Wilson Asset Management: A big market-mover is coming … and soon

A potential “taper tantrum” as the US Federal Reserve eventually winds back record stimulus is the number #1 macro topic for 2021, Wilson Asset Management portfolio manager Matthew Haupt told Livewire Markets' Patrick Poke in the latest Rules of Investing podcast.

“The elephant in the room is tapering. We’re now out of the emergency, so to speak, and yet we’ve still got emergency-level policy settings. That must change, and it will.” 

“When it changes is very much up for debate, but you’d expect it to happen this year.”

Haupt flags watching for that moment when central banks around the world – starting with the US – turn from extremely dovish to hawkish as the biggest macro event markets need to watch.

“The shock will be felt when a concrete announcement on that is made. Now all the CBs are leaking information out to the press about tapering, so you can tell it’s coming, but the conversation needs to happen – that will be the biggest driver.”

How long is a piece of string?

So, what is “tapering” in this context? Before I outline the core elements of this economic shorthand, you need to remember that the order of these operations can vary and the timeframe for each step is highly flexible. And some of these steps are sometimes skipped entirely.

And remember, tapering refers to both fiscal and monetary policy – either one then the other, one only, or both in tandem. There’s no hard and fast rule on how much, which or for how long.

But isn’t inflation the bogeyman right now?

Not really. Asked whether the debate around rising inflation – whether the movement in bond yields we’re seeing currently is part of a structural upsurge or only transitory – is top-of-mind, Haupt is equivocal.

“As an investor, you don’t even need to know the answer to this yet, you can just trade on the probabilities,” says Haupt.

“Over the next six months we’ll get different prints (from the Fed); the probabilities will shift, and you can make money on that.

For him, the key questions on inflation revolve around the COVID overhang of supply issues that are causing what he terms “artificial inflation” and the base effect, which he expects will be transitory. In this context, “base effect” refers to how the shift from a historically lower or higher base in the previous year affects the economic environment in the earlier stages. In this case, Haupt expects the base effect to “roll-off” quite quickly.

“Looking at rents ticking up in the latest print – rents account for about 40% of CPI - gives me more confidence that we’re not going to get a big fall in inflation,” he says.

“The heavy inflation prints were always going to come through and will keep coming through at decently elevated levels, but I think that will come off in about two or three quarters, then we’ll go back to a more normalised level of inflation.

How WAM gets an edge on the market

Some of the key indicators Haupt and his team watch include gross domestic product (GDP), employment figures and inflation. And some of the extras he likes to look at include the Chicago Board Options Exchange Volatility Index (VIX) and the MOVE Index. The VIX is popular as a gauge of volatility and market sentiment, in particular the degree of investor fear. MOVE tracks US Treasury yield volatility of 2-year, 5-year, 10-year and 30-year Treasuries.

Haupt also looks at the slope of the yield curve – a common rule-of-thumb technique – to get a read on the forward-looking perspective for the market’s bond yield expectations.

“When the VIX is low I get cautious – at these times there’s no room for error,” he says. And on the MOVE index: “Looking at the volatility in bonds helps us work out if there is scope for a bond rally or a bond fall.”

Haupt also looks at the slope of the yield curve to get a forward-looking perspective on expectations for bond yields – which is quite commonly used.

Stock markets are about to pop: yes, or no?

Another “million-dollar” question, alongside inflation and the stimulus wind-back, relates to equity market valuations. Are we in a bubble? And if so, when will it pop?

Haupt declines to answer outright. Instead, he frames his answer around the expectations for the current “goldilocks” environment that persists for investors, courtesy of the billions of stimulus dollars circulating.

But if you assume the current period is not a “new normal” (and rightly so, most would argue), we are in a bubble. “I’d argue it will be normalised. There is a lot of excess out there – you’re seeing it through crypto and the US ‘meme stocks – it’s a ridiculous period we’re in now," Haupt said.

“We’ll look back on it and I’m not sure if we’ll laugh or cry, but it’s definitely not normal, because we’ve had every bit of policy thrown at it – monetary and fiscal – and you’re always going to get bubbles in these circumstances.”

The “pop” when stimulus taps turn off may not be as violent as some fear, but some blowback is inevitable.

“I can’t see it going smoothly, we’ll no doubt have the taper tantrums again and then it’ll just be down to the resolve of the Fed and others – do they pause or keep going and try to deflate some of this bubble activity?

“Maybe we don’t even get through the tapering before we get rate hikes – it really depends how strong the economy is and how strong fiscal support will be on an ongoing basis.”

This time may be different to the sell-off of the last taper tantrum in the US, at the end of 2018 and into 2019. This is mainly because the last time the US’s cash printing presses were fired up, China was also winding back fiscally, so couldn’t support the tapering.

“This time you could argue the fiscal backdrop should support tapering,” Haupt said.

“But it will never be smooth. We’ve seen it already in some of the US tech stocks. That’s just a preview of what’s to come over the next one or two years.”

Stocks and sectors to watch

Probably one of the biggest surprises on this front – for me, anyway - was WAM’s view on the retail sector. Sure, he’s reasonably positive on retail, largely in the areas of hardware and home office equipment along with apparel and consumer electronics. But he doesn’t hold much in the space, beyond a whack of Wesfarmers (ASX: WES) largely because it holds Bunnings and Officeworks.

“Bunnings is a fantastic business and is still in the sweet spot now,” Haupt says, with similar views on Officeworks.

“But in retail it’s very hard to put a lot of capital to work in that sector now. The return profiles and earnings growth potential over the next 12-18 months means you’ve really got to be selective,” he says.

Even pointing to Wesfarmers, he doesn’t expect much in the way of M&A activity over the next couple of years – ironically because management is so fiscally disciplined. This is one of the big appeals of the conglomerate, which famously spun off Coles a couple of years ago, but red-hot valuations right now mean there’s not much around it would consider buying.

He’s more bullish on the big general insurers, anticipating premium rates will rise strongly alongside a bolstered outlook for the interest they earn on their “premium floats.” In simple terms, this is the income insurers earn on the premium dollars they collect from policyholders.

The biggest hurdle for them is in business interruption insurance – an overhang from 2020 that is currently keeping insurance company share prices in check.

“I think this will be the next trade that has lagged the banks. Australian banks provided for losses in March and April of last year and were able to reverse those quite quickly, whereas insurers were providing payouts throughout 2020, but that still hasn’t been resolved.”

The best-performing insurers will be those who invested more heavily in the shorter-dated fixed interest end of the market – they predominantly invest in credit – because of rising interest rates.

“The macro environment is incredibly supportive for insurers, so they should re-rate post the ‘cleansing’ of the business interruption insurance,” Haupt says.

Because of this, and its solid reinsurance program that is a very global play now, his team’s top pick in the space is QBE Insurance (ASX: QBE).

Insurance Australian Group (ASX: IAG) and Suncorp Group (ASX: SUN) are also in the WAM Leaders portfolio, ranked similarly in terms of their appeal. Haupt expects both to re-rate after earnings season, between August and October.

“Until then it’s hard to see them take off from here, but in the back-end of this year they’ll be a great place to have some of your capital.”

The wrap

As you can see, Haupt covered a lot of ground. And while macro commentary always runs the risk of heading “into the weeds” of economic complexity and jargon, Haupt steered listeners through without reverting to lots of buzz terms or bluster. The full recording is worth a listen – and though we don’t have such a rating on Livewire Markets, if we did, I’d give Patrick Poke’s interview with WAM’s Matt Haupt 4.5-lightning bolts out of five.

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