Chagsy
- as opposed to rising inflation plays
It looks like interest rates will be heading up at some point in the next 12 months, or if central bankers are to be believed, a little longer than that.
Either way, it is an environment that most of us as investors have rather forgotten about. I am conscious that much of my recent success in the sharemarket has been on the back of small cap growth stocks transitioning from being cash flow -ve to cash flow +ve or indeed profitable.
But these companies are trading on significant multiples today, and aren't likely to perform as well as other sections of the market in a rising interest rate environment. Much as it pains me to move away from this realm, I think it might be prudent to re-position some/much of my portfolio to companies that will get a re-rate from higher rates. These are unlikely to be as high risk/reward, but it should be possible to identify a number of solid businesses which will benefit from this "rising tide". On the flip side, many companies that I currently hold will experience the exact opposite, either because they will have debt that will need servicing at a higher rate, or the WACC jumps and suddenly the DCF valuation of companies making profits in the future, no longer looks as attractive as those making a profit right now.
I was prompted into this thought process by two lines in the October Lakehouse small cap report:
We still see Netwealth as a beneficiary of this trend, and even though market rates are looking closer to 0.75% above the overnight cash rate, Netwealth’s earnings still stand to lift by around 4% for each 0.25% increase in short-term interest rates.
and
Meanwhile, EML is in a good position to benefit from economies (and malls) reopening, and is another portfolio holding that benefits from a rising interest rate environment given the $2 billion of float on its balance sheet.
I seem to remember that Computershare is another company that would also benefit from this theme.
I believe insurance companies might fit into this frame as they hold large quantities of short dated bonds, but I have little appetite for these as I can only see claims going one way with climate change. Although perhaps health insurers might be a better option? And financial institutions are the other classic play.
Does anyone else have any suggestions?
It's hugely satisfying getting high growth companies right, as evidenced by all the interest on Strawman in the micro and small cap space. Pretty much all of the success I've experienced has been done on the shoulders of others, for which I am very grateful, but I wonder whether it is going to be the best space to play in, going forward?
Chagsy
Hey RD!
There’s an old axiom in management that goes: always answer a question with a question, that way you never have to give an opinion - and that way you can never be wrong!
Let me disavow you of the “big bucks” idea! I believe, like you, I was a member of MF Pro. So did well from that. But my average has been a shade under 30% CAGR for the last 5 years. Nothing stratospheric compared to some here. And much of that is probably related to market sector selection rather than individual company selection. But yes, this is exactly about timing the market. Not THE market, but asset allocation within the market. Which is quite different. This may not be relevant to most, but I hope to stop working in a few years so the stakes are perhaps higher
As to interest rates, I don’t think we will go crazy, but a rise in the OCR to 2% from where we are now at 0.1%, required 5.5 doublings! That will have some profound implications. I’m not sure rising interest rates in relation to a stagflation scenario is the same as rising internet rates in response to a red hot economy. But here’s a theory:
Lets say I was no better than average at small cap stock picking, I would stil have looked like a genius in the small cap area over the last 6 years. But I would have had to be superb over the 5 years prior to that (2010-2015), where small caps generally lost money:
Now, if we overlay the returns to the biggest 50 ASX companies onto that graph, we can clearly demonstrate how asset allocation would have worked wonders between 2010-2015 ( blue asx50, red asx small companies)
And as interest rates fell to silly levels we could flip into the high growth small cap space……
so - if we look at the OCR for the last 10 years:
Damn it can’t insert the graph here’s link
Its not an original idea - small caps tend to do worse in higher interest rate environments than larger caps but my hope is to find companies of any size that will benefit from higher rates, small or large, higher growth ….or not so electric.
I don’t trade. I don’t do warrants or options .
I have a very high risk portfolio outside of Super, which is what I am mulling over this question……..