Expert: Julia Lee – Searching for opportunities in today’s market

Bryce: [00:00:15] Welcome to another episode of Equity Mates, a podcast following our journey of investing. Whether you're an absolute beginner or approaching Warren Buffett status, our aim is to help break down your barriers from beginning to end. My name is Bryce and as always, I'm joined by my equity buddy Ren. How are you going?

Alec: [00:00:30] I'm very good, Bryce. I am excited for this episode. It can sometimes feel tough to get excited with the markets doing what they are, but we have a returning favourite here joining us today and how could we be not excited about that? 

Bryce: [00:00:45] That's it. It is our absolute pleasure to welcome Julia Lee back to the Equity Mates studio. Julia, welcome.

Julia Lee: [00:00:51] Great to be here. Thanks for having me on again. 

Bryce: [00:00:54] So as Ren said, Julia is a returning favourite here at Equity Mates. Suggest going and listening back on the number of episodes we've done with Julia over the last number of years. She is the chief investment officer at Berman Invest and has been closely watching the Australian stock market. And we're here to unpack what Julia is saying at the moment and how she's positioning her portfolio as a result. So we got plenty of sort of key topics that we want to touch on. So let's kick it off with current market conditions. Ren. 

Alec: [00:01:25] Well, don't ask me. Ask Julia. Julia. The the year has been tough in Australia, but it's been even tougher in the US. You're primarily focussed here, back here at home in Australia. So what are you saying? How are you thinking about it? How would you sum up the the opening few months of 2022? 

Julia Lee: [00:01:47] Well, 2022 has definitely been tough. And I guess when I look at the market, I like to look at it in terms of cycles and the cycle certainly has turned. And that really means, hey, you do need to have a bit of a different mindset as an investor. And we've gone from easy monetary policy into a tightening environment, and that's a more difficult environment for investors as well as the markets. It's also quite an exciting one. Here you are all about market timing. The volatility means that there's lots of movements in share prices to take advantage of, but generally as interest rates are rising and just at that inflexion point, there's sort of worries around those interest rate sensitive stocks. And I guess, you know, just having a look at it from an investment point of view or even a company fundamental point of view, rising interest rates means that the cost of borrowing is more expensive, which means it's more difficult to to make a profit. And also companies that rely on that future profitability is more doubt around it. So future growth is discounted quite severely. So there's high growth areas like tech. Well, you know, it's seen a pretty painful ride that on the flipside, generally, you see more defensive sectors doing well. And I guess given the inflation rate environment, the commodity space also doing well. 

Bryce: [00:03:13] So we've just overnight or over the last 24 hours, inflation over in the UK has hit 9% for the year to April, which is pretty astounding. And we're seeing sort of similar numbers over in the US and of course Australia is facing into some inflation headwinds as well and as such where we're seeing interest rates. So when you're, you know, experiencing a market like this, how do you think about starting to reposition your portfolio? 

Julia Lee: [00:03:41] Julia Sure. I guess firstly when we're seeing a market like this, I think it helps to break it into time buckets. So short term, medium term and long term and long term, we know that, you know, interest rates are rising on the back of inflationary worries. But short term, you know, there is a question of whether we have seen inflation peaking. And I think central to that is just watching what's happening in China. China is the manufacturing hub of the world. Over the last couple of months, we've seen major lockdowns in key cities in China, which has impacted on the supply chain, which means that, you know, the goods that are out there have been disrupted transportation costs. And then adding to the mix, the war between Ukraine, Russia, the conflict there and the impact that's had, particularly on energy prices and security. So I guess the question is, you know, is inflation going to get worse from this point or is it going to get better? And the reason why the central banks are trying to tackle inflation here by raising interest rates is they're hoping that by raising interest rates, they'll be less demand for goods. So hopefully inflation will come down. But I think separate to that, investors do need to be watching China because if we start to see that supply chain going again, well, maybe we'll see goods flowing again. And a greater supply of goods also brings down prices. 

Alec: [00:05:03] I remember in previous episodes we've done with you, you had some some novel ways of, I guess. Researching companies. I remember when the baby formula craze was really hot, you would be walking the the aisles of Coles and Woollies and saying what was on special and what was sold out and stuff like that. When it comes to something like inflation, you mentioned that it's important to look overseas Russia and Ukraine, the China Zero-Covid story and the lockdowns as a result. But are there any lead indicators here at home that you're keeping an eye on that will sort of give you a clue about where inflation is going, you know, retail prices or anything like that that you keep a close eye on?

Julia Lee: [00:05:46] It's a really good question. And I guess when when we look at it, it comes to the heart of what's driving prices at the moment. And I guess the question around the economy is an important one because, you know, when we look at the market, this sort of three key lenses to look at, and one is the fundamentals of what's happening in the underlying company. Secondly, is the technicals or the price action. And the third lens, I think, is the macro view. What's happening in terms of the economy? And I would say that the key driver of prices at the moment is the macro view rather than the company fundamental. And the reason I say that is because there are a number of companies that are still in an upgrade cycle and yet the share prices haven't been going up. So that disconnect, I think comes from investors positioning because of what's happening globally in terms of the macro. I think a good example of that is Goodman Group. This week we had Goodman Group coming out and they increased their earnings expectations. So Goodman Group has been on this beautiful tailwind of e-commerce, having that industrial property for storage to allow for a greater e-commerce to occur. And look, that tailwind is still occurring. They're still developing properties. They're doing really well. They just upgraded earnings expectations from the high end of growth of 20% to 23%. And yet, you know, the share price is lower since that announcement. And the reasoning behind that is that Goodman Group is in the property space, which is impacted highly by rising interest rates. So, you know, the company fundamentals are looking good and yet the share price is going down. And that's really because the macro view here in Australia, we're mostly a follower. So rather than looking at what's happening in terms of the Australian economy, while it's important things like wage inflation as well as the cost of goods rising, mostly I think we're looking at a two key trading partners and that's the US and China. And I think the good news for Australian investors is that we do have high exposure to China and China's in a very different macro cycle to the US, the US we're seeing rising interest rates in China completely the opposite, where they're looking to stimulus as well as spend on infrastructure, cutting the official interest rates over there. So I think that bodes well for Australia and probably will be a key reason if we manage to avoid recession while we see probably a high probability of the UK and Europe going into recession is probably one of the key reasons. Looking across the globe, I'm a lot more positive on places like Australia and Canada because of the commodity based exposure and the exposure to China, which is on a different macro cycle. 

Bryce: [00:08:31] So for a lot of the Equity Mates community who have started investing within the last sort of 8 to 10 years, none of us have really experienced interest rate rises. And so it's been a story of growth stocks and tech to the moon. So now that we've we're obviously going to see rates rise and rise pretty sharply. What are some of the sectors in the market that traditionally investors look to when interest rates are rising?

Julia Lee: [00:09:00] Sure. I mean, generally, if you go back into history and have a look at the correlations or the relationship between rising interest rates and the share market, you know, pre global financial crisis, actually rising interest rates usually occurred when the share market was rising because it was indicative of a strong economy and economy that was improving. At the moment, what we're seeing is something a bit different, I think, and that is that inflation isn't a demand problem at the moment. It's it's also a supply problem. So, you know, some of that is simply because of COVID 19, the supply disruptions that we've been seeing. And so I think it's different to the periods in time where generally when, you know, interest rates have been rising, the share market has been rising as well. And we're just seeing worry is that what we're seeing at the moment is a bit different, that we're seeing rising interest rates not into a growing economic situation and growing economic growth, but we're actually seeing rising interest rates into a slowing economy. And I think that is the worry at the moment that the economy has already started to slow and central banks are. Raising interest rates because they have no other choice but to tackle inflation here. So the worry is that they are too aggressive in fighting inflation. And what we get is a recession over in the major economies like the UK, Europe and possibly the US.

Alec: [00:10:28] It is a scary time. Hearing some predictions like that and I guess for a lot of investors like us, it can be hard to sort of wrap our heads around it. And that's why we turn to people like you, Juliette, to help us understand it when it comes to portfolio positioning at a point like this. William Price, they were chatting on a podcast earlier today about the options you have. You know, go to cash, try and play it, move to a defensive position, maybe short the market or you just hold through and and, you know, wait it out and really focus on the long term. There are a number of different options that investors have. How are you approaching this sell off and how you positioning your portfolio?

Julia Lee: [00:11:14] Sure. I think the difficulty around shorting the market here at the moment is that the moves down a bit, but the moves up are quite violent as well. So if you're positioned on the wrong side of that, you know, unless you are pretty brave, it's going to be a bit of a rollercoaster ride. So for I guess more first time investors, it would be a chance to move more into defensive assets in cash and look at protecting your capital. Having said that, you know, the market's starting to price in the probability of recession or slowing growth. The market's always forward looking. So if you if you think, oh, okay, I am I'm going to buy the market during the recession, it's usually too late. The market's already priced in the recovery. So the key for investors is not to be focussing in on what's happening now or the next six months, but what's already priced into the market and then what's likely to occur after that. So I think that's a difficult thing at the moment and there's a lot happening, but the market, I think, is just being too pessimistic when it comes to those interest rate hikes. I don't think they're going to be as aggressive as what the market's pricing in, but that's because there's a lot of nervousness at the moment as well. So, look, a market like this is hard because it's not just about company fundamentals and the price action canned, I guess, go into a death spiral because you can see, you know, large fund managers, large funds having things like margin calls, which increases the force selling. And when this was selling, you know, the fundamentals sort of go out the window. What that means is for a longer term investor that can look through the cycle, there's opportunities there. So if you're not ultra short term and you can look through this weakening cycle, then there's certainly opportunities to pick up stock at much cheaper prices. But just recognising that many sectors of the market are tied to economic performance and the reason why we call them cyclical is because they move in cycles, they move with the economic cycle. So usually, you know, when we're seeing a slowing down in terms of the economic cycle, we see defensive sectors outperform. And defensive sectors are usually areas that we have to spend money on, whether the economy is going up or down. So, you know, things like our phone bill, utilities going shopping at the supermarket. So, you know, those sectors are things like telecom, utilities as well as consumer staples. On the flip side, the sectors that underperform are usually growth areas of the market. And, you know, financials are very much usually a geared investment into the economy. So they tends to be cyclical, consumer discretionary, certainly cyclical, the industrial sector cyclical and commodity cyclical as well. Although, you know, I'd probably look be looking at the China cycle as much as the rest of. 

Alec: [00:14:11] The globe on the point around consumer staples being defensive because people, you know, always have to buy food and stuff like that. I was surprised this week that Walmart and Target have been have fallen so heavily in the US. Walmart I think down about 15%. I think Target was down about 25%, 24% in a trading day. How do you think about that in terms of these companies being, you know, consumer staples but still falling significantly? 

Julia Lee: [00:14:40] Yeah, I think, you know, when we have a look at things like Big W came out, which is probably the more equivalent here in Australia, that to me falls into the discretionary category. When I'm talking about supermarkets, I'm thinking Woolworths, Coles or Metcash. So that's probably the more defensive part of the market where, you know, something like Wesfarmers, which sort of has a whole lot of different retail and different companies, probably classified more as retail and same way with the Harvey Norman's JB. High flyers of the world as well. So this visit, as you know, interest rates rise, that consumers are going to have less money to spend. They're going to be less confidence than we are going to see those discretionary items being hit, things like electronics, entertainment, even clothing, adult clothing. If you just put off buying your next pair of work shoes until there's a hole in it, and you know that the somewhat being reflected in the consumer confidence numbers that we're seeing here in Australia where they have been falling quite rapidly. Yeah, there's interesting areas of the market where you would also think that they were they would move with the economic cycle, things like gambling, gaming, casinos. But actually what we've found from past cycles is that these areas tend to be relatively defensive, which is pretty, pretty incredible. So you'd think that if you had less spending in your pocket, you'd be spending less on gambling. That doesn't seem to be the case. If we have a look at what's happened in past cycles. 

Bryce: [00:16:11] Let's change tack a little. Another element to all of this is the upcoming election. At least it's upcoming by the at the time of recording, by the time of release, we will have had a result. How do you factor in the lead up to an election in your portfolio, Julia? Or is it something that is it's just not worth worrying about. 

Julia Lee: [00:16:31] It's just major shifts in policy. And of course, the government is one of the biggest spenders in the economy. So it is very important and it does impact on on specific sectors, especially if there's big cash splash outs. And, you know, we usually see the retailers having a bit of we haven't necessarily seen much of that this time around, probably cause there's less money in the kitty. But I think the major question for investors in Australia is whether or not we have a hung parliament because that's probably the most bearish scenario for Australian investors having a Parliament which is sort of hamstrung and where not a lot happens and there's not a lot of agreement. So it would be good if we, if one party or the other got control. But in terms of policies, you know, there's not a huge amount of difference between the two parties here in Australia. So I think it's more and whether we get a hung parliament or not, which is important when it comes to elections. 

Alec: [00:17:30] Well, Julia, there's a whole other conversation we could have about the how much actually gets done in a minority parliament. I think if we look back at 2010, they actually were probably more productive than perhaps some of the parliaments that came after them. But look, this isn't a politician. 

Julia Lee: [00:17:46] For prime minister. 

Alec: [00:17:48] This isn't a politics podcast, as Bryce keeps reminding me. So we'll move on to something that, you know, has buoyed Australian investors and Australian markets of light, which is commodity prices. The being a nation that dig stuff out of the ground and sends it overseas has really worked in our favour the last sort of 6 to 12 months. But I guess the question is how long can it last? On one hand, people talk about a commodity supercycle and prices just going from strength to strength on other hands. People talk about perhaps this being close to the peak of the cycle for some of these key commodities, especially the energy commodities. How are you thinking about it? How are you viewing it? And I guess how you positioning the portfolio as a result?

Julia Lee: [00:18:33] So good question. And I think when you're looking at energy, you have to look at it maybe differently from other commodities out there. We we talked about how China and the rest of the world is on a different cycle at the moment. So China's looking at stimulus through things like infrastructure, and that's good news for things like I know it needs to be used for steel to make bridges and buildings. But on the flipside, when you're looking at energy in the oil and gas, space is very different where we've seen prices there increasing and, you know, oil prices are over $100 a barrel at the moment. And that's mainly on concerns around energy security and the conflict between Ukraine and Russia. Long term is at $100 a barrel price sustainable? I don't think so. When the cost of production is, you know, sort of under $50 a barrel, it doesn't take much to bring oil back online. It just takes time. So it's a timing issue, I think, in terms of the energy market and all about short term price action rather than long term price action, long term process should probably settle more closer to 60, $70 a barrel as a fair price. So, look, I think you have to be careful in terms of the oil market. I think if you heard that, you know, Russia and Ukraine had come to a peace agreement, you didn't actually see oil prices taking a massive tumble. So oil was very different to how some of them other major commodities are trading. You know, and when we're watching China coming back online, we know at the heart of economic performance is the health performance. And we know China's still sticking to COVID zero. So what? Seeing the health implications very closely. Given that what happens if you see another five cases of COVID in Beijing or Shanghai, do we see another lockdown? So I think policy there is very important. The longer we see China keeping to that zero-covid policy and COVID being an issue, the longer we're going to see, you know, a negative economic performance not only for China but for Australia, especially. Our commodity and best figures are dead in the world. So I'm watching, watching China closely and hopefully if we do see that zero COVID policy being abandoned in China because having a massive impact over there, not only on on people, their mental state, but also in terms of economic performance and destruction of potential growth.

Bryce: [00:21:02] Yeah, it's such a radical policy. I just do not understand how they believe it's sustainable. Like the moment they open borders to anyone and store black. 

Alec: [00:21:11] Yeah, COVID all. 

Bryce: [00:21:12] Is just going to come straight in. It's just. I don't understand. But anyway, we're not here to debate China's political policies. So how, Joy, before we turn to other areas of the markets, we're just going to take a very quick break to hear from our sponsors. So, Julia, we're in the midst of a pretty heavy tech sell off. We've seen some of the big names that went so well during COVID. The peloton zooms all being hit incredibly hard. And for some of our audience, you know, it's a time that we've never experienced before and we've never seen such high negative numbers next to some of the positions in our portfolios. With your experience and knowledge of what's going on. I guess the question is with the unprofitable tech sell off, like how bad do you think it could get? 

Julia Lee: [00:22:03] Oh, well. 

Bryce: [00:22:05] Of course, we all like share. 

Julia Lee: [00:22:09] Prices down, so 70 to 90% in some of these cases. You know, I think things are pretty bad in that space and the easy money is gone. So it is all about being able to see that path to profitability or being secure around growth. And I think what the pandemic really did, it pushed future growth into the pandemic period. And what we're seeing now is that, you know, those growth rates that we saw during the pandemic and that were pretty much priced in forever for investors, or that's not going to be the case. That's what we're seeing. We're seeing markets sort of looking at the growth scenarios for, you know, companies like Netflix, Zoom, Peloton, that all really benefited during the pandemic and saying, well, you know, we saw this fantastic growth during lockdown. Where to now? And, you know, of course, they're not going to be able to reach the same heights because they did accelerate growth. And now we're seeing a slowing down, of course, and that's just the market. We saw this during the tech boom and Rick, back in 2000 where we were seeing companies coming out and, you know, valuations do matter in the end and valuations in this space have been huge. I mean, to give you an idea, you know, the average multiple for the Australian market is about 16 times earnings. That means that, you know, if earnings were to remain stable, you'd pay off your investments sort of in 16 years. But for the tech space, in a lot of these scenarios, you know, it's not unusual to see multiples at 100 times earnings or a thousand times current earnings or, you know, there is no multiple because there no earnings. So in that type of scenario, that's fine when the economy is doing well because all that talks about is expectations. So for a company with a p e ratio, let's say, of 30 times or a multiple of 30 times, the general rule of thumb is I want to see earnings growing 30% over the next couple of years, but a company with a multiple of 100 times earnings, the earnings growing 100% over the next couple of years. And in a company with earnings multiple of a thousand times, well, I want to see that company growing earnings by 1,000% over the next couple of years, and that's fine as long as the company can achieve that. But, you know, if a company is priced to see, you know, 100% growth over the next couple of years and it's only able to achieve 10%, you know what's going to happen to the share price? Is it going to adjust upwards for that information or downwards? And the answer is downwards and that's what we're really seeing at the moment. These companies are on very high multiples and high growth expectations and they're unable to steal them. So the way it works is that the share price adjusts downwards to allow for that new information. I mean, if a company on a multiple of 100 was able to see growth at 1,000% with the share price, you know, adjust upwards or downwards in that scenario, and the answer is upwards. And that's also why during a reporting season, sometimes you see companies coming out with a record profit result, profits growing by 30% and the share price goes down because you know, the market had priced in growth of 60% and they only came out with 30%. So does the share price adjust upwards or downwards in that scenario and adjust down to that information? So it's important to keep up to date with company forecasts for growth and also, you know, the expectations or the consensus forecast in the market for that growth as well because the market is just a pricing mechanism. 

Alec: [00:25:49] I've never heard that rule of thumb before, but I kind of like it. It's quite plain. If a company is trading at a ten PE, you want them to say you want to see them grow their earnings at 10% a year. It was that that was it, right. 

Julia Lee: [00:26:01] It's an adjustment of the PE ratio. So it's called the PEG ratio.

Alec: [00:26:05] Oh, yeah. 

Julia Lee: [00:26:07] GROSS Yeah. So it's just instead of letting, you know, valuations seem like it's sort of like an imaginary thing or a made up thing, what it does is it ties valuations to potential, which makes sense when it comes to investing in the market. 

Alec: [00:26:24] Yeah. So, Julia, we when we get you on, we love speaking about. Individual stocks, individual stocks that you're watching. You've had some big calls over the last few years. I think you peaked Linus quite early is one that I always remember. I sort of. 

Bryce: [00:26:41] Listened to Julia.

Alec: [00:26:42] Listen to Julia. So would love to talk about some companies that you're watching that might be in the portfolio or that, you know, that you think are interesting at a time like this. So I guess open ended question. What are some companies that are catching your eye at the moment? 

Julia Lee: [00:27:03] I think with companies is it changes from week to week depending on what the share price is and what's looking like value. So I guess there's a list of companies that I'm interested in and it may not necessarily be right now, but it's the price actually gets really interesting. I mean, the one company that I do like right now, the prices they're at is IDP education. This is a company that looks at, you know, international student placement into universities as well as English testing. And what I like about this company is that throughout the pandemic, they've actually made acquisitions and the acquisitions have been quite good. So there's a quite a company called B.C India and not only have the synergies from this acquisition been more than expected, so the company has had a benefit from scale and integrating this company, but also the margins have increase since the acquisition. So they've been able to get better prices going. And this is a company that has been hit by the pandemic because international students haven't been able to move freely around the globe, but they've adjusted through a digital strategy which has been working very well for them. So coming out of the pandemic, not only will their traditional business or is it traditional business starting to see an uptick because people are starting to move around the globe. But they've got another arm, which is a digital business, which is another avenue of growth. Now, I think the company's coming out of the pandemic in a much stronger place and where it started. So I like IDP education. The risks to that is, you know, we see competition in this area or travel once again being curtailed. But generally, you know, international student placement is, is a pretty robust industry. Yeah, I like IDP education. 

Bryce: [00:28:48] So then prices aside and with the caveat obviously that this is would be a price dependent decision, but other what other companies are on, I guess the watch list that would excite you should the opportunity arise. 

Julia Lee: [00:29:02] I should mention with IDP education, its CEO just recently mentioned that he would be resigning, which is why the share price has taken a bit of a battering as well, because he has presided over the company over seven years with the share price, has seen some phenomenal returns and the company has seen some great returns. As far as you know, under his leadership, if we sort of go back seven years, let's have a look at two, four, six, seven. Now, the share price seven years ago was at about 3.34 and now it's at $23 now. So, yes, there's been a big impact. But having said that, you know, the tailwinds are still there. The international movement, the India acquisition, that's all still in place. So that should benefit the company. 

Alec: [00:29:49] It's a real it's a real popularity contest when a CEO is either announced or resigned. Like if you if you resigned as a CEO and the share price went up, it would it would cut you. 

Bryce: [00:30:00] Yeah. 

Julia Lee: [00:30:01] There are some scenarios where that does actually. Yeah. Which is a bit depressing. You feel the CEO. Yeah. But you know certainly the line of the to withstand such an incredible job that you know she ever resigned. I'd be crying having a look across the portfolio. I think it is time to be a bit more defensive. You know, she can grab stocks like Transurban around 13.50. I think that's a great investment for the long term. It's inflation protected to some extent because toll roads, you know, they go up with inflation. There are companies in this sector. I still like CSL around these prices. I think in terms of the cycle is just able to collect more blood plasma, which means that, you know, things going back to normal, which I think is positive for CSL, even though it is on the higher multiple and it is looking relatively expensive. I mean, Ramsay health care, we have seen a bit of takeover action there. But in terms of elective surgeries, we know this a bounce back there as well. I'd be willing to bet that there'd be a lot more visits to dental surgeries throughout the next few years. I don't think everyone's been keeping up to date with the dental checks, which means more cavities and more work. But having said that, the flip side of that is that health insurance companies are probably going to have greater claims throughout the next 2 to 3 years. So I would probably be avoiding the health insurance companies, but I do like more large global insurers like QBE Insurance. Premiums are increasing, claims being relatively low, and the investment portfolio is seeing better returns. 

Bryce: [00:31:35] I mean, it's been an absolute pleasure. Julia, we have we have just about run out of time and we've covered so much ground and it's just been a joy to listen to you and your thoughts on the markets again. There's obviously a reason why our community loved listening to you as well, so I hope it's all going well for you at Burman Invest and that you've been safe and well over the last sort of I think I remember when we last spoke, to be honest. But I'm glad we have got you back on. 

Alec: [00:32:04] Let's not let's not leave it so long. Neck. Yes. 

Julia Lee: [00:32:08] And don't be scared of the muck of volatility. I mean, these are exciting times. These are when fortunes are made or lost, be one of the ones that makes, fortunately.

Bryce: [00:32:18] A lot of luck. Well, I've lost my fortune, so now I've got to rebuild. 

Alec: [00:32:22] But again, it's a moment of a lot of possibilities. 

Bryce: [00:32:25] It's a lot of possibilities. Yes, that's it. A lot of possibilities. That's how we're looking at it. And Julia, thank you so much for your time. It's an absolute pleasure, as always. Thank you very much. 

Julia Lee: [00:32:33] Love talking to you guys. Thanks, Bryce. Thanks, Ren. 

Alec: [00:32:36] Thanks, Julia.