Positioning Equity Portfolios For Recovery

Australia | Sep 17 2020

While shares have rallied from March lows, there are several sectors of the market awaiting a V-shaped recovery.

-Are we on the cusp of an equity boom?
-Domestic exposures versus offshore earners
-Supplementing well diversified portfolios

By Mark Woodruff

There remains a consensus view that both the global and Australian economies will recover in 2021. The fact we haven’t as yet experienced a traditional V-shaped recovery suggests the potential to position an equity portfolio for its arrival.

Descriptions vary on the type of recovery the Australian stock market has experienced since the March lows. Stockbroker Morgans likens it to an extended V-shaped recovery. Similarly, Wilsons notes the market is in a holding pattern, and is not pricing in a V-shaped recovery. To illustrate this, the broker constructs a covid-19 recovery basket that includes impacted stocks across seven market sectors. This 'recovery index' is clearly lagging the ASX200's performance.

The catalysts for the recovery index to rally are considered to be a re-opening scenario for Victoria and a successful vaccine. However, before contemplating a rotation toward stocks benefiting from a recovery, we should discover where we are placed now.

The Current Position

Instead of the prospect of another extended financial crisis and another recession, governments and central banks were able to reduce the pandemic to a problem such that it was much more like a global natural disaster rather than a global financial crisis. The difference between those two, explains Morgans, is a recovery from a global natural disaster is much faster.

During the recent August reporting season, the broker concludes earnings generally tracked ahead of some very depressed expectations. It appeared that equity markets were not as dislocated from reality as the market had anticipated. Consensus is forecasting market earnings to fall around -20%-25% in 2020 before rebounding toward 2019 levels by 2022. Hence, the derivation of the label "extended V-shaped recovery".

Generally speaking, domestic cyclicals were considered to have surprised (retail, travel), while larger defensives underwhelmed prior expectations (utilities, telcos). Smaller stocks also recorded their highest rate of surprise (28%) and lowest rate of disappointment (18%) for several seasons. Expectations here were clearly more fearful than for larger-cap peers due partially to questions over short term liquidity. The surprise positive impact of fiscal stimulus also had a larger proportional benefit in this segment.

The Economic Outlook

Morgans assures us not only are we are going to come out of the pandemic malaise, but also we may come out of it much more rapidly than previously thought.

In somewhat of a replay of the years following the global financial crisis in 2008-09, the broker expects we are on the cusp of another boom. The even bigger fiscal stimulus this time around is going to generate over the next two years downward pressure on the US dollar. That means the euro, the Australian dollar and commodity prices will go up.

In short, a portfolio encapsulating a recovery trade, with a weather eye on the impact of the Australian dollar, may be prudent.

Where To Invest

Macquarie also sees foreign exchange risk for offshore earners as commodity prices lift the Australian dollar. Utilities, financials and communications are considered the sectors with the most domestic exposure, which lessens currency risk. As a result, the broker has some preferred domestic exposures including:

Charter Hall Group ((CHC)), Cleanaway Waste Management ((CWY)), Aurizon Holdings ((AZJ)), Challenger ((CGF)), Telstra ((TLS)), Stockland ((SGP)) and Transurban Group ((TCL)).

There are three additional stocks that make the list of preferred domestic exposures and are also stocks most negatively impacted by covid-19. This makes them preferred plays on a vaccine as well.

The stocks are Crown Resorts ((CWN)), The Star Entertainment Group ((SGR)) and Sydney Airport ((SYD)).

In the wake of the reporting season, Morgans nominates key stock ideas exposed to the recovery play thematic. It is considered the best opportunities from here are likely to be those stocks that have higher operational linkages to economic activity, and low expectations. These stocks are likely to be in the travel, gaming, energy or commercial services sectors.

The stocks chosen are Sydney Airport, Corporate Travel Management ((CTD)), ALS Ltd ((ALQ)), Aventus Group ((AVN)), Santos ((STO)), Beach Energy ((BPT)), Eagers Automotive ((APE)), and Incitec Pivot ((IPL)).

The Wilsons basket of 23 recovery stocks contains those exposed to international travel, inbound tourism, banking, selected resources (mostly energy), real estate and transport infrastructure.

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