Rudi’s View: Global Recession Is Next

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Dear time-poor reader: behind covid-19 lurks a global recession. You should start preparing now

In today's Rudi's View:

-Cum Laude
-Investors Should Plan, Now
-Conviction Calls

By Rudi Filapek-Vandyck, Editor FNArena

Cum Laude

"When the going gets tough
The tough get going"
(Billy Ocean, 1988)

I am probably going to state the obvious here, as I am sure most of you are well aware of the enormous mountain the team of journalists here at FNArena is facing every morning, again and again.

I am saying it anyway: I think the team is doing a fantastic job under intense pressure. At times it feels like we have been transformed into war correspondents with the only thing missing the loud sound of bombs exploding nearby.

The key difference between 2008 and 2020 is this time around stockbroking analysts are putting in their best efforts trying to identify key risks such as too much leverage on the balance sheet and lack of sufficient cash flows, while back in the GFC they collectively froze like deer staring into a the light.

The result is comparable to an extended corporate results season for us. Usually, the peak in reporting season is situated in the third and fourth week of February and August. This year, we have extended the February workload and pressure well into March, and we are far from finished.

And that's just the daily Australian Broker Call Report.

Just wanted to express my gratitude, and how proud I am of the performance and dedication of the FNArena team. We cannot turn this Bear Market around for our readers and subscribers, but we can keep you up to date and informed under the most challenging of circumstances.

(I should finish this with a funky sounding #hashtag, but cannot think of one, alas).

Investors Should Plan, Now

You need a plan.

Whether you are sitting 100% in cash (you've done well), or 100% in beaten down Australian equities, or somewhere in between; you need a plan, and the sooner the better.

Without a plan you won't be at your best; you might even make regrettable mistakes. A well-thought through plan is your best guide right now.

After selling off by -38.8% to 4402, the ASX200 has now rallied in excess of 16% to pull back above 5000. This makes it likely that Monday's downdraught marks the low point for the intermediate term. Do note I didn't stop after "the low point", I added "for the intermediate term".

History shows things can still get a lot worse. It may not seem plausible after a rally of 16%, but it is still possible. Bear Markets are a process, they never fall in a straight line and then abruptly end. During the GFC share market indices ultimately lost more than -50%. After 1929 the bottom wasn't found until the index had fallen by -89%.

And now for the most valuable of share market truths: no index tells the story of your individual stocks.

So step one of your plan is deciding how much pain you can and are willing to bear. And for how long? When do you sell? What do you sell? Do you need to sell? Do you want to sell?

Step two is of equal importance. A global recession is in the making. Your portfolio and stock preferences date from January, before the sell-off. The world has changed. You need to change.

Time to read up on what happens during a recession. Which stocks perform best, which don't. Don't be embarrassed if you don't know. Australia hasn't had a recession in 29 years. This is kinda new. Plus this recession is borne out of a pandemic, which makes it rather unusual.

Many a strategist is predicting a sharp but short recession. If I were managing my own money, like most of you are, I would not count on it. Better safe(r) than sorry. I am of the cautious kind. Staying invested during a Grand Bear Market is already challenging enough.

Feel free to disagree, in which case you'll have to decide how much of the portfolio can be allocated to economic recovery post the recession. Be prepared you might be way, way too early.

Let's hope we now have left (most of) the forced selling behind us, and risk assets can swing around in a less violent manner. This will make it easier for all of us to make changes to the portfolio and prepare for the bad news that is yet to come.

Let there be no misunderstanding: there is a lot of bad news accumulating underneath the surface right now, and it will come out. We just don't know exactly when.

I cannot predict what is going to happen with covid-19 or high-yielding corporate credit in the USA, but I do know there is a queue gathering momentum for negative news announcements at the individual corporate level in this market.

Investors have already witnessed the early signs of it. Troubled satellite services provider Speedcast International ((SDA)) simply cannot get out of its trading halt. (Don't hold your breath). Webjet ((WEB)) had a failed capital raising. Cochlear ((COH)) and oOh!media ((OML)) successfully raised extra capital. Dozens of companies have scrapped their guidance and decided not to pay a dividend. Many more are waiting behind the curtains.

Downer EDI ((DOW)) cannot get rid of unwanted assets, and Woolworths ((WOW)) had to cancel the planned spin-off of its liquor and hotel operations. Northern Star ((NST)) has seen covid-19 interrupt its operations and had to withdraw guidance. The list goes on and on, and will only grow larger from here.

This is why you need to plan. If you are in the market, you won't be able to avoid being hit, somewhere, somehow, at some point. But you can still plan to avoid obvious booby traps, and higher risk exposures, by re-arranging the portfolio.

A few observations from today's Australian Broker Call Report (Thursday, 26 March 2020):

-Macquarie updates on EclipX Group ((ECX)) and slashes the price target to 49c, below the share price
-Credit Suisse has now reduced its price target for FAR Ltd ((FAR)) to 3c from 10c
-Morgans has lowered its price target for Firstwave Cloud to 11c from 24c
-Macquarie dropped its price target for G8 Education ((GEM)) to 50c, below the share price

Irrespective of what happens to global covid-19 curves, the global recession is coming, and it will soon start showing up in economic data and indicators. You should start preparing now.

FNArena subscribers have 24/7 access to a dedicated section on the website on my research into All-Weather Performers. In addition, my recent Weekly Insights and Rudi's View stories contain lists and portfolio suggestions from equity strategists and market analysts elsewhere, including further below.

Do note: the FNArena-Vested Equities All-Weather Model Portfolio has sold out of Macquarie Group ((MQG)). Its business model relies on financial markets that are operating freely and efficiently; this is no longer the case.

In addition, pressure on the Oil & Gas sector and on infrastructure operations, including airports, has the ability to create some serious negative news flow for the Golden Doughnut.

We decided we are more comfortable when observing from the sideline. It's a risk assessment.

Conviction Calls

Investing during a Bear Market requires maximum flexibility. In other words, when the facts change, I change my mind. What do you do, Sir? (John Maynard Keynes).

And so it is that Wilsons has removed Mosaic Brands ((MOZ)) from its selection of High Conviction Buy recommendations. The sharp escalation in covid-19 fallout in Australia and New Zealand has forced the closure of all retail outlets trading under well-known labels such as Noni B, Rivers, Katies and Millers, affecting 6800 staff members.

The company has managed to negotiate favourable lease terms with its landlords, but there is no compensating the significant loss in sales. Analysts at Wilsons assume shops will remain closed until June and then only re-open gradually. The result is a forecast -89% drop in EPS for FY20, to be followed by a steep rise in profitability in the two following years, but even so, FY22's forecast of 7.4c still doesn't match last year's 9.4c.

Investors hoping to buy the shares for a quick recovery in dividends are also on a road to disappointment with Wilsons forecasting a payout of 0.5c per share only in FY21, and then a rise to 1.5c for a yield in excess of 6% (at today's share price). There won't be any dividend this year, for obvious reasons.

Just as a side-remark: Solomon Lew's Premier Investments ((PMV)) is taking a hardcore approach in order to force his landlords to the negotiation table. If anyone wants to know why shares in Vicinity Centres ((VCX)) and Scentre Group ((SCG)) have fallen as deeply as they have, look no further. You have found the answer.

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Analysts at Macquarie have identified what they believe are 14 stocks that are best placed to benefit from the ultimate recovery once this covid-19 pandemic has been dealt with. Macquarie has taken the view that 2020 will be dominated by the virus, but 2021 will be all about post-pandemic recovery.

On this basis, they have selected Aristocrat Leisure ((ALL)), Amcor ((AMC)), Cochlear ((COH)), Fortescue Metals ((FMG)), Goodman Group ((GMG)), Harvey Norman ((HVN)), Northern Star, Pushpay Holdings ((PPH)), and REA Group ((REA)) -all beneficiaries from a weaker Aussie dollar- plus Cleanaway Waste Management ((CWY)), Medibank Private ((MPL)), Steadfast Group ((SDF)), TechnologyOne ((TNE)), and Transurban ((TCL)).

It goes without saying, balance sheets from all companies mentioned are deemed relatively resilient to weather the challenges that will present during this year's economic recession.

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While wild swings kept on dominating the Australian share market last week, Bell Potter tech sector analysts Chris Savage and TS Lim updated their thoughts and preferences for the sector in Australia. The three key picks are (in order of preference) Appen ((APX)), Uniti Group ((UWL)) and Citadel Group ((CGL)).

Equally noteworthy, there are very few tech stocks under coverage at Bell Potter that do not carry a Buy recommendation. These are Infomedia ((IFM)) and WiseTech Global ((WTC)), both on Hold, while Envirosuite ((EVS)) is rated a Speculative Buy.

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Equity strategists at UBS have one firm message for investors: get ready for the economic recession that will follow in the wake of this year's virus pandemic.

Translated into forecasts for earnings per share (EPS), UBS points out history shows economic recession means average EPS will fall by -32% from peak to trough, involving an average decline of -44% for Resources, -37% for Financials and -25% for Industrials ex-Financials.

UBS strategists would not disagree with the general assessment that Australian equities, after the steep fall from the February peak, now seem attractively priced but the ultimate decision maker whether this will prove the case is the labour market.

Were unemployment to spike by more than 3%, and the economic recession to extend beyond the current calendar year, investors should expect shares to fall a lot deeper.

The strategists have selected a number of ideas for investors ("favoured names") and these include Aurizon Holdings ((AZJ)) and APA Group ((APA)) as Defensive Income options. The strategists also like ANZ Bank ((ANZ)) and Woolworths ((WOW)).

Another category of stocks that should shelter portfolios during recession is Defensive Growth. Here UBS remains attracted to CSL ((CSL)) and ResMed ((RMD)).

Stocks UBS strategists do not like include AMP ((AMP)), IOOF Holdings ((IFL)), Afterpay ((APT)), Japara Healthcare ((JHC)), Regis Healthcare ((REG)) and G8 Education ((GEM)).

As one would have inferred from the favouritism towards high PE stocks CSL and ResMed, UBS remains confident that exceptionally low interest rates and bond yields, combined with a scarcity of sustainable growth in Australia implies investors will continue to pay a premium for Quality Growth stocks.

Within this context it is interesting to note UBS's observation that low PE stocks have been punished a lot harder during this sell-off.

One interesting fact pointed out by UBS is that APA Group, since listing in 2000, has never cut its dividend. A true Australian based dividend Aristocrat thus.

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Those same strategists are responsible for UBS's Model Portfolio and two weeks ago they decided to reduce exposure to discretionary retail as it became obvious there would be an increasingly larger fallout from the covid-19 pandemic. So out went Adairs ((ADH)), Flight Centre ((FLT)), Harvey Norman ((HVN)), and Webjet.

Instead UBS reduced the underweight position of the banks, and increased exposure to Woolworths, while also adding APA Group and AusNet Services ((AST)). Most preferred stocks remain CSL, ResMed and now also ANZ Bank ((ANZ)). Least preferred AMP, Challenger ((CGF)), Afterpay, and IOOF Holdings.

(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: info@fnarena.com 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.)  

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