Rudi’s View: Why Are Equities Rallying?

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In this week’s Weekly Insights:

-Why Are Equities Rallying?
-Question Of The Week
-Rudi Talks
-Conviction Calls

Why Are Equities Rallying?

By Rudi Filapek-Vandyck, Editor FNArena

Despite the 45^th president of the United States’ claim that if he were voted out of office, the share market would tank savagely, equities the world around are having a jolly good time in November.

Of course, it’s far too easy to draw solely a direct connection with the outcome of the US elections; that isn’t the full story by a long shot.

As predictions prior to November 3 had tightened around a likely win for challengers Biden & Harris, some institutional funds had positioned for a renewed boost for the so-called reflation trade, whereby trillions of stimulus enacted by Democrats in power would improve operational conditions and the outlook for share market laggards including oil & gas stocks, financials and other cyclicals.

That scenario hasn’t gone 100% missing, but it is now linked to a successful vaccine-development, which remains a genuine possibility, but it remains uncertain.

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Other investors had elected to take some cash out of the market, and that cash is now rapidly re-entering, which easily explains the strong gains witnessed for US equities last week, as well as in Australia.

That sudden switch in momentum has been backed up by the US bond market which saw yields initially creeping higher on anticipation of trillions of dollars in Democrat stimulus-spending, but the yield on US treasuries has once again retreated since, which has been taken as a signal that it’s safe again to buy into US technology stocks.

In simple terms: rising bond yields weigh on valuations for longer dated assets and capital-light business models, meaning for today’s technology stocks, falling yields provide for an extra boost to those valuations.

Such moves are usually replicated on the Australian bourse, but because large techs like Apple, Alphabet, Microsoft, Amazon and the like nowadays represent some 40% of the S&P500, the gains for the Australian share market have once again been but a shadow of those seen in the USA.

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Another supportive factor has come from the RBA with governor Phillip Lowe & Co joining all major central banks overseas with enlarging the balance sheet in order to provide excess liquidity to the Australian economy and pin local bond yields down close to zero yield territory.

In light of the multi-trillion bond buying programs enacted by central banks in Japan, Europe, Canada, the UK and the USA, it seems a bit far-fetched to adhere a lot of influence to the additional $100bn program the RBA announced this month.

But a recent analysis by Macquarie suggests when looked into what the RBA is planning to do on a relative basis, the RBA is catching up quickly on the Federal Reserve in the USA.

On a relative basis, argues Macquarie, the RBA buying in $5bn in Australian bonds each week is far more powerful for the much smaller economy that is Australia’s than the Federal Reserve spending US21bn per week in support of US credit and bond markets.

Assuming all of the RBA’s programs and intentions are fully exercised, its balance sheet is projected to rise to circa 25% of local GDP compared with the Fed at circa 34% of America’s GDP.

On Macquarie’s analysis, the sectors with the strongest positive links to central bank Quantitative Easing (QE) programs are real estate, technology and communications, with the added observation most industrial sectors are beneficiaries.

In 2020 the correlation with consumer staples hasn’t been great, but Macquarie suggests this is due to investors treating the likes of Woolworths and Coles as covid-safe havens this year, which means those stocks did not de-rate during the sell-off in February-March.

The twist in this story is that Macquarie suspects the key beneficiaries from the next $100bn in RBA QE might be financials, i.e. banks and insurers.

That latter view will be negated if the RBA starts targeting longer-term bond yields, or decides to move into negative yield-territory.

In the absence of these two scenarios, Macquarie sees yields on longer-dated bonds move higher over the next six months, which also provides support for those still hopeful the reflation trade, otherwise known as ‘value’ investing, can still make a come-back in 2021, and/or beyond.

(Even without a vaccine).

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It goes without saying, every time global equities embark on the next upswing there is always an element of short-covering involved. Plus, it is but logical that rising share prices carried by numerous fundamental underpinnings equally translate into supportive reading on technical analysis price charts and momentum indicators.

There is one other factor that hasn’t attracted much coverage just yet: expectations for more mergers and acquisitions announcements are rising.

Debt remains cheap and the worst of the pandemic impact is probably behind us. Analysts suspect more and more businesses will be looking for growth.

In many cases, the easiest way to achieve it, might just be through buying a cheaper priced target.

Note market speculation surrounding Tabcorp Holdings ((TAH)), while companies including Link Administration ((LNK)) and AMP ((AMP)) have received unsolicited approaches.

See also last week’s Weekly Insights – Snippet 5: M&A is back!

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On top of all of the above, the most important development in recent weeks has come from companies updating shareholders and other investors on how their operations are performing.

The bottom line: in most cases it’s better than anticipated, meaning analysts have to lift their forecasts, injecting renewed buying interest into stocks including Brambles ((BXB)), Iress ((IRE)), CSR ((CSR)), News Corp ((NWS)), ResMed ((RMD)), and REA Group ((REA)).

The latter two have since surged to a fresh all-time record high.

The renewed bottom-up momentum that is emanating from corporate Australia (mimicking the US) is also reflected in FNArena’s Corporate Results Monitor which, as of Monday, 9^th November 2020, post-August has lined up 32 company reports of which 25% met expectations (8 companies) and with beats and misses on 37.5% (12 companies) each.

Admittedly, at face value this remains far from fantastic, but as per new practice post-2013, if we leave out the ASX50, the numbers look a lot better with 9 companies (47.4%) out of 19 from the ASX200 beating market forecasts.

Either way, earnings misses to date can be mostly blamed on perennial underperformers in deep existential struggles, such as Myer and Unibail-Rodamco-Westfield, and on sectors facing structural headwinds, such as coal companies, banks, bricks and mortar retailers, and producers of dairy.

The most important change this month should therefore not come as a surprise: earnings forecasts are rising as the likes of Brambles, CSR, Amcor and others are releasing better-than-expected financial numbers and in some cases upgrading their guidance for the full financial year.

History shows share market uptrends are usually more solid when supported by positive company performances and rising forecasts.

Certainly, this month’s renewed momentum in profit forecasts has reinvigorated expectations that continued economic recovery, even if the path remains wobbly and filled with uncertainties, can continue carrying share markets to higher levels in the year ahead.

Over in the US, bond yields are now lower than prospective dividend yields on listed equities, once again fueling speculation your typical bond investor might be enticed, or even forced to switch, which would undoubtedly add yet more momentum to the current upswing.

It is very much doubtful though this year’s good news story will continue to unwrap in a straight line, as it pretty much has done since the low in March.

Within this context it is interesting to note one of Morgan Stanley’s market strategists, Mike Wilson, is predicting the S&P500 will remain inside a trading range between 3100 and 3550 for a while yet.

This month’s rally has pulled that index from near the bottom of that range to now near the top of it, so it will be interesting to watch further developments from here.

The reason as to why Wilson thinks that range will hold for the time being is because the US economy is about to start generating more subdued economic data, which should keep a lid on further share market enthusiasm.

Wilson has called the market correctly on numerous occasions in the past, including in 2015-2016 and in 2018 when he correctly put forward a trading range for US indices which ultimately held until deep into 2019.

As such, the 2020 US presidential election might have provided the initial boost for equity markets, it also places a reasonable question mark over the medium-term outlook.

No doubt, republicans and democrats will see the need for further stimulus and support for businesses and an economy that has been hit hard by the virus, but politicians being politicians they might need to see some blood in the streets first, and that would support Mike Wilson’s forecast.

Final thought: the recent federal budget from Canberra was equally a positive for corporate Australia, and thus for the Australian economy and share market, but it will have to be followed up with more, more, more.

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To keep track with FNArena’s Corporate Results Monitor:

https://www.fnarena.com/index.php/reporting_season/

I have also been receiving numerous questions about portfolio approach, strategy and composition. Some of my recent writings could provide both insights and inspiration:

Rudi Interviewed: Four Baskets For Equities Portfolio:

https://www.fnarena.com/index.php/2020/11/06/rudi-interviewed-four-baskets-for-equities-portfolio/

Rudi’s View: Equities Portfolio For 2021:

https://www.fnarena.com/index.php/2020/10/29/equities-portfolio-for-2021/

Rudi’s View: Quality & Growth, Confidence & Execution:

https://www.fnarena.com/index.php/2020/10/22/rudis-view-quality-growth-confidence-execution/

Rudi’s View: Investment Themes In Australia:

https://www.fnarena.com/index.php/2020/10/15/rudis-view-investment-themes-in-australia/

For more info about the FNArena-Vested Equities All-Weather Model Portfolio: see further below or send us an email at info@fnarena.com

Question Of The Week

FNArena receives a wide variety of questions on a regular basis. In order to broaden the purpose of me responding to most of them (as quickly as I am able to), I am sharing some of my responses through this weekly email.

This week’s question: Can you explain to me the significance of the 200 day moving average line in charting and the other lines involved. Which is considered the most important?

Response:

Investors and traders treat the 200 days moving average as a longer-term trend line, to give them that extra handle on what the possible outlook is for a given stock.

And continuing on that path, the 60 days or 50 days moving averages are used to gauge short term direction/sentiment/funds flows.

Here at FNArena, we long ago decided to opt for the 60 days instead of the more broadly used 50 days. Often, the difference between the two is pretty small, but at that time we took guidance from a number of experienced traders who preferred the 60 days proclaiming it was the superior trendline of the two.

Whatever your focus or preference, we only display these trend lines on price charts as a broad and general indicator for price action.

As an investor myself, I do not much pay attention to such technical tools. I find they are often as misleading as they are useful, also because I am not necessarily interested in what is happening with the share price in the immediate future.

You might want to take into account my long-term observation that technical analysis works best for low quality, small cap minnows that often lack any fundamental underpinnings. It most often fails when you’re dealing with high quality, large cap stocks.

I am sure you can draw your own conclusions from this.

As per always: none of this is financial advice. I am merely sharing my personal insights and experiences.

Rudi Talks

About 2.5 weeks ago I interviewed Harry Dent, infamous because of his prolonged bearish predictions for Wall Street and global equities.

It’s not everyone’s cup of tea, and the interview becomes more balanced after the one-sided monologue covering the opening 20 minutes or so, but plenty of investors have sat down and viewed the video, and plenty have sent in thank you notes, often with additional commentary.

FNArena received a few questions from rather concerned investors too.

Do I believe Harry Dent’s forecast for an emerging Armageddon is about to reveal its accuracy? No, I don’t. I think I made that clear with my questions during the 60 minutes of interviewing him.

But I do think investors should not be too casual about the problems that underpin Dent’s forecasts. I agree with him (and others) in that financial markets have a habit of paying no attention to what could possibly disturb the current uptrend, until they are forced to.

The spreading of the global pandemic earlier in 2020 provides yet another prime example of this. It’s easy to forget today, but the savage sell-down in February-March was preceded by yet another no-worries-at-all strong rally in US Equities in January.

I am by no means forecasting this month’s strong upswing is the precursor to the next fall-off-the-cliff experience. But I do think we should all be mindful of what is happening beneath the surface of it all.

Remain informed, remains my motto. Yesterday’s price action is not necessarily the best guide for what can possibly lay ahead.

After we added the 60 minutes interview with Dent on the website (see: FNArena Talks) we also added the recorded webinar I did with members of the Australian Shareholders Association (ASA) in late September.

For those who have not seen it, I highly recommend you take one hour out of your busy schedule and view it. You’ll find it is a different kind of explanation of what has been, and still is happening in economies and financial markets the world around.

To watch both videos:

Harry Dent:

https://www.fnarena.com/index.php/fnarena-talks/2020/10/23/one-hour-with-harry-dent/

Investing In Times Of Corona:

https://www.fnarena.com/index.php/fnarena-talks/2020/11/03/investing-in-times-of-corona-webinar-asa-22-sep-2020/

Conviction Calls

Australia-based investment manager DNR Capital reminded investors this week dividends received make up around half of total returns achieved from owning shares in Australia, over time.

Assuming total dividends paid out in 2020 by constituents of the ASX200 might drop to $58bn from the circa $73bn forecast at the beginning of the year, DNR points out this still equals total dividends paid out in calendar 2013.

The average yield for 2021 and 2022, on updated forecasts, remains 4% to 5% so the advice is investors should adopt a more flexible approach, and not remain stuck with the dividend payers from yesteryear such as the major banks.

DNR Capital’s four dividend favourites are IPH Ltd ((IPH)), Atlas Arteria ((ALX)), BHP Group ((BHP)) and Telstra ((TLS)).

Comparing DNR’s forecasts with FNArena’s market consensus (see Stock Analysis) the fund manager is definitely among the more bullish forecasters for each of the four mentioned stocks, including the conviction that Telstra will continue paying out 16c in the years ahead.

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Guardians of the Best Stock Ideas at Morningstar have added Brambles ((BXB)) and Spark Infrastructure ((SKI)) and removed Bingo Industries ((BIN)).

Morningstar’s list of Best Ideas, all selected because trading at a sizeable discount to intrinsic valuation, now contains a total of 14 inclusions.

Apart from the two newcomers, the list also includes Avita Therapeutics ((AVH)), Challenger ((CGF)), Cimic Group ((CIM)), Computershare ((CPU)), Flight Centre ((FLT)), G8 Education ((GEM)), Link Administration, Southern Cross Media ((SXL)), Viva Energy Group ((VEA)), Westpac ((WBC)), Whitehaven Coal ((WHC)), and Woodside Petroleum ((WPL)).

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The selection of conviction calls at Wilsons has been expanded with United Malt ((UMG)). Wilsons is attracted to the Graincorp spin-off’s quality asset base and reasonably defensive revenue profile, plus the company seems to be enjoying improved sales momentum.

Industry feedback supports Wilsons’ view that orders have been picking up in recent weeks, while the share price valuation is still seen as attractive.

Other stocks on Wilsons’s list remain ARB Corp ((ARB)), Collins Foods ((CKF)), Integral Diagnostics ((IDX)), Telix Pharmaceuticals ((TLX)), ResMed, Whispir ((WSP)), Appen ((APX)), and ReadyTech ((RDY)).

(This story was written on Monday 9th November, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story 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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– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
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