Lex Hall: The post-covid earnings recovery is under way and has a long way to go according to Ned Bell from Bell Asset Management, we're going to talk about that. We're going to talk about the US earnings season. And we're also going to discuss inflation.

Ned Bell, welcome back to Morningstar.

Ned Bell: Thanks for having me, Lex. Great to be here.

Hall: Likewise, it's good to see you, again from Melbourne. Now, tell us about this recovery and why you're sort of confident that it still has a way to play out.

Bell: Yeah, so I think, as we've spoken about in the past, earnings last year in 2020, and covid, got hit particularly hard. So, for example, the small and mid-cap sector of the global equity market earnings were down by (15 per cent), took a big hit. But I think, there are two key points I'd make, first of all, companies right across the market cap spectrum, they cut their cost basis right back. And what that has effectively done, it set companies up for a period of a very strong earnings recovery, that we've really not seen in the past. And so our way of thinking has been in the last three months that as economy started to accelerate globally, and you start seeing top line growth accelerate, the magnitude of the underlying earnings growth will be quite meaningful. And from our perspective that really hasn't been factored in by the sell side of the market yet, and it's still a long way to play out.

Hall: OK. Let's talk about US earnings season. Before we got on camera, you said you were pretty impressed by the way that's gone about. Tell us a bit more about that.

Bell: Yeah, so the US earnings season has just finished. In all honesty, I mean, I've been doing this for 25 years, it was the strongest earning season I've ever seen. So we had of the 70 odd companies we own, predominantly across the US and Canada, they beat their earnings by an average of 17 per cent, which was absolutely remarkable. We had I believe, it was 23 companies beat their estimates by more than 20 per cent I have never seen that before. So again, the magnitudes of the beats were huge. In terms of the thematics that came out and what we're hearing from management, first of all that top line revenue growth as a result of, you know, not only the stimulus to the US economy, but also the pent-up demand, in much of the consumer sector has been massive. And the cumulative effect of that has been absolutely extraordinary. So the top line growth has been extraordinary, the US consumer, simplistically the way to think about it's like they've been locked in their apartments for 12 months, have been busting to get out and spend money. And that has started to happen. The biggest problem a lot of these companies have got is the inability to meet demand, it's having the inventory there. So, that's been amazing.

The other big thematic we've heard is that a lot of companies have made the point that they've taken effectively three years of measures to do with improving their websites, taking cost efficiencies, and putting them all into one year. So again, there's been a lot of change in companies, a lot of companies have, they've taken advantage of, the old saying you never waste a good crisis. And if you take a company like YETI (YETI) for example, one I've spoken about in the past. So, later in the US market in drinkware, coolers, that sort of thing. Their online sales, they took this as an opportunity to really ramp up that part of their business. So their direct to consumer business, which is much higher margin has gone from 43 per cent of sales a few years ago to about 55 per cent, now. So there's lots of those types of stories where companies have really entrenched their positions as a result of covid.

Hall: And you say that it's still got a long way to play out, which sort of sectors do you think will will lead the charge?

Bell: Yeah. It's a good question Lex. And I think you need to break it down into a bit. First of all, within the, if you break down into, for example, the market cap buckets, the small and mid-cap stocks, as a whole have got a long, long way to play out. So that earnings recovery, we feel like they're in the second innings of a baseball game. They've taken some of the cost efficiencies, some of that top line growth is coming through. It's bit more skewed towards the US, you haven't seen that as much as what—you'll see more of that in Europe and Asia, I think in the next second half of the year. But to give you some context, the last time we saw a crisis of this, this sort of magnitude and earnings crisis was post the dotcom boom and bust and post the GFC. More small- mid-cap stocks delivered as an asset class they delivered returns bit over 200 per cent in the subsequent five years. So we feel like we're on the path to that sort of recovery.

From a sector perspective, it's hard to look past the consumer discretionary sector, that's where you've got that real alignment to what the consumer is doing. And the consumer, again, has been over 70 per cent of the US economy, and they're having money to throw in. And I think that's got a long way to play out. And again, if anything, if I look at estimates for next year, for these companies, they're way under coping the reality of what the companies are actually saying. So I think that's a long one to play out. The other sector would probably be the industrial sector. So, the US administration by no secret of their desire to get the US economy back on its feet through a lot of infrastructure projects, that will take time to play out, but I think it is still an important underpinning of the general industrial sector.

Hall: OK. And finally, Ned, I just wanted to get your quick thoughts on inflation, which has been a subject on the minds of people for a long, long time now, is it transitory and what sort of effect does it have on the end investor, people like me.

Bell: Yeah, it's a great question Lex. In short, I don't think it is transitory. I think when you think about the US economy, for example, the UBS economists were saying, predicting the US economy is going to grow by something like 8 per cent this year, I mean, that's a big number, you cannot get, you can't have that amount of growth without some inflation. I think we've been so hardwired into the idea of having no inflation, that any inflation comes as a complete shock to everyone. But you've got to break it down into, I guess, wage inflation. Now, we think that that's not transitory that will be with us for a while. What's possibly more transitory is the commodity bucket type inflation. So food inflation, cost of raw materials, that's obviously had a big pickup. In terms of how it flows through to everyone in the community. Food inflation is an obvious thing, I mean, we're hearing that food inflation, for example, in the US is skyrocketing, that's becoming quite a big issue. So, that's clearly something that hits the hip pocket of all consumers, naturally, when oil prices do what they're doing now, that also hits the hip pocket, through the (indiscernible). So, it does have an impact.

Where it has probably the biggest impact is in the companies who can't pass on those increased costs. And they tend to be, very particular industries, very low margin industries, those are the ones that and often, quite the value stocks. Those are often the ones that just don't have the pricing power. And I think those are the names that might actually become a little bit unstuck, as we start to see inflation sort of be with us for a little bit longer. And it's probably a bit better for, like quality type investing. In other words, companies that have got great franchise and pricing power. Those are the ones that we'll get through this a little bit better. But we've never seen, I don't think we've ever really seen a macro environment whereby every government around the world is simultaneously trying to stimulate their economy as much as possible. And that's the reality of the situation we're in now.

Hall: All right, Ned Bell from Bell asset management. Thank you very much for sharing your insights today.

Bell: Pleasure. Thanks for having me Lex.

Hall: I'm Lex Hall for Morningstar. Thanks for watching.