Why this fundie is selling ASX tech stocks - and what he would love to buy instead

Stocks outside the ASX 100 have been gaining a lot of attention on the Livewire website of late. As the fear of an Australian recession subsides (rightly or not), investors are looking through the valley and trying to find opportunities in beaten down areas of the market. 

Antares Equities' John Guadagnuolo recently described the ASX mid-cap index as the "Goldilocks" zone of the local market, given constituents of that index tend to deliver higher returns for the higher risk profile. 

Speaking to our very own Sara Allen, FNArena founder Rudi Filapek-Vandyck also argued the better opportunities will be in mid-caps over the coming 12 months (he even nominated six of his own that you may want to have a closer look at).

And Janus Henderson's Daniel Sullivan went one better, telling Livewire managing editor Chris Conway that mid-caps are a great place to go hunting for commodities stocks opportunities.

But despite Guadagnuolo's argument and the sentiments of both Sullivan and Filapek-Vandyck, the ASX Mid-Cap 50 is up just 1% year-to-date. On a 12-month basis, the same index is up just under 5%. While good, it trails the ASX 50, which has returned more than 8% over that same time period. 

So is that all about to change? In this wire, we speak to someone who should know a thing or two about mid-caps. 

Brenton Saunders heads up Pendal Group's coverage of the ASX mid-caps space. Saunders is also the subject of one of Livewire's most popular wires this year. Recently, I caught up with him to discuss what has changed (or hasn't) since our last conversation.

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Have there been any big changes to the mid-cap opportunity set since we last spoke?

The macro backdrop continues to change - and in his view, it's still complicated. But all the biggest changes are happening in the materials sector. At one end, a downbeat Chinese economy which is not being massively stimulated is an issue for Saunders and iron ore companies.

"Unless we see a fairly significant change in the focus of stimulus and even the magnitude of stimulus pivoting towards property, like it has done historically, we don't think that steel or iron ore is going to be able to maintain the strength through the course of 2024," he said.

At the other end, Saunders continues to remain structurally bullish on the lithium and wider electric vehicle mega-trend.

"We have seen growing pains in the ASX lithium market and lithium prices have been weak and so lithium stocks have been weak with that. We certainly weren't expecting that so it's been quite frustrating," he added. 

"We certainly don't think that will last and the long term trend remains intact. But it has created quite a soft patch here in the third quarter, for some of the stocks and commodities in that space."

How would you characterise the recent August reporting season for the ASX mid caps?

Saunders thought it was a good reporting season for many of the companies in the portfolio, given it was really company-specific and one where individual stock moves rather than sector plays told the story. 

"It was much more of "Did the company hit its targets"? If things were in the company's control, and if they executed on it, then generally stock prices did well through the reporting season. This sounds very intuitive, but hasn't been the case for a very long time where sector trends dominated," he said.

A perfect case in point was the dichotomy between Altium (ASX: ALU) and Wisetech Global (ASX: WTC). 

"Altium delivered an in-line result but had upgraded its outlook for various components of its business, notably its access to enterprise and larger company adoption of its software," Saunders noted. 

"Whereas Wisetech, which had an enormous run up to the results, disappointed in a couple of areas where they are having to reinvest in the business. And they saw some very modest margin erosion. The performance difference between these two stocks, which have very similar thematics told the story. One was up 20% and the other one was down 20%. So it was very much what companies specifics did," he said.

The other key thematic for Saunders was the increasing cost of capital and servicing debt. 

"With elevating interest rate expectations and higher bond yields, the long-duration stocks like real estate have been hurt through that period," he said. 

"You had quite a big adjustment to the forward looking earnings estimates for resources. For me, that's more about the impact from headline inflation, especially, in Australia, on the labour cost side. But it also reflects a very discretionary increase in capital expenditure and reinvestment for a lot of these businesses that haven't really had elevated CAPEX since the last cycle. They've been in a CAPEX austerity mode for the last 10 years," he said.

"That's a penny that's going to have to drop as well."

What changes have you made to the portfolio as a result of earnings?

Perhaps, what was most interesting is that Saunders is trimming positions in the fund's technology holdings. Even as the picture becomes more clear on interest rates and inflation, Saunders is choosing to take profits rather than lean into a trade that has been a strong performer this year.

"One of the things that I did do, both in the lead up to the reporting season and during the reporting season, was just take profits on some of the companies that have done particularly well, especially in the growth space like Wisetech, REA Group (ASX: REA) and Carsales (ASX: CAR)," he said.

"We've also taken the opportunity to sort of buy down into some of the beaten-up stories that we thought were a little bit overdone during that period. So we increased some exposure to companies like Seven Group (ASX: SVW) - it continues to do incredibly well. It's a very well managed business and the Boral (ASX: BLD) result helped that," he added.

What has been the biggest single change (addition or subtraction) to the portfolio since we last spoke?

Since we last spoke in June, the fund has exited its position in Nine Entertainment (ASX: NEC). Saunders says the move centres around the team's bearish views on consumer discretionary companies. 

"The ad cycle has showed itself to be a lot more susceptible to slowdown in the discretionary consumption environment, than it has done in previous cycles. The amount of downturn that we've seen in this cycle relative to what we'd see in the GFC or any period after that was a lot higher. It's quite hard to understand whether that's the function of the changing structural landscape of free-to-air TV or if that's just a cyclical consideration," he said. 

In the consumer discretionary sector, the fund owns only a select few names like Premier Investments (ASX: PMV) and JB Hi-Fi (ASX: JBH). 

What is one stock (ASX or NZX) you would love to add to the portfolio if the valuation presented itself?

The stock Saunders nominated is Reece Holdings (ASX: REH). 

"It's a very high quality business and it never really gives you the opportunity to buy it at a low valuation because it's such a high quality business. But it's one of the businesses that has an absolutely dominant position in Australia and then has very slowly expanded in the US," Saunders said. "We're watching it very closely."