Romano Sala Tenna: 3 sectors (and 11 stocks) to outperform right now

Romano Sala Tenna, portfolio manager of the Katana Australian Equity Fund, is currently sitting on a lot of cash. And while he usually holds anywhere between 55 to 65 stocks in the portfolio, he currently is sitting on just 42 - the tightest it's been in more than a decade. 

Why? Well, like many investors out there (and possibly even you), Sala Tenna is feeling particularly cautious on the market right now. After all, there seems to be an infinite number of headwinds plaguing the market. And, unfortunately, the Fed is definitely not coming to the market's rescue this time. 

But that doesn't mean you can't generate alpha in this market. According to Sala Tenna, there are three sectors that can help investors outperform while the rest of the market pivots towards defensives. 

In case you were wondering, Sala Tenna does indeed know a thing or two about alpha. He's generated staggering outperformance from the All Ords Index since the fund's inception in December 2005 (7.24% annual outperformance net of fees).

In this interview, Sala Tenna shares why he is feeling bearish right now, how much of the pain anticipated by the market has already been priced in, as well as 11 stocks to play his three favourite themes. 

Plus, for those investors who are feeling a little more bullish right now, he shares three investment ideas (and four stocks) that could outperform when the market turns. 

Note: This interview was shot on Tuesday 20th September 2022. You can watch the video or read a written summary below. 

Managed Fund

Katana Australian Equity Fund

Australian Shares

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It's time to be bearish 

The Katana Australian Equity Fund can hold up to 80% cash in the portfolio, however, it typically has anywhere between 15-35% of its investible assets on the sidelines. Right now, it's sitting at 34% cash. 

It may also interest you to learn that the fund usually holds somewhere between 55 to 65 stocks throughout the cycle. At the moment, it is only invested in 42. 

"This is the tightest portfolio we've had in over a decade. It's difficult for us to find sectors or thematics that we like," Sala Tenna said. 

That's because, like many investors, he's cautious on the outlook for the Aussie market. Why? Well, there's a plethora of reasons. Think China's property market woes, as well as its continued COVID lockdowns, as well as fresh quantitative tightening out of the US, which is yet to flow through to markets. 

And, of course, there are those stubbornly rising rates that have caused valuations around the globe to plummet. 

"People have to understand that we are in a structurally different moment now compared to the last decade or so," Sala Tenna said. 

After all, during that time, the market was blessed with a "Fed Put". This means there was "no cost or no pain to Main Street" if the central bank stepped in with fresh accommodative policies to buoy markets. 

"If Wall Street comes up against Main Street, Main Street is going to win every day of the week," Sala Tenna explained.  

"The voters are going to determine governments and governments determine policy."

Think back to the "taper tantrum" of late 2018, when the Fed moved to tighten and was met by a wave of backlash from Wall Street. Soon after, the Fed promised to stop raising rates, and around eight months later, the cash rate started on its trajectory south. 

"That's not going to happen again. At that time, in 2018, there was no cost to Main Street. Inflation wasn't out of control (and inflation is the number one determinant of living standards and it hits lower and middle-class earners more than anyone else)," Sala Tenna said.  

"Now the Fed can't blink. Now the Fed has to follow through. The Fed will follow through, or central banks globally will follow through and they'll go too far in the wrong direction." 

How much of this has already been priced in by the market? 

As you may have cottoned on from many of the articles on this website, right now the market is incredibly bearish - meaning that there is a record level of consensus positioning in preparation for future drawdowns in markets. 

"From what we are seeing, almost every single person that we are in contact with has positioned for the market rolling over the next few months. And so if people have already positioned for that, then who's left to be that nervous seller?" Sala Tenna asked. 

"You'll get some forced selling, of course, but that means a lot of people are positioned [for a further fall in markets].

For example, a few weeks ago, the market "had a record put-to-call ratio", he said. 

"The ASX put-to-call ratio was 8:1, which is the highest in 20 years. That means people are positioned for the downside," he said.  

With much of the market positioned for the worst, Sala Tenna believes the path of least resistance is actually up from here. However, for conservative investors - like the Katana team - he recommends a little patience (at least a month or two) before diving in. 

"For more aggressive investors, I think they can start positioning," he said. 

"You can't get a great stock at a great price with certainty, you've got to give up one of those three things. At the moment you can get a great stock at a great price if you're prepared to give up certainty." 

So when will Romano and his team start putting that cash to work? 

There are two clear signals that investors can use to know when to start investing their cash in the market again: 

1. When the Fed finishes its rate tightening cycle.
2. When there has been a quantifiably positive shift in earnings. 

Unfortunately, it's not that simple. After all, markets are much too fluid and forward-looking for these two factors to signal the perfect time to start investing, Sala Tenna explained. 

"So things from previous cycles that might have worked through the power of evolution don't necessarily work as well this cycle," he said. 

"We are trying to very clearly look at what it is that might create more panic. Markets usually bottom at peak fear, so we are trying to work out on the art side, when have we seen peak fear." 

And we haven't seen peak fear yet. Instead, "it's really been quite a steady, considered decline to this point, particularly in the Australian landscape," Sala Tenna added. 

3 sectors to generate alpha in this market 

While Sala Tenna admits that he can make a case for and against "pretty much every stock and sector" at the moment, he points to three sectors that he continues to like. 

The first is the decarbonisation and electric vehicle (EV) thematic, which the Katana team is playing through EV metals like lithium and copper, and surprisingly, through a couple of exchange-traded funds (ETFs) exposed to offshore technologies. 

This includes Mineral Resources (ASX: MIN), the fund's top holding - which boasts "one of the two largest hard rock spodumene mines in the world", Sala Tenna said. It's also been in the press a lot of late thanks to rumours of a spin-off with its lithium business. Plus, it doesn't hurt that it's also the largest contract crusher in the world - clipping the ticket on 300 million tonnes annually. 

He also points to smaller cap lithium producer Allkem (ASX: AKE) as another favourite, as well as copper-focused miner Oz Minerals (ASX: OZL) - which recently dodged a takeover offer from BHP (ASX: BHP), but is rumoured an acquisition could still go ahead. 

However, of the "half a dozen copper producers on the ASX", Sandfire Resources (ASX: SFR) is Sala Tenna's pick of the bunch. 

"Sandfire is the one that screams value and quality," he said. 

The ETFs the team is using to get exposure to offshore EV technology include Global X Hydrogen ETF (ASX: HGEN) and VanEck Global Clean Energy ETF (ASX: CLNE). 

The second area of the market that Sala Tenna believes can generate alpha right now is LNG. 

"The war in Russia has created a structural watershed moment. The war could end tomorrow and Europe is still not going to go back to being reliant on 40% gas from Russia," he explained. 

"This is a line in the sand now. So I think companies like Woodside Energy Group (ASX: WDS) and Santos (ASX: STO), which feature prominently in our top holdings as well, are two companies that make a lot of sense." 

Normally, LNG will trade at US$7-8 per MMBtu. Currently, it's trading at $42 per MMBtu. At some points, it's been as high as US$70-80, Sala Tenna said. 

"Not only that, you can actually hedge that out 18 to 24 months at those enormous prices," he said. 

"Now most of what Woodside and Santos sell is on contracts, but about 10-15% is in the spot market and having your spot cargo going out at those prices is a huge windfall for them." 

The final area of opportunity is metallurgical coal, which boasts "fantastic tailwinds", Sala Tenna said. 

"I've been investing for 26 years now and I've never seen thermal coal trade at a premium to met coal like it is at the moment," he said. 

"Thermal coal is fetching US$450 a tonne approximately. Met coal is fetching US$250 a tonne. Clearly, they're trying to replace energy sources in Europe. Now some of the met coal can be substituted into the thermal coal market and that's already happening as we speak. 

"You only need to take 10% of met coal volumes out of that market and you'll have quite a pronounced deficit there." 

With that in mind, he believes that met coal and thermal coal prices will eventually meet in the near future, and has been building positions in stocks like Coronado Global Resources (ASX: CRN), Stanmore Resources (ASX: SMR), and Yancoal Australia (ASX: YAL) to take advantage of this. 

3 contrarian investment ideas for when the market turns

According to Sala Tenna, tech is the clear elephant in the room. After all, it's not going anywhere and continues to impact every aspect of our lives. 

"Tech is a beautiful leverage model. That virtuous cycle or circle effect is hugely leveraged. You get the right play and with very little additional horsepower or dollars, you can magnify the outcomes very, very dramatically," he explained. 

He points to NextDC (ASX: NXT) as a possible candidate for investors wanting to take a bite out of tech. 

"They've put so much work and money and infrastructure into what they're doing and now they start to reap the benefits of that," Sala Tenna said. 

"I think if you can find any tech stock that is cash flow positive, has got a good CAGR, good management team and a business model you can understand and they're either number one or two in their space, those businesses from here will probably see a rerating over the coming two years." 

In at least one to two years, he also believes that the consumer discretionary sector "will come back into its own". 

"At the moment in Australia, we're at the stage where we need to see some pain in that space," he said. 

"All the numbers are still rearview looking, so they're all still very good, but the consumer's going to come under distress." 

When we start to see more pressure on consumers' wallets, we could see a "huge sell-off" in the consumer discretionary sector. 

"That will create the opportunity," Sala Tenna said. "But we're on the wrong side of that at the moment." 

He also points to the non-bank finance sector as a possible winner in six months' time. 

"You've got companies like Pepper Money (ASX: PPM) sitting on four to five times earnings, Australian Finance Group (ASX: AFG) on eight times earnings. Liberty Financial Group (ASX: LFG) on six to seven times earnings," he said. 

"These are great businesses with long-term track records, great CAGR, and super management teams that are trading on four to five times PEs." 

However, investors should expect NIMS to contract further, bad debts to blow out more, and see some volumes ease off before this opportunity presents itself. 

"But in the back end of this financial year, perhaps FY24, I think that's probably the one space that presents the biggest opportunity," Sala Tenna said. 

Three lessons to help you become a kick-ass investor 

There are three lessons that Sala Tenna has learnt from his 26 years in markets, and luckily he's decided to share them with you.

1. Compounding

"Compounding is the number one most important concept in finance - bar nothing. Even Albert Einstein said the same thing," he said.

"The issue we have is that with compounding, it's as much about the upside as protecting from drawdowns."

As an example, if you lose 50% of your invested capital on a stock, you need to make 100% back on that investment to just break even, he explained.

That said, "you don't have to take big risks to make big money. You have to take good risks and put time on your side," Sala Tenna added. 

"You'll be absolutely amazed at how much money you have at the end of the journey there and it's a great thing to be passing on to the next generation," he said. 

2. Stop loss or taking losses early 

Katana has a mandatory stop loss review policy. If a company's share price falls 15% from the initial purchase price, the firm's portfolio managers have to re-do their analysis and submission of the stock for the portfolio and continue to review the stock every two weeks.

"When companies get sold down, it could be an opportunity or it could be a crisis and there's no simple answer," Sala Tenna said. 

"You have to do your work and work out which one it is. So understanding a stop loss and taking a stop loss early if you're going to do it is important." 

If the stock's share price has fallen 50-60%, it's probably too late at that stage. If you are still confident in the outlook for this stock, it's better to average down when the cycle turns, he adds. 

3. Emotional Intelligence (or EQ)

Contrary to popular belief, it's not IQ that's going to determine your success in markets, it's EQ, Sala Tenna said.  

"The smartest kid in my class got a PhD in mathematics and is in actuarial studies, and he's failed as a trader!" He said.

"It's understanding what's going through the minds of the masses and being able to move ahead of that. It's also how you're able to understand and control your own emotional responses that'll determine your success as an investor. Resilience and patience." 

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