If Tim Carleton from Auscap Asset Management has conviction about one thing, it’s that our home country bias should be embraced, not managed.

“Don’t get bearish, Australia,” he tells The Australian Financial Review. “This is the best spot to invest over our lifetimes. I have no doubt about that.”

Carleton’s conviction will be on full display on Friday, when he makes his third appearance at the annual Sohn Hearts & Minds Investment Leaders Conference, where stock-pickers share their best ideas in the name of medical research.

After a dramatic year in bond and stock markets that has weighed on the $550 million listed investment company, which executes the best ideas of conference presenters, Carleton says it’s a great idea to buy into both the ASX listed Sohn Hearts & Minds fund (known as HM1) at its double-digit discount to asset value, and a ticket to the Hobart event.

“There’s a fair bit of value around domestically and internationally,” he says.

Presenters keep their tips close to their chests. But if the portfolio of Carleton’s Auscap Asset Management is any guide, it’s likely to be a bet on the Lucky Country.

“Over the last 100 years Australia has performed better from the stock market perspective than the US, and it’s been an extraordinary 100 years for the US,” says Carleton.

“Yet, on a go-forward basis, you’d have to say there are more tailwinds for this economy than there are for the US.”

Time to go shopping

In his previous speaking gigs at Sohn Hearts & Minds, Carleton pitched Macquarie Group in 2018 and retailer JB Hi-Fi in 2019. The out-of-favour Australian retail sector is where he believes good money can be made.

“Opportunities are in sectors that the market is pessimistic about based on what Howard Marks would consider to be a level-one observation: interest rates are going up, therefore, disposable in households is going down, and therefore discretionary expenditure gets hit.

“We think you need to look a little deeper and analyse what’s actually going on in individual companies. If you do that, there’s a lot of compelling opportunities.”

About a third of Auscap’s portfolio is invested in consumer discretionary stocks, according to its November update. That still includes JB Hi-Fi, along with Lovisa, Premier Investments, and Nick Scali.

Carleton says the disconnect is due to the market under-estimating how resilient Australian household balance sheets are, but there’s also an element of mis-categorisation when it comes to the retail category.

Specifically, the goods that listed discretionary retailers sell have become more like essential items over the last 20 years, a point he says is underappreciated by the market. That includes electronics like mobile phones and laptop computers.

“You tell me which person could do without either of those products in their house for even a single day. I would suggest to you that these are among the least discretionary items.”

The migration of electronics from discretionary to staples is partly due to our increasingly connected world, but also, two decades of deflation as they’ve become a smaller part of the household budget.

While Carleton is a natural stock-picker, he devotes extensive time and effort to studying the macro environment, and 2022 has been all about the macro, as the war on inflation drives the direction of asset prices.

The peak is near

In July, Auscap wrote a detailed 22-page update examining the macro environment to determine if and when inflation was likely to peak, and what that would mean for shares.

It concluded that it was “reasonable to expect that many of the inflationary pressures that are currently driving global inflation are likely to abate over the coming year”.

So, when the S&P/ASX 200 surged almost 3 per cent on Friday on a high – but lower than expected – US inflation result, Carleton was feeling good about how he had positioned his portfolio.

If history is any guide, he says, sharemarkets bottom when inflation peaks. That’s been the case in five of the last six episodes, explaining the market’s spectacular end to last week.

The signs that inflation may have peaked in the US, and that it will peak some time next year, are there. He notes that global shipping rates are down 73 per cent from their peak in September 2021.

“They were a large part of the reason inflation picked up for different categories. Anything that is imported into our country has the shipping cost associated with it.

“We knew this firsthand because of Nick Scali. They had told us that shipping costs had gone up so much that for some items they were representing up to a third of the cost of the product, which is pretty extraordinary, given it’s selling big ticket items.”

Inflation, Carleton says, is actually positive for the most efficient, well-run retailers. Since all operators experience the same cost input inflation, the less efficient retailers are under more pressure to increase prices.

That, he says, allows leaner ones to lower prices to capture market share, or to simply earn higher margins because their cost base is lower than their peers.

“In that environment, you actually want to own the efficient retailers because they will probably deliver results well ahead of expectations.”

Auscap’s origin story

Carleton founded Auscap in 2013 with his former Goldman Sachs trading colleague Matt Parker.

It has grown into one of the most well-regarded boutique Australian equities managers, and has delivered annualised returns since inception of 15.3 per cent. compared to 8.9 per cent for the broader All Ordinaries index.

The fund is down 12.4 per cent over the calendar year, but up 17.3 per cent so far this financial year.

Carleton says it’s been a period driven by sentiment rather than outcomes.

“We’ve seen companies give pretty significant upgrades and trade down, because the expectation is that the bearish news will come next time.”

But he’s comfortable with how Auscap’s companies are performing in the portfolio, and he’s been enjoying hitting the road, visiting operations around the country.

Which brings us back to Australia, and why Carleton believes it will be an investors’ paradise for years.

The reasons he lists are favourable demographics, a functioning democracy with rule of law, an abundance of soft and hard commodities, and all the ingredients to be at the centre of a green energy revolution.

“If you think about the big picture issues that are going to determine the path for Australia over the next 50 years, they all look fairly positive from our perspective,” says Carleton.

“The companies that operate here and the people who live here will be natural beneficiaries.”

The Australian Financial Review is a media partner of sohnheartsandminds.com.au

This article was originally posted by The Australian Financial Review here.

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