Chanticleer
What it’s really like inside a fund manager’s morning meeting
Chanticleer was given a rare look inside the morning meeting of Yarra Capital Management’s equity team. Here are four big themes that emerged.
The equities team starts filing into the main conference room in Yarra Capital Management’s headquarters on Melbourne’s Collins Street just before 9am.
It’s Friday morning, the day after the official end of February profit season, and this is a chance for the group – led by executive chairman and head of Australian equities Dion Hershan; executive director and head of Australian equities research Katie Hudson; and head of macro and strategy Tim Toohey – to share the intelligence picked up during a busy month, and extract some of the big trends.
Dion Hershan, Katie Hudson and Tim Toohey of Yarra Capital.
Chanticleer has been given a rare and exclusive opportunity to sit in on the discussion, which includes 15 investors and analysts, two of which are beamed from Yarra’s Sydney office.
After some brief introductions – and some gentle ribbing about Toohey’s caricature by The Australian Financial Review’s brilliant cartoonist David Rowe – Toohey opens the batting with an update on what the latest economic data is saying about the big picture.
Yarra’s house view is that the global and Australian economies will prove far more resilient than expected in 2024, underpinning a 10 per cent return for developed market equities. Toohey is confident the data is backing up that view.
He says capital expenditure data released this week in Australia is already looking much stronger than the market expects, and Wednesday’s monthly inflation data also contained good news.
Yarra Capital Management’s Tim Toohey. David Rowe
While he’s cautious the data for January can be noisy, Toohey points out we are already only 0.2 per cent above the Reserve Bank’s June forecast for trimmed mean inflation of 3.6 per cent. A monthly inflation reading of 0.4 per cent or less in February would take the six-month annualised rate below 3 per cent and inside the RBA’s target band.
That said, Toohey says the central bank will probably want to see two more months of good readings before it changes its tone in the way the US Federal Reserve has done.
The remainder of the 45-minute meeting is taken up with a free-flowing discussion about big-picture themes in markets. For an outsider, what’s particularly noticeable is the way data points are corroborated with intelligence across various sectors, and across large caps and small caps. There’s the odd challenge to another investor’s thinking, too; have you thought about this, what about this historical precedent?
Here are four big ideas Chanticleer gleaned from the conversation.
Wage pressures fading
The Yarra team asked every company they met during reporting season to nominate the big inflation challenge that lies ahead, and everyone around the table seemed struck by how good the picture looks. Almost every sector reported a softening of labour market conditions and is now anticipating wage growth pressure of 2 per cent to 3 per cent in the next 12 months, which is a stark contrast from the 4.3 per cent growth seen in December’s official numbers.
That anecdotal evidence matches up with Toohey’s data on fortnightly EBA agreements, which, while very volatile, do suggest early signs of wage growth moderation. No doubt the RBA will be hoping for a Goldilocks world where wage growth eases, but remains strong compared with the past decade or so.
One concern inside the Yarra team is that better news on wage growth won’t help some sectors outrun cost pressures, because they are in catch-up mode after a long period of underinvestment; the banking sector is a good example.
Supply issues the focus for commodities
While commodity markets have been watching signs of weaker demand out of China closely, the Yarra team thinks supply issues are about to become a bigger factor. The house view is that a period of oversupply looms in iron ore, in large part because production will come online from the Chinese-backed Simandou project in Africa in 2025, of which Rio Tinto is a partner. This could push the iron price down from about $US117 a tonne towards $US80, which has implications for miners and Australia’s tax revenues.
There was some pushback on whether that long-predicted price fall will actually happen this time, given big miners have proven adept at managing value over volume in recent years. But the sense is Simandou is a game changer; just as China has changed the nickel sector by backing new supply, so too does it want to see a shift in iron ore.
It’s a very different story in copper, where supply problems are exacerbating a structural undersupply. Remarkably, the world is back to copper inventory levels last seen before China’s industrial boom, even as demand from the energy transition accelerates. As iron and copper producers, BHP and Rio are obviously on both sides of this coin and Yarra is cautious on their outlooks.
The resilient consumer
Toohey says real household disposable income is set to turn positive again in the coming months, which helps explain the big move up in consumer names in February – the median stock was up 8 per cent versus the broader market’s gain of 1 per cent. The Yarra team says this rally has been driven by an expectation gap – the earnings pullback the market feared in the December half didn’t happen and this has led to the median consumer discretionary stock’s FY24 earnings forecast rising by 11 per cent, although revisions for FY25 and FY26 are much more muted at 5 per cent and 3 per cent.
But the Yarra team maintains the gap between the highest quality retailers and the rest of the pack remains large; JB Hi-Fi is Yarra’s long-held top pick here. The team has also been wary of the supermarkets for three years, which is now playing out as sales are hit by falling inflation, costs keep rising and regulatory pressure builds.
Yarra is also more positive on the retail real estate investment trust sector, particularly Vicinity Centres and Region Group; retail sales are holding up, occupancy is back above pre-COVID levels and rent as a percentage of sales actually lower than before COVID, dropping from 16.5 per cent to 15.5 per cent. But Yarra does not expect depressed net tangible asset values to rise in the sector for another 12 months or so, given debt costs will keep rising.
Momentum rules the market
Perhaps appropriately on the day the ASX 200 hit another record high, the Yarra team also dug into one of other big features of reporting season: big share price jumps in reaction to results, with 39 members of the ASX 300 delivering a gain of 20 per cent or more in the past month.
The unanimous view was that the momentum in the market is hugely stunning, with earnings beats and guidance upgrades being met with big buying support – and misses being punished, too. Hudson says this has created much more opportunity for trading in small caps than would typically be the case in reporting season.
The macro environment is helping too, Toohey says, with recession risk basically taken off the table by resilient data and markets pricing in an end to quantitative tightening by the Fed.
He says we’re about five months into a nine-month run for markets. Toohey says this is the hope phase, where investors go risk-on in anticipation of rate cuts. But by early May, markets will want evidence that those cuts look more certain.
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