Rudi's View | Jul 05 2023
This story features JOHNS LYNG GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: JLG
In This Week's Weekly Insights:
-A Dozen Insights For FY24
-El Nino And Insurers
-When Quality Goes Missing
-Conviction Calls & Best Ideas
By Rudi Filapek-Vandyck, Editor
A Dozen Insights For FY24
If one well-chosen graphic compensates for 1000 words, imagine how many words we are saving with the charts and graphics below.
Twelve charts to shine a light on the things that have mattered and those that will matter for the year(s) ahead.
First up, investors should expect a lot of positive commentary and chest-beating market updates from institutional investors and asset allocators in the weeks ahead. Double-digit returns, including dividends, should act as a welcome offset to last financial year's dismal outcomes.
Herein lays the foundation for this year's positive results: when calculating returns, it matters from which base those calculations start. In the current situation, last year's fall-into-the-abyss deep dive towards the end of the financial year is providing the ideal starting point for outsized positive results twelve months later.
The graphic below, with arrows to highlight the point, tells the story. Average returns for the first six months of 2023 have been a lot more nimble, but over the twelve months the ASX200 Accumulation index has returned 14.5%.
It's not customary to look back at financial year returns divided by half-yearly periods, as is the case in the overview below. The effort by Infinity Asset Management is offering a more detailed insight, which has become more relevant, it seems, in recent years.
More insights from Infinity Asset Management: the sectors that performed over the six months past, and those that didn't.
Same exercise, but this time for the whole of calendar 2022. Not all sectors underperforming last year have caught up thus far in 2023, and the swings have, in most cases, been significant.
How did Australia compare to the rest of the world? ETF provider VanEck put together the sector comparison below for the three months ending on June 30. The biggest surprise is probably that Australia's IT sector has left global peers in its shadow in Q2, while Materials, Healthcare and Consumer Discretionary have lagged noticeably.
Plenty of indicators around suggesting the US technology sector has accumulated too much hot air during its extraordinary rally in H1 this year. The chart below shows the performance gap between the Nasdaq100 index and the Russell2000 in the US. That relative gap has seldom been this wide.
We can discuss market sentiment, and people's attraction to be part of upward momentum, until the cows come home, and that debate will still not be fully concluded. As long as the market consists of humans participating, it never will. The one correlation highlighted below is between Fed liquidity and US equities in general.
In extension of the previous chart above, the graphic depiction below equally suggests US equities have gapped away from stagnant liquidity in the US financial system. Most forecasters are anticipating shrinking liquidity in the weeks and months to come. More reasons to be concerned about what might follow next? Chart courtesy of VanEck.
Despite corporate earnings and economic data showing a lot of resilience to date, economists are still forecasting an economic recession on the horizon, though the exact timing of that pain point for the world's largest economy continues to shift further out.
The forecasts below are from Oxford Economics, currently anticipating Q3 and Q4 will unveil the long awaited US recession. But, say the economists, confidence in the exact timing is not very high. Which implies that Q3 forecast might be too bearish.
Maybe that recession only starts in the final quarter. What if it only happens next year?
One of the key reasons as to why consumer spending, and thus the US economy overall, has held up better and for longer in the face of prolonged steep tightening through Fed rate hikes is nicely summarised in the graphic below.
Excess savings, equally prevalent in Australia and elsewhere, have provided a significant cushion against inflation, higher rates and other pressures over the past three years. But the excess is in speedy decline, as highlighted by Longview Economics.
Excess savings are by no means the full story. Consider credit card debt owed by US households is now at an all-time high, as also highlighted by Longview Economics.
Equally important: while official US GDP numbers to date shine through resilience, another measure for the economy is through Gross Domestic Income (GDI), which some economists argue provides the better insight.
Whatever the debate, history shows both are usually closely correlated. Here too a gap has opened up with US GDI running in the negative against a still robust-looking GDP reading for Q1.
David Rosenberg reminded his readers last week real GDI (inflation corrected) was down -1.8% in Q1, having contracted -3.3% in Q4 of last year. Real GDI is now negative for three of the past four quarters and down -0.8% from twelve months ago. The historic correlation between the two measurements, reports Rosenberg, is 96%.
Data digging going back to 1948 reveals never has real GDI trended in negative territory on a four quarters trailing calculation without the NBER declaring later on an official US recession had occurred.
Rosenberg did spot two earlier precedents when GDP and GDI showed divergence; in 1970 and 2001. In both cases GDP caught up with the GDI and the US economy fell into recession.
One of this year's disappointments, apart from the occasional rallies based on 'hopium', is the rather tepid recovery for the Chinese economy.
Country watchers highlight the fact Chinese households did not receive the same financial support during covid lockdowns as their peers in developed economies. Might this explain this year's struggle to reignite the country's engine?
VanEck released the historical comparison below, suggesting appetite to take on new loans in China is running at levels well below the years past.
El Nino And Insurers
In last week's edition I made the comment that, while insurers continue enjoying highly supportive industry dynamics, there always remains the threat of a sudden change in weather or climate patterns with unknown financial consequences.
While that observation remains true, the omission here is that weather forecasters are bracing for an El Nino period to follow La Nina and this, history suggests, coincides with significantly fewer claims from catastrophes and other weather-related disasters.
To continue the good news story for the sector: forecasts are for a dry winter this year, coming off an exceptionally wet period which should provide further positive news for the industry.
I'd wager this is likely co-responsible for the lacklustre share price performance for insurance repair contractor Johns Lyng ((JLG)) this year.
When Quality Goes Missing
The never-ending debate between investors: does literally everything have a price (meaning: if it's cheap enough it is a Buy) or should we also pay attention to corporate Quality and not be afraid to pay a premium for it?
Both sides of the argument have their real life experiences and market observations to support each side, and then some.
One company that has bamboozled many since listing in late 2015, including yours truly, is Link Administration ((LNK)), supposedly firmly connected with its clients inside Australia's managed funds industry, to offer loyal investors a solid, long-term, sustainable growth path.
The sad observation is that Link never lived up to expectations. Not operationally, and certainly not in terms of share price performance. Even the supposed jewel in the crown, Pexa Group ((PXA)), has all but disappointed since being spun out of the group in late 2020.
Link's leadership team is populated by Liberal ex-politicians whose asset buying strategy has raised plenty of questions in years past. Just about every financial metric to judge (and value) the company has deteriorated significantly over the past three years which have been, unsurprisingly so, defined by negative EPS growth for all three consecutive years.
Now the latest news sees major client Hesta jump ship and partner with competitor Grow Inc. For companies like Link, it never rains, but it pours.
So how important is Quality, or as is the case with Link: the absence of it?
Sure, the share price will fall further and at some point it'll look extremely oversold which will attract some buyers; the ones who believe that everything has a price.
Depending on overall market sentiment, the shares might at some point even put in a genuine rally. But low quality companies don't make for great value creators over time. They merely rally on hopium and maybe on a temporary lucky streak, only to fall back into prior habits.
Plenty of examples around on the ASX to back up that statement. Maybe a takeover offer, exact timing unknown, would be the best outcome for long-suffering shareholders who cannot convince themselves to take it on the chin?
Conviction Calls & Best Ideas
Are share prices going up because investor sentiment has improved or has sentiment improved because share prices are going up?
The dilemma in particular relates to the US where the Nasdaq has put in its best half-yearly performance in forty years, up 31%-plus, whereas the local ASX200 ex-dividends is only up 2.34% year-to-date, but plenty of signals on social media and elsewhere that positive sentiment is everywhere.
One observation stands: those experts critical of market momentum since the start of the calendar year are in no mood to change their view, like the global macro strategy team at UBS.
Starting off with a rhetorical question of if everyone already is expecting recession, can markets still sell off?, the UBS team suggests a gap has opened up between what equities are seemingly pricing in and what is happening beneath the surface of the US, and global, economy.
This gap, UBS remains confident, will be closed through weaker share prices. In the team's view, share price weakness will come sooner than weakness in corporate earnings, with history suggesting that's usually how the process unfolds.
Currently, the team concludes, not one single asset is pricing in a global recession, with crude oil and Chinese rates the least optimistically priced.
UBS has attempted to create a model that allows the strategists to identify what have been the major drivers behind this year's asset price movements.
The modeling suggests of the circa 13% of gains for the S&P500 at the time of modeling (the index gained 15.91% over the first six months, sans dividends) no less than 9% of those gains can be attributed to liquidity, with actual earnings and surprises from US corporates only adding a minor contribution.
The big surprise this year, UBS argues, is that weakness in the US banking system turned into an unexpected positive for markets as the Federal Reserve added liquidity to the financial system in order to prevent worse case bank scenarios to materialise.
This process is about to reverse in the second half and thus UBS is forecasting yields on shorter dated US bonds to fall (the so-called "bull steepening of curves") relative to longer dated bonds, with high yielding credit and equity valuations both expected to weaken.
In terms of US corporate earnings, UBS's estimate for an average 2023 EPS of US$101.30 sits -12% below market consensus. Consensus has penciled in US$246 EPS for 2024, which is considered wildly over-optimistic, led by tech euphoria.
Over in Australia, UBS's market strategists are equally sticking with a cautious approach given the local share market will be forced to face up to risks of a consumer-led recession. In particular sectors that are exposed to the domestic consumer are forecast to remain out of favour in coming months.
Another deep dive into the local healthcare sector has instantly propelled this sector into favoured status, with CSL ((CSL)) most preferred among peers. Both CSL and ResMed ((RMD)) have been freshly added to UBS's Most Preferred list, while the ASX ((ASX)) and Super Retail ((SUL)) have been added as Least Preferred.
The full list of Most Preferred exposures now consists of 20 names:
-AGL Energy ((AGL))
-APA Group ((APA))
-IDP Education ((IEL))
-IGO Ltd ((IGO))
-Netwealth Group ((NWL))
-Qantas Airways ((QAN))
-QBE Insurance ((QBE))
-Seven Group ((SEV))
-Steadfast Group ((SDF))
-Suncorp Group ((SUN))
-WiseTech Global ((WTC))
The list of Least Preferred stocks now counts nine inclusions, with Pilbara Minerals ((PLS)) removed and the above two added to:
In terms of sector allocations, UBS recommends having Overweight allocations to healthcare (upgrade), infrastructure & utilities, insurance and technology, Neutral allocations to consumer staples, energy (downgrade), industrials and mining. Underweight exposures are recommended for banks, building materials, consumer discretionary and real estate.
The local Conviction Buy list of Goldman Sachs last week abandoned Westpac ((WBC)) in favour of ANZ Bank ((ANZ)) with the stock pickers arguing the market is failing to properly value ANZ Bank's institutional business, also the lender's most important revenue contributor.
Westpac never lived up to forecasts and Goldman Sachs has now adopted the view that costs are to remain a problem for the bank, mainly from staff and IT.
Goldman Sachs' list contains ten names, and changes tend to be few and far between. The oldest inclusion, Lifestyle Communities ((LIC)), dates from late July 2016 and, honest is honest, has put in mixed performances since.
The other eight names:
Best performers are Xero, REA Group and Qantas, and all retain their spot.
Portfolio managers at Wilsons refuse to join the more bearish forecasters; in their modeling both inflation and economic momentum continue to weaken in the months ahead, with corporate profits to remain relatively resilient for a modestly positive outcome for US equities overall.
The one change made is Wilsons has dialled back its allocation for Australian equities to Neutral as the risk for a local recession has noticeably increased.
Wilsons strategists observe the momentum behind corporate earnings in Australia is lagging the rest of the world with an unfavourable index composition to blame; too much weight for resources and banks, in essence.
The advice for investors is to adopt an active, diversifying strategy to circumvent the unfavourable bias locally towards resources and banks, and, essentially, outperform the local index. The Aussie dollar is also expected to weaken.
Wilsons' Focus Portfolio has seen the inclusion of South32, to include the trend towards a low-carbon future (while acknowledging commodities are still cyclical), while exposure to Allkem ((AKE)) has been reduced and shares in Nine Entertainment ((NEC)) have been sold in full.
Even though Wilsons retains a positive view towards resources (but stock picking remains key) the overall preference remains with defensives, Quality and Growth.
Portfolio managers at Morgan Stanley observe there's currently a hot debate taking place globally whether exposures to the resources sector are appropriate at this point of the cycle.
Morgan Stanley prefers energy over bulks, a preference that is, funnily enough, not represented in the broker's Australia Macro+ Focus List.
That list hasn't seen any changes since late January this year, with the following ten stocks included:
No changes also, as far as we can tell, for Macquarie's recommended portfolios.
The 18 stocks included in the Growth portfolio (ranked in order of exposure, highest weight on top):
-The Lottery Corp ((TLC))
-Flight Centre ((FLT))
-Cleanaway Waste Managment ((CWY))
-Mineral Resources ((MIN))
-Ramsay Health Care ((RHC))
-Treasury Wine Estates
The 18 stocks inside the Income Portfolio (same order of rankings):
-National Australia Bank ((NAB))
-BHP Group ((BHP))
-Coles Group ((COL))
-Atlas Arteria ((ALX))
-Aurizon Holdings ((AZJ))
-Deterra Royalties ((DRR))
-GPT Group ((GPT))
-Charter Hall Retail REIT ((CQR))
-Premier Investments ((PMV))
-GUD Holdings ((GUD))
My research into All-Weathers: share prices have been updated for the June quarter at https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/
Paying subscribers have 24/7 access to the dedicated section on the website.
A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.
(This story was written on Monday, 3th July, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).
(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: contact us via the direct messaging system on the website).
For more info SHARE ANALYSIS: AGL - AGL ENERGY LIMITED
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