Rudi's View | Mar 08 2018
In this week's Weekly Insights (published in two separate parts):
-The Battlelines Are Drawn
–February 2018 Reporting Season Review
[Note the non-highlighted item appeared in part one on the website on Wednesday]
The Battlelines Are Drawn
By Rudi Filapek-Vandyck, Editor FNArena
According to the ruling view that is on display daily on Finance TV and in mainstream newspapers, not to mention the many blogs and other forms of finance commentary on the Internet and on social platforms, inflation is back and the world needs to prepare for much higher bond yields.
In the share market, according to the same view, the risk is that higher valued growth stocks will de-rate and thus trigger losses for investors whose portfolios are not yet in tune with the new environment.
Very few are willing to stand up against the general opinion, which is supported by scary warnings from the likes of Kenneth Rogoff, Professor of Economics at Harvard University and pretty much seen as the Ubermensch Economist of his time, and from Magellan CIO Hamish Douglas.
If Rogoff's prediction proves correct, global bond yields will be significantly higher in a year's time, and financial markets are not positioned for it today. Douglas wagers a significant sell-off for equities sometime in 2018 is now a 50/50 proposition, which is why Magellan has been upping the cash component in the investment portfolio in recent months.
Forget about Trump's erratic deal making strategies, this is all about rising bond yields on the back of returning inflation and backtracking central bankers.
The irony here is that, apart from defenseless bond proxies which have all been de-rated mercilessly, there is very little signaling from actual share prices action that such portfolio re-directing is the most accurate course to follow. Take the so-called reflation trade. Back in late 2016 it was all about reflation and buying up on miners, energy companies and banks.
But in 2018 those same sectors are finding the going a lot tougher, despite the same commentary from the sidelines, over and over, and over, and over, again.
In fact, as we are now in the third month of the calendar year, energy stocks, as a group, are well down for the year-to-date, and so are the financials, and to a lesser extent the miners. But what is most striking is that the two sectors in the Australian share market that have significantly outperformed are the two that should have been sold according to the (apparent) consensus view; healthcare and technology.
Never underestimate the potential for markets to surprise?
ASX-listed Janus Hendersons ((JHG)) has been touring main Australian cities in recent weeks, with presentations to the local investor community also including the out-of-consensus in-house view that investors should be bracing for an economic slow down, which will eventually impact on the Fed's policy, as well as on inflation readings, bond markets and equities.
According to some market watchers, there is an argument to be made this slowing down is already happening as suggested, for example, by Citi's global economic surprise index. It's early days yet, the signs are at best inconclusive, and definitely not everybody agrees with this view/observation.
At Janus Henderson the view is the Fed policy shift is already impacting on global liquidity and whereas most see the world as still swimming in cash, and the Fed merely normalising, Janus Henderson suggests "tightening" is the operative word, with most experts underestimating what is occurring below the surface of seemingly buoyant economic data and indicators.
At the very least, it's quite refreshing to know one of the successful investors listed on the ASX is not singing from the same hymn sheet as many of the worry beads and reflation trade proponents are. This, of course, doesn't mean equity markets won't remain volatile or they won't have a correction this year.
There is an argument to be made here that if the world is truly slowing down, and the Fed remains intent to stay on course, the chances for a correction will definitely increase.
And that just about sums up 2018: widely diverging views and predictions, price action that surprises, lots of risk from known unknowns and from unknown unknowns. President Trump's economic advisor Gary Cohn resigning is simply the latest of such events.
Only one certainty stands tall for the year ahead: volatility is back. Better get used to it.
Bell Potter analyst TS Lim has updated his selection of most preferred technology stocks listed on the ASX. His current top three "Key Picks" are The Citadel Group ((CGL)), Infomedia ((IFM)) and TechnologyOne ((TME)). WiseTech Global ((WTC)), nominated as Key Sell for the sector in December, remains a Key Sell, despite the sharp fall in share price on the back of a disappointing result in February.
Altium ((ALU)) was also nominated as a Key Sell in December, but that proved the wrong call (no mention of it in the sector update, though) with the share price today substantially higher on a quality "beat" in February and with Bell Potter having moved the rating back to Hold from Sell. Begrudgingly.
No one wants to take the telephone calls from clients who sold on the December recommendation and are asking questions today.
Bell Potter maintains the future is bright for The Citadel Group, while Infomedia released yet another set of weak financials in February, but the thinking here is that things can only get better. Bell Potter is forecasting much better performance from the perennial underperformer.
TechnologyOne remains a Key Pick because, simply put, the business model remains robust and healthy, with the outlook for strong growth and the share price languishing, which means a valuation gap has opened up with other technology stocks, such as WiseTech Global and Altium.
I, of course, concur with the latter assessment and TechnologyOne remains a core holding in the All-Weather Model Portfolio.
Senetas ((SEN)) and Appen ((APX)) both lost their spot on the Key Picks selection, with both downgraded to Hold since December. Appen's share price has performed splendidly, Senetas' not so as investors try to figure out what exactly is the future for distributor Gemalto in Europe, and how might it impact on the relationship with the Australian encryptor.
One technology company that impressed analysts at Wilsons is Melbourne IT ((MLB)), one of few local remnants from the dotcom mania years. Growth should be a lot lower than the dazzling 106% and 55% recorded in the two years past, but there should still be double digits on offer and that makes the share price rather attractive, according to Wilsons.
Melbourne IT has been elevated to Wilsons' list of Conviction Calls with the added observation the yield doesn't look too bad, given the PE ratio remains relatively benign.
Bell Potter also covers the stock and rates it a Buy with a $3.50 price target. Wilsons' Buy rating is accompanied by a $3.59 target.
Strategists David Cassidy and Jim Xu at UBS have, post February reporting season, stuck with their year-end target for the ASX200 of 6275, implying double digit return can still be achieved if one includes dividends and franking. The strategists have added BlueScope Steel ((BSL)) and Webjet ((WEB)) to their preferred list of stocks, labeled 'Key Portfolio Overweights".
Other stocks on the preferred list are Origin Energy ((ORG)), Janus Henderson ((JHG)), BHP ((BHP)), Aristocrat Leisure ((ALL)), AGL Energy ((AGL)), Star Entertainment ((SGR)), Qantas ((QAN)), Link Administration ((LNK)) and Woodside Petroleum ((WPL)).
In terms of interesting observations, I picked up the following in UBS' strategy commentary:
"It is interesting that the growth segment has not been hampered by the recent rise in bond yields albeit the Australian 10 year has been more subdued. In the growth area we continue to overweight the US focussed Aristocrat, Resmed as well as small cap IT play Next DC. We see attractive GARP in AGL Energy, Brambles, Star Entertainment Group, Tabcorp and Woolworths. We concede some of these results were underwhelming but we still see the attractive medium-term growth thesis at a reasonable price as intact in each case."
Macquarie analysts, reviewing the February reporting season for the local healthcare sector, observed most companies reaffirmed their guidance, but CSL ((CSL)) once again stood out by lifting its previous range for the year. Growth inside the sector is becoming more divergent with more subdued growth rates for service-based businesses with domestic exposure.
Taking a three-year horizon, and then reflecting back on today's share price valuations, Macquarie finds CSL and Ramsay Health Care ((RHC)) do not look expensive, but Cochlear does. Least preferred exposure: Primary Health Care ((PRY)). Most preferred: CSL.
Healthcare analysts at Credit Suisse also retained CSL as most preferred long term exposure, even though the sector overall looks expensive trading on meaty premia against other segments of the Australian share market. Least preferred exposures according to CS are Healthscope ((HSO)), Primary Health Care and Ansell ((ANN)).
The four unit team of retail analysts at Citi dared to stick their neck out, post February reporting season, and nominated Accent Group ((AX1)), Beacon Lighting ((BLX)) and Michael Hill ((MHJ)) as their highest ranked, most preferred exposures to the domestic small cap retailers segment.
Elsewhere, Citi strategists removed Caltex Australia ((CTX)) from the Focus List Australia/New Zealand, though they emphasised the company's fundamentals remain sound. The roll-up of the franchise model will be weighing down earnings growth in the short term. Against this sits an undemanding valuation, suggest the strategists.
Stocks that retained their inclusion are Aristocrat Leisure, ALS ltd ((ALQ)), Goodman Group ((GMG)), Lend Lease ((LLC)), Newcrest Mining ((NCM)), NextDC ((NXT)), Qantas ((QAN)), Rio Tinto ((RIO)), Star Entertainment Group, and Trade Me ((TME)).
The list of High Conviction Stocks at stockbroker Morgans also saw two changes post the February reporting season. Morgans added BHP ((BHP)) and removed Corporate Travel Management ((CTD)) justifying the latter by referencing the strong share price rally that has occurred since the financial result.
UBS analysts argue there is opportunity for investors amidst tough market dynamics for companies exposed to consumer spending in Australia. The broker's Key Picks are Flight Centre ((FLT)), Woolworths ((WOW)) and Costa Group ((CGC)).
Audio interview earlier in the week on Reporting Season and what is happening in the share market:
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Friday, 11am Skype-link to discuss broker calls
Rudi On Tour
-An Evening With Rudi, Paddington, 11 April
-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 15 July
-Presentation to ASA members and guests Wollongong, in September
(This story was written on Monday 5th March and the second part on Wednesday 7th March. This first part was published on the Monday in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. This is Part two).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: email@example.com or via the direct messaging system on the website).
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