is really strong as well. We think it's a great place to be at the moment.

In terms of healthcare, I'll have to put a caveat on this, we do like Ramsay Health Care (ASX: RHC). We think it's going to have a poor half-year coming up. Obviously, with elective surgery deferrals - I think they just reinstated them in New South Wales this week - we think that really does knock them around. But going forward, all these deferrals, that requirement isn't gone. All it does is firm up your future demands. So we think they'll operate at very high utilisation rates going forward. We also think waiting lists, particularly in the public system, and this is not just domestically, this is overseas as well, we think the waiting list is a real political problem. They'll start pushing public patients through private hospitals. They do have growth options as well, whether it be through procurement or brownfields developments. Given its growth opportunity over the longer term, we do think the valuation at the moment stacks up quite nicely.

Ally Selby: Well, that's all we have time for today, we hope you enjoyed that episode of Buy Hold Sell. I'd love to know what stocks you're backing for the year ahead, let us know in the comments section below. And if you haven't already, subscribe to our YouTube channel. We're adding new content every week.

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