Hofflin: Big moves are creating great value on the ASX

Patrick Ian Polk (0:03)

Today on The Rules of Investing podcast, I'm talking with Dr. Philipp Hofflin, analyst and portfolio manager at Lazard Asset Management. The last time I spoke with Philipp, he issued a warning on the levels of complacency in markets and explained why he had been busily buying an eclectic mix of stocks, including CSL, that could be broadly described as fallen angels. Today, we're going to discuss how those fallen angels have performed and why the cocktail of falling liquidity and rising volatility in the larger stocks is creating opportunity.

We'll also dive into the front page headlines, including bod market signals, energy and the domestic economy, where house prices are dominating the conversation. Now make sure you stick around to hear about the stock that Philipp would be happy to own if markets would shut for the next five years. Now, Philipp, it's great to catch up. I always enjoy our conversations. Welcome to The Rules of Investing.

Philipp Hofflin (0:55)

Thank you very much, James. It's a pleasure to be here.

Patrick Ian Polk (0:57)

Now, I've given people an overview of what we'll be talking about today, but before we do, you're a value investor.

Let's cut the jargon. Give me the 101 or give the audience the 101 on what value investing is.

Philipp Hofflin (1:08)

Look, I think the simple summary is value investing is buying low expectations.

It's like the old joke about it's great to be a pessimist because you're never disappointed. It's very much like that. You buy low expectations, low multiples, high cash flow yields, and so forth. In the long run, you do better than if you hope for some great transformation in the future, and that's probably it.

Patrick Ian Polk (1:35)

Well, we'll talk about it, what it looks like in practice in a bit more detail as we go on, but let's talk about the backdrop in markets at the moment. There's a confluence of factors weighing on the domestic economy, and the list is long. Inflation, high oil prices, rate hikes, falling house prices.

What does this mean for the market outlook in your eyes?

Philipp Hofflin (1:56)

Yeah, look, let me preface everything that is the sort of discussion, because you're talking to a value investor, and things can turn into a real teddy bear's picnic, right? Let me preface everything by saying these are risks, so they don't have to happen. The other thing I'd like to say is, there are always things to worry about. But having done this for a fair few years now, there are much more worrying signals and dynamics out there than there have been in the past in a really fundamental sense. And one of the things about the things you listed, James, is that they share something in common, and that is inflation. And that is, I think, the biggest problem out there at the moment. If I just quickly run through the setting, in Australia and in the US, underlying inflation is running at 3% to 4%. So it's already too high. The starting point isn't great.

There's a huge artificial intelligence capex boom in the US. That means that IT costs, which normally fall over time, have turned enormously inflationary. There's a wonderful chart from the USPPI which shows that, on average, hardware costs fall. They're deflationary. And by the middle of the year, they were up 30%.

Next time you buy an iPhone, you'll notice that.

And then there's the energy question. Now, energy prices per se aren't that high, right?

Let's call it $95. Pre-GFC in 2007, in today's dollars, they were over $200.

Not that high per se, but they have gone up. And the real problem is that inventory levels around the world are just going lower and lower and lower. And the risk that something breaks and they really spike increases. Already, you know, the number you see quoted is the futures price. When you look at dated Brent, which is for delivery, it's already 15% higher. So there's a real squeeze on physical delivery. And that's not all on the energy side, because the other thing that's really tied is refining capacity. So the refining margin, or the crack spread as it's called, is sky high.

So Viber and Ampol are making huge amounts of money on the refineries. There was a time, I think a month ago or so, when the diesel crack spread was higher than the crude price. In other words, it cost you more to refine a barrel than the actual barrel cost you in the first place. And the reason for that is, there's a lot of refining shut in in the Gulf. But there's another reason. The Ukrainians keep on hitting Russian refineries. There are times when half the Russian refineries are either offline or are running at reduced capacity. And the Russians are huge refiners, particularly of diesel. So they normally export a lot of diesel, and there are stories that have been importing diesel. So those two conflicts are going to keep the pressure on.