Rudi's View | May 01 2020
Dear time-poor reader: Institutional investors have been caught out long in cash and high on defensives. Plus some experts are daring to ask that question
In today's Rudi's View:
-Sceptics A-Plenty, But For How Long?
-The Last Defensives?
-The End Of The Bear Market?
-Further Upside, Downside?
By Rudi Filapek-Vandyck, Editor FNArena
Sceptics A-Plenty, But For How Long?
Bank of America's global funds managers survey for April was released more than a week ago. In today's context this equals close to an eternity, but it's still worthwhile pointing out the main observations and conclusions.
The number one reason as to why this survey attracted more than usual attention is because it revealed cash levels among global fund managers had spiked to the highest level since 9/11 in 2001.
Number one conclusion to draw is thus that overall sentiment reached a low point in April, and we have seen equity markets continue their strong recovery throughout the month.
An overwhelming 93% is expecting an economic recession in the wake of the virus pandemic, which should be no surprise. Instead, my first mental response was: what exactly did the other 7% have in mind?
The high in cash coincided with a low in total allocations to equities. Instead, fund managers favoured bonds and cash and, among shares, healthcare, staples, utilities and technology. In terms of geography, US markets were most preferred.
Out of favour were European equities, including the UK, equities in general, and, within equity markets, energy, materials, banks and industrials.
When I was reading these core observations, I couldn't help but thinking I pretty much identified the same trend-lines in my market analysis on Monday. See Weekly Insights: https://www.fnarena.com/index.php/2020/04/30/rudis-view-solving-the-share-market-enigma/
The big question mark then becomes, if all of the above is reflected in today's share markets, when will change take place?
Bank of America itself draws upon the general scepticism from the April survey to conclude the current recovery rally will soon run out of breath. The advice to investors is to start taking profits when the S&P500 in the US reaches the 2850-3000 zone.
The index entered that bandwidth on Tuesday (Wednesday morning Australian time).
The majority of survey respondents believes the post-pandemic recovery will be U-shaped, meaning it won't be fast and smooth, but rather gradual and longer-winded; probably through stages of unlocking the lockdowns.
The question what will be the catalyst to power life into distressed cyclicals came in the form of an V. This time this V stands for "vaccine" – again highlighting general scepticism about the post-lockdown recovery, which equally reflects upon (the lack of) funds flows into beaten down laggards in the out-of-favour sectors mentioned earlier.
What then might bring down the almighty technology sector? Here the answers pointed to a much stronger US dollar in response to another major credit event, which might occur on the back of three identified weaknesses the world is facing today: the energy sector, the eurozone, and emerging markets.
Remarkably, only 15% of respondents predicted the post-virus recovery will be V-shaped. Total allocations to equities in April had sunk to their lowest level since March 2009.
Key findings of the BofA survey were replicated in the local version which is published by JP Morgan. Alas, JP Morgan's survey still reflects upon March, which is even further away (what stretches beyond "eternity"?).
So fund managers carried a lot of cash in March, and their portfolios were defensively positioned. This might be why, on JP Morgan's assessment, more than half (52%) managed to handsomely beat the falling index in that month by no less than 200bp.
And now for the interesting part… on JP Morgan's experience, based upon past data analysis, whenever the local funds management industry shifts into defensive portfolio positioning, such shift usually lasts 3-4 months.
The analysts make no bones about it. Will the shift that became apparent in March last that long? they ask out loud.
I'd wager that at least some of the excess sitting in cash has found its way back into equities, in particular during the week past. We won't know for certain until the next survey updates.
There is nothing that beats the threat of severely underperforming the market. Not when you're a fund manager worried about his job or -ultimately- survival.
On my observation, news flow is of most importance during a bear market and it can hardly be denied the flow of news has carried a positive undertone in April, and it still does.
The above cartoon came across my Twitter feed during the week past. I couldn't help but thinking how clever, but also: how apposite!
Guidance Upgrades Forewarned
It's probably no coincidence both stocks are included in the stockbroker's Top Three sector picks, the third one being Catapult Group ((CAT)).
Investors might draw confidence from the fact Bell Potter does not anticipate any guidance downgrades from within the sector for the current financial year.
Canaccord Genuity has updated on its Best Investment Ideas in the Australian share market. The ideas are separated per large, medium and small cap segments, but for the ease of this report, I'll simply rank all stocks via common sector.
-Resources; BHP Group ((BHP)), Alumina Ltd ((AWC)), OZ Minerals ((OZL)), Iluka Resources ((ILU)), and Saracen Minerals ((SAR))
-Oil&Gas; Woodside Petroleum ((WPL)) and Origin Energy ((ORG))
-Banks: National Australia Bank ((NAB)) and Westpac ((WBC))
-Financials: Macquarie Group ((MQG))
-Materials: Amcor ((AMC)), Boral ((BLD)), and Reliance Worldwide ((RWC))
-Industrials: Brambles ((BXB)) and Cleanaway Waste Management ((CWY))
-Communication Services: Nine Entertainment ((NEC)), MNF Group ((MNF)), and Over The Wire Holdings ((OTW))
-IT: REA Group ((REA)) and NextDC ((NXT))
-Infrastructure: Transurban ((TCL)) and Atlas Arteria ((ALX))
-Utilities: AGL Energy ((AGL))
-Consumer Staples: Treasury Wine Estates ((TWE))
-Wagering & Gaming: Aristocrat Leisure ((ALL)) and Tabcorp Holdings ((TAH))
-Healthcare: CSL ((CSL)), Sonic Healthcare ((SHL)), Ansell ((ANN))
-AREITs: Stockland ((SGP)), Goodman Group ((GMG)) and Abacus Property Group ((ABP))
Investors should note there are no nominations for mining services and neither for consumer discretionary stocks.
The Last Defensives?
Admittedly, Goldman Sachs' portfolio strategy report titled "Under-appreciated defensives that should perform well through the crisis" was released on 23rd April, well before the market decided let's put more money to work in equities, and let's do it in the laggards and the beaten down cyclicals.
In it, the Goldman Sachs strategists expressed their scepticism about the 20%-plus recovery rally off the March bottom. There still is the risk for a second wave in this pandemic, the report highlighted, plus a lot of the recession-induced bad news is still waiting to rise to the surface in the form of high unemployment, bankruptcies, rising public debt and significant shifts and consumer and business behaviours, to name but a few.
Similar to my own assessment on Monday (see earlier), the local strategists at Goldman Sachs observed the strong recovery rally was essentially carried by strong balance sheets and resilient growth stories, which signals an ongoing defensive focus among investors, not the rise in optimism others were inferring.
On the false assumption that investors would not be prepared to significantly move beyond stability and defensiveness in the share market, the strategy report highlighted a number of ASX-listed with defensive characteristics that had not yet fully participated in the strong recovery rally.
That small list of overlooked defensives comprises of Aurizon Holdings ((AZJ), Freedom Food ((FNP)), Charter Hall Social Infrastructure REIT ((CQE)), Cleanaway Waste Management ((CWY)), St Barbara ((SBM)), and Telstra ((TLS)).
For some reason, Telstra has been high on the favourites lists at Goldman Sachs for quite a while. The fact that it turns up again as an overlooked defensive is probably the best indication that it hasn't genuinely managed to live up to expectations just yet.
The End Of The Bear Market?
US equity indices significantly outperformed in March (lesser damage) as well as in April (stronger rebound) but irrespective, with the ASX200 ending April on a high (so to speak), gaining 8.8% for the month, and still looking strong, the question on many an investor's mind is: is this it?
Is this how the 2020 Bear has been put back in hibernation?
The global strategy team under supervision of Robert Buckland at Citi dared to tackle the question one week ago (I know, it's an eternity away) and their conclusion was: not yet.
What the team would like to see is PMI surveys showing improvement, combined with lower virus infection rates globally, supplemented by earnings revisions showing a positive bias, all against a background of lower credit spreads.
Once this Bear Market is over the recovery trade will be V-shaped and pro-cyclical, predicts the team, meaning energy producers, mining stocks, mining services providers and banks will all instantly turn into flavour of the moment.
Interestingly, Buckland & Co share my view that once that pro-cyclical recovery trade rally runs out of puff, investor attention will likely revert back to growth and defensive stocks that were in fashion before this year's Bear Market interrupted the global post-2019 enthusiasm.
I should add here those same (quality) growth and defensive stocks have equally been the outperformers throughout the initial phases of this year's Bear Market.
Lastly, the best strategy to put in place is to buy the dips, says the Citi strategy team. On the team's assessment, there was no genuine exuberance preceding this Bear Market. As such, the team opines there is no reason to revisit those March lows, regardless of how bad fundamentals still can become.
Further Upside, Downside?
And now for the BIG Finale…
What if it all turns to nought? What if we do see a second, potentially even more powerful wave of covid-19 forcing societies back indoors?
Economists at UBS estimate such a set-back would translate into equity markets turning south and revisiting the March low. In practical terms, UBS estimates the difference for share markets translates into -20% downside if such a second wave set-back eventuates.
The more optimistic scenario, the one that is feeding current optimism and upward momentum, has another 8% upside left. That's calculated from last week Friday, so less by the time you read this.
Under a scenario of gradually winding back lockdowns from mid-May, predicts UBS modeling, equities should still end -10% negative for the full year. Assuming those calculations prove accurate, I think we can all see the key problem here: we are not even half-way through the calendar year!
(If ever someone illustrated the need for portfolio rotation, surely this is it?)
More negative developments are on the horizon, predicts UBS, and under less favourable scenarios of renewed and/or extended lockdowns, these negatives risk becoming really, really nasty.
Number one is an explosion in government debt. One third of all countries monitored by the economists will see public debt surge above 100% of GDP. While low bond yields and global central bank easing is keeping debt servicing costs low, UBS nevertheless sees government budget deficits remaining a long way from stabilising balances, including for Italy, South Africa, Brazil, and also for the USA.
Instability will also become the hallmark of emerging markets, predict the economist. The good news, reports UBS, is that emerging markets are not short of US dollars to defend currency pegs, as happened in the 1990s, and so the asset dislocation should not be as dramatic. However, the bad news is that concerns surrounding high public debt will likely accelerate significantly, and neither the IMF nor easing by DM central banks can help much.
A virus comeback will also lead to more defaults in high yielding corporate bonds, predicts UBS, with spreads to spike significantly higher. This time around, US banks should not come under systematic threat with private equity, hedge funds and family offices bearing most of the losses.
UBS prefers high yield in Asia above the US and/or Europe.
The final piece of advice for investors is to stop worrying about inflation. Banks will not likely be able to put all central bank stimulus in the real economy through additional loans while the hand-outs are one-offs and not enough to compensate for the income losses incurred.
Official nomination for most honest quote of the week: late on Thursday I received a press release citing CEO Nigel Green of DeVere Group with the exact following quote:
"The Fear Of Missing Out will drive many investors – including myself – off the sidelines."
And just when you thought interpreting the direction of share markets was getting straightforward, at least the short term ahead, the team at ANZ Bank puts out a report titled "Sell in May (despite the cliche).
The key paragraph in this report reads as follows:
"In the medium term, we are concerned that the pace of economic growth will be shallower than the market hopes, straining corporate solvency. This will become an issue for central banks which will have to change their mandates if supporting corporate solvency rather than liquidity and market function becomes necessary. We do not expect this road to be smooth and, as such, heightened volatility will be a feature of markets and risk appetite will struggle into the second half of the year."
And just to top it off, and this really finishes today's story, three key paragraphs from Wilsons' Asset Allocation strategy update:
"It is possible equities have run too hard too fast (particularly the US market) but we still believe the bigger picture (12 month plus) outlook for equities is positive. This attractive medium term case for equities is our key message.
"Equities may be short term overbought but we disagree with the notion that equities are expensive.
"We do concede that stock-markets have bounced hard and there is still significant uncertainty ahead. Indeed we can’t completely rule out the bear case that infection rates re-accelerate materially and stocks either find new lows, or significantly retest the lows of March 23."
(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.)
P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to My Alerts (top bar of the website) and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.
P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
FNArena is proud about its track record and past achievements: Ten Years On