Starting Points Matter

Airlie Funds Management

January 2025

Understanding the three components of shareholder returns.

I learned a valuable lesson in July 2022, the last year the S&P/ASX 200 index posted a negative return, that starting points matter. I had gone on leave to have my second child in December 2021 as markets were making all-time highs, the cash rate was on the floor (and the RBA was promising to keep it there for years) and a raft of IPOs were hitting the ASX.

When I returned six months later, it was like returning to a different planet: the S&P/ASX 200 had fallen 12%, the Fed and the RBA were aggressively raising rates, and what was most notable to me was the absolute consensus bearishness that had taken hold. Things were bad, and they were only going to get worse. This bearish view had become so dominant that we actually chose the title 'Beware the Dominant Narrative' for our national roadshow that year, suggesting the fundamentals facing most Australian companies weren't actually that terrible.

If we take that starting point of July 2022, the S&P/ASX 200 has gone on to return 38% inclusive of dividends, an impressive return over two-and-a-half years. What is interesting about this strong return is that, in my view, it was a function of the starting point. In any year, your total shareholder return as an investor is driven by three components: earnings growth (how much did earnings per share change by?), dividends, and the change in the price/ earnings (P/E) multiple. It is this last component I find the most interesting: how much are investors willing to pay, on average, for a particular earnings stream?

If we look at these three components at an index level, as in the chart above, the P/E multiple is the best guide we have to the 'psychology' of the market: when market participants feel bearish, as they did in CY22, the market P/E contracts. Despite delivering 18% earnings growth, the S&P/ASX 200 return was flat because of this sizeable de-rate. When market participants feel things are improving, the P/E expands. As you can see in the chart above, the bulk of the 38% index return generated in the last two-and-a-half years has come from the P/E re-rating rather than earnings growth. In fact, over the last two years, earnings have declined 11%, while the P/E has re-rated by 27%.

Whether or not this is sustainable is anyone's guess, albeit I would speculate that actual earnings growth is going to be needed for further returns from here. If we do get a rate cut or two in 2025, such earnings growth should be achievable, although it is interesting that our market has rerated over 2024 in line with the US, which enjoyed 100bp of rate cuts over the year, despite the lack of falling interest rates in our own economy.

So now we have a new starting point, 1 January 2025, and it's a very different one. The average P/E multiple of the S&P/ASX 200 has re-rated from 12.7x in July 2022 to 17.7x today. In particular, the re-rating in the Big Four banks, which collectively drove almost 40% of the return of the ASX over the last two years, has rendered the 24% of the S&P/ASX 200 index, which they represent as overvalued, in our view, considering their anaemic profit growth outlook. Does this mean it's a bad time to invest? Not necessarily. We are big believers in the age-old saying, "It's time in the market, not timing the market" that drives long-term wealth creation in investing in equities. That said, we are tilting the portfolio towards businesses where the starting point reflects depressed, rather than elevated, expectations.

A number of these investments are positions we established in 2024: BlueScope, IDP Education, IGO, The Lottery Corporation - all businesses where expectations are muted. Others are positions we've added to as share prices have fallen: Ampol on weak refining margins and production issues, BHP as Chinese stimulus disappoints, CSL as the Vifor acquisition has fallen short of expectations. What these businesses have in common are strong balance sheets and good management teams, as well as the ability to generate good returns through the cycle. In an expensive market, we believe positioning the portfolio towards businesses with strong financial characteristics and somewhat "beaten up" valuations should prove a good starting point for decent long-term returns.

By Emma Fisher, Deputy Head of Australian Equities & Portfolio Manager

Funds operated by this manager:

Airlie Australian Share Fund, Airlie Small Companies Fund

Important Information: 

This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation.  This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. No representation or warranty is made with respect to the accuracy or completeness of any of the information contained in this material. Airlie will not be responsible or liable for any losses arising from your use or reliance upon any part of the information contained in this material.

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Hedge Clippings | 14 February 2025

The RBA has (not surprisingly) kept a very low profile for the last few weeks, not wanting to give any hint as to their thinking prior to the monetary policy announcement due at 2:30 next Tuesday.

Not so every other politician, economist, or market observer, with the Treasurer leading the charge, extolling the government's track record, and putting pressure on Governor Michele Bullock and her colleagues, while also trying to claim that he's not doing just that.

The market, and most economists, are pretty well convinced that the RBA will start the ball rolling next week (although they're by no means unanimous), citing the latest CPI result of 2.4%, well within the RBA's target range.

Those going against the flow note that the RBA prefers the trimmed mean CPI number of 3.2%, which of course excludes electricity, which without generous government rebates both Federal and State, would have risen 0.2% in the December quarter, rather than falling 9.9%, and 25.2% over the year. While voters might be fooled, the RBA well understands that these are temporary handouts and don't want to jump the gun too soon.

Also on the negative side is the noise coming out of the US Federal Reserve, with US inflation rising more than market expectations, up 3.3% excluding volatile food and energy prices, leading to doubts about further cuts in the US. Added to Jerome Powell's concerns will be the inflationary effects of Trump's policies, whether it be widespread tariffs, or the mass deportation of low cost illegal immigrants driving up labour prices.

Although Trump's policies are unlikely to have an inflationary effect in Australia - although they could arguably prove deflationary depending on how the Tariff Wars all play out - the RBA is likely to be keeping a careful watch on the global knock-on effects of the Donald Show, Series II.

Whatever the outcome, Tuesday's decision will be hailed by one side of politics or the other as vindication of either their policy, or opposition thereto.  

By chance, this week we were reminded of the late, great Robin Williams, who in his 2006 film "Man of the Year", said "Remember this ladies and gentlemen: It's an old phrase, basically anonymous, politicians are a lot like nappies, they should be changed frequently, and for the same reasons. Keep that in mind the next time you vote."

Which co-incidentally, won't be too far away.

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Funds operated by this manager:

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Funds operated by this manager:

abrdn Sustainable Asian Opportunities Fund, abrdn Emerging Opportunities Fund, abrdn Global Corporate Bond Fund (Class A), abrdn International Equity Fund, abrdn Multi-Asset Income Fund, abrdn Multi-Asset Real Return Fund, abrdn Sustainable International Equities Fund