Rudi's View | Oct 17 2019
Dear time-poor reader: the real question to ask might not be what is the outlook for equities, but rather for which part of the share market exactly?
In this week's Weekly Insights (published in two parts):
-Does (Lack Of) Substance Mean (Lack Of) Momentum?
-Conviction Calls – Part One
-Uncorrelated Yield – Research Reports
-Conviction Calls – Part Two
-Rudi On Tour
[Items not in bold are included in Part Two, which will be published on Friday morning on the website.]
Does (Lack Of) Substance Mean (Lack Of) Momentum?
By Rudi Filapek-Vandyck, Editor FNArena
Brief recap of what has transpired across the Australian share market since January: upon an initially tepid recovery from deeply oversold levels, equity markets put in a multi-month rally which saw cheaper-priced laggard stocks lead the rest of the market higher by some 20% by late July (total return, including dividends).
In professional funds management parlance the period can today be classified as a brief return to outperformance for "Value" over "Growth". In other words: this was the time for miners and banks, and for industrial cyclicals to shine. It's not that the operationally more solid Growth performers weren't performing; they still did, just not to the same extent as their much cheaper priced brethren.
As the general focus started shifting to the increasingly challenged global outlook, and to the fact many companies operating under the "Value" label were issuing profit warnings ahead of the August reporting season, momentum in the share market swung back to the relative safety of proven, reliable performers such as CSL ((CSL)), REA Group ((REA)), Goodman Group ((GMG)) and smaller cap popular favourites Afterpay Touch ((APT)), Jumbo Interactive ((JIN)), and others.
The swing in relative momentum proved justified throughout the August reporting season with most stocks in the "Growth" basket meeting or beating market expectations, while their (still) cheaper priced peers, in general terms, continued to display weakness, vulnerabilities and an overall inability to beat already much reduced expectations. Underlying, the first cracks have started to appear in Australia's outlook for shareholder dividends, but this story will have a much longer tail ahead.
Shortly after the August reporting season, global equities made another attempt to swing momentum back to "Value" away from "Growth", at times helped by corrections in bond yields and pompous announcements by the White House marketing machine about the Greatest Inter-Country Deal about to be signed off on in human history.
Naturally, if such a deal were ever forthcoming, and it would genuinely stimulate economic growth in 2020 and beyond, this would undoubtedly benefit miners, banks and other cyclicals, which is why these shares rally harder whenever financial markets decide to run along with the official White House narrative.
In the absence of any concrete appeasement containing a lot of substance, those same cyclicals, otherwise referred to as "Value" stocks, continue to face slowing economic momentum, and possibly worse. Ongoing negotiations between the USA and China, with regular updates on prospective outcomes, have directed investors' attention away from corporate profits, and from specific threats and vulnerabilities.
Here is where things might become interesting in the coming weeks. The Q3 corporate results season in the US is about to take off. In Australia, investors focus is about to be awoken by banks reporting financial results, as well as the likes of Australian Pharmaceutical, Unibail-Rodamco-Westfield and Orica, all firmly in the "Value" basket, while expectations remain buoyant for quarterly and out-of-season financial reports from "Growth" companies including ResMed, Xero, TechnologyOne and Macquarie Group.
Of equal importance: the AGM season for corporate Australia is about to commence and this sees many boards updating or issuing guidance for the first half or full financial year, and shareholders will be voting on remuneration and other resolutions.
With general sentiment cautious but positive and share prices in general terms "not cheap", while also drawing a direct reference to ongoing tough circumstances for large parts of the local share market, only weeks after August delivered possibly the weakest performance from corporate Australia post-GFC, it seems but plausible this latest attempt by professional funds managers to favour "Value" over "Growth" could inject, at the very least, many a twist and turn into daily market moves, with elevated market volatility as the cherry on the cake.
"Growth" stocks might have enjoyed some seven years of relative outperformance over "Value" in the Australian share market (in US equity markets Growth outperformance is now in its 11th year), the key problem with switching into "Value" today remains slowing economic growth, while bond yields are making no attempt to jump higher (outside of temporary "corrections"), inflation remains absent and central bank stimulus remains the all-important driver, whether investors like it or not.
Against this background, the next few weeks can provide a number of fresh insights, and raise additional questions. Maybe this is a time when one shouldn't be too confident either way?
AGM Season In Australia
Both stockbroker Morgans and analysts at Macquarie released their previews for the upcoming AGM season in Australia.
Morgans has selected Macquarie Group ((MQG)), Cleanaway Waste Management ((CWY)), IPH ltd ((IPH)), Super Retail ((SUL)), Accent Group ((AX1)) and Afterpay Touch ((APT)) for a potential positive surprise. Candidates selected for negative admissions include Flight Centre ((FLT)), Bega Cheese ((BGA)), Pendal Group ((PDL)) and Qube Logistics ((QUB)).
Investors should note since the release of that preview, Flight Centre did issue a profit warning while Pendal Group's quarterly update was apparently not as bad as feared, with its share price regaining upward momentum this week. The story of these two opposites further adds to the complexity of owning cheaply priced stocks that continue to be surrounded by bad news.
Analysts at Macquarie point out recent AGM seasons in Australia have seen aggregate trading volumes for stocks pick up by some 37% on days of a company's AGM. Another interesting observation is that stocks tend to underperform, albeit only marginally, post AGM. They tend to catch up after approximately four weeks (but not last year).
In addition, those company boards that receive a "strike", meaning investors vote down the executive remuneration report, also tend to subsequently underperform. The incidence of such strikes has been on the rise in Australia in recent years. Last year total strikes amounted to 9.3% of all AGMs.
Under the current two-strike legislation, if more than 25% of shareholders vote against a remuneration report two years in a row, this automatically triggers a motion to spill the Board.
Boards that received one such strike last year include ANZ Bank ((ANZ)), Austal ((ASB)), Brickworks ((BKW)), Clean Teq Holdings ((CLQ)), Computershare ((CPU)), Emeco Holdings ((EHL)), Goodman Group ((GMG)), Harvey Norman ((HVN)), Karoon Gas ((KAR)), Mineral Resources ((MIN)), Myer ((MYR)), National Australia Bank ((NAB)), Tabcorp Holdings ((TAH)), Telstra ((TLS)), and Westpac ((WBC)).
For both Karoon Gas and Myer last year marked the second consecutive strike. For Mineral Resources it was the third in a row.
Companies that may well deliver a positive catalyst during AGM season, according to Macquarie, include a2 Milk ((A2M)), Charter Hall ((CHC)), Domino's Pizza ((DMP)), Lendlease Group ((LLC)) and Origin Energy ((ORG)) among ASX100 members. Outside of that index Macquarie is anticipating potential positive news from Autosports Group ((ASG)), Bapcor ((BAP)), IDP Education ((IEL)), IPH ltd, Lovisa Holdings ((LOV)), Polynovo ((PNV)), and Steadfast Group ((SDF)).
It appears both Morgans and Macquarie have nominated IPH ltd on the potential for management to achieve higher than anticipated synergies out of the acquired Xenith IP.
Companies considered at risk of making a bad news announcement include Regis Healthcare ((REG)), Sims Metal Management ((SGM)), Wagners Holdings Company ((WGN)), Blackmores ((BKL)), and Genesis Energy ((GNE)).
To further muddle the how best to navigate the AGM season this year guide, investors should also consider the following observation from Macquarie analysts post a positive surprise at the company's AGM: "on average investors perceive an overreaction in the short term resulting in a short-term negative drift in the first three weeks following the AGM. Thereafter sentiment reverts and the stocks begin outperforming the market on aggregate."
There is market speculation that CSL could potentially lift guidance for the full financial year at its AGM this week. No doubt this is one contributing factor to the share price rising past the consensus price target of $247.27 on Tuesday, further closing in towards the newest price targets which are all above $250.
UBS 20/20 Model Portfolio
The reason as to why professional funds managers are trying to outperform through cheaper priced "Value" stocks is because, in theory, there are higher returns to be had from beaten down, laggard shares prices of, say, Karoon Gas, Galaxy Resources ((GXY)), Lycopodium ((LYC)) and Shine Corp ((SHJ)), but "in theory" does not automatically translate into "actual outcome", and timing is definitely not guaranteed.
One common example is bank/insurer Suncorp ((SUN)) whose share price has been ranging between (roughly) $12.50 and $15 since early 2014. This means the shares have essentially not generated much in terms of sustainable return, outside of the dividends paid over the period.
Over those five years the stock has featured a number of times as looking attractively priced, and as offering an attractive yield, but now stockbroking analysts are forecasting a steady decline in dividends for the years ahead. Unless this dynamic reverses, it is difficult to see how the Suncorp share price can rally back to the top of the range, let alone beyond it.
Another reason to re-position portfolios towards the "Value" segment in the market is the belief that central bankers will apply everything in their toolkit to support growth, and to reset growth to a higher level. If they succeed in their mission, global economies can potentially be in a different environment altogether by this time next year. Either that, or governments will have to jump in as well.
The opposite view is that either central bank policies are losing their might and the next economic recession is already unavoidable, or maybe "Value" investors are jumping the gun way too early. What about the third scenario whereby central bankers keep on pushing cash rates and bond yields towards zero (and possibly beyond) but the outcome remains tepid inflation and low growth?
The latter view is backed by equity strategists at UBS who recently launched their 20/20 Model Portfolio on the central belief that interest rates are now in a lower-for-longer environment and real growth opportunities are to remain few and far in between on the share market.
On this basis, the two most preferred sectors in the UBS Model Portfolio are Healthcare and Technology. Most preferred portfolio inclusions are CSL, REA Group, and Altium ((ALU)). Least preferred stocks are Sims Metal Management and Stockland ((SGP)). The latter because of ongoing tough dynamics for retailers combined with weak land and residential sales.
UBS clearly continues to like selected AREITs, such as Shopping Centres Australasia ((SCP)), GPT ((GPT)) and Charter Hall ((CHC)), as well as Transurban ((TCL)) and Woolworths ((WOW)). More technology is represented via Carsales ((CAR)), Appen ((APX)), ResMed and Nanosonics ((NAN)), though the latter two are officially branded as "healthcare" stocks, while Carsales resides under the "media" label.
Treasury Wine Estates ((TWE)) is in there too, as is a2 Milk, and gold miner Evolution Mining ((EVN)). Banks and other financials, building materials and other cyclicals; they are not on UBS's most preferred list.
Special Note: FNArena continues to monitor corporate results in Australia via a dedicated section on its website: https://www.fnarena.com/index.php/reporting_season/?
This section also includes a corporate results calendar.
Conviction Calls – Part One
Analysts at Morningstar have not been big fans of investing in mining stocks for quite a while now, and they usually emphasise to investors mining companies are ultra-cyclical, require a lot of capital and have no moat.
Nevertheless, Morningstar recently took it upon itself to rank local mining stocks in line with the perceived "quality" of the businesses. As such, it probably surprises no-one the two highest quality miners listed on the ASX are named BHP Group ((BHP)) and Rio Tinto ((RIO)), followed by Newcrest Mining ((NCM)) and Iluka Resources ((ILU)).
From then onwards the ranking splits in two groups:
-short life metal miners with relatively low operating costs
-other bulk commodity miners
Stockbroker Baillieu has updated its selection of Top Picks (most preferred exposures) among mid and small cap ASX-listed companies.The selection contains Adairs ((ADH)), Ardent Leisure Group ((ALG)), Bapcor ((BAP)), EQT Holdings ((EQT)), Hansen Technologies ((HSN)), Monadelphous Group ((MND)), MNF Group ((MNF)), Steadfast Group ((SDF)), and Village Roadshow ((VRL)).
Analysts at UBS lined up their favourites among consumer stocks in Australia and the selection consists of Flight Centre ((FLT)), Treasury Wine Estates ((TWE)), a2 Milk ((A2M)), and Premier Investments ((PMV)).
While the report was released prior to Flight Centre's profit warning, we note the price target has hardly budged and UBS's rating for the shares has remained Buy.
On Monday, I was interviewed by Peter Switzer about the Trade War and where equities might be heading. A separate video fragment has been uploaded to Youtube and can be accessed here:
Rudi On Tour In 2020:
-ASA Hunter Region, near Newcastle, May 25
(This story was written on Monday and Tuesday, 14 & 15 October 2019. Part One was published on the Tuesday in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two will be published on Friday).
(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: firstname.lastname@example.org or via the direct messaging system on the website).
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(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.)