Rudi’s View: Family Zone, Healthia, Mineral Resources, ReadyTech, And Xero

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In this week's Weekly Insights:

-Market Sentiment And Warning Signals
-What's With Liquidity?
-Conviction Calls
-FNArena Talks
-Rudi Presents

By Rudi Filapek-Vandyck, Editor FNArena

Market Sentiment And Warning Signals

Are we witnessing a glaring disconnect between unbridled share market optimism and deteriorating market fundamentals?

Yes, say market strategists at Bank of America, whose April survey of global funds managers revealed overall anxiety about deteriorating growth, potentially resulting in 1970s style of stagflation, and has not been this high since August 2008, when the GFC bear market was about to take yet another major tumble downwards.

Actually, the April survey showed optimism regarding global growth has by now sunk to an all-time low with survey data going back all the way to 1994.

Traditionally when sentiment sinks this low it is treated as a Buy-signal by the strategists, but not this time. This time, suggest BofA strategists, investors should treat the disconnect in equities as an opportunity to lighten up and take risk off the table.

In institutional lingo this becomes "Sell the rallies" with the strategists describing the opening weeks of the calendar year as merely the "appetizer not main course of 2022".

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Not everybody is on board with the BofA view, of course, how else to explain the swift recovery that occurred in March, giving the ASX the chance to outperform on the global stage.

But there is growing sympathy for the view elsewhere. The strategy team at Morgan Stanley has been warning for a while that corporate profits will come under pressure in the US, though this is not yet visible in market forecasts.

Morgan Stanley's team led by Mike Wilson pointed out last week the breadth that carries US corporate profit growth is narrowing, and has been narrowing for a while.

Wilson & co believe the current reporting season is when revisions to profit forecasts in the US will turn negative, which, if history can be relied upon, will take the steam out of US markets' momentum.

Digging deeper through in-house data and indicators, the strategists believe the market looks poised to retreat to 4000 (S&P500) from its current level of circa 4400.

All eyes on the US corporate results season thus, as it might turn out a whole lot more important than has been the case over the past two years.

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US strategists at Citi are equally issuing more cautious views and research this month.

Citi's Panic/Eurphoria index, re-labeled as Levkovich index in memoriam of the deceased, well-respected market strategist, has now risen into Euphoria territory. History shows this index can move a lot further into Euphoria, but nevertheless, Citi reports the current index level suggests a 27% probability of a positive return over the next twelve months.

Everyone with an eye on the missing 73% in that statistic can understand why Citi strategists are turning more cautious. Though they are, as yet, not as convinced as are the colleagues at Morgan Stanley, that US corporate profit revisions stand ready to provide a wake-up call to investors.

What caught my eye is Citi's proprietary Bear Market Checklist, always widely reported on when market observers need an independent tool for confirmation the outlook remains rosy. This time around, Citi's checklist has 45% of items in the red, at least calling for caution.

In Citi's own experience, it remains too early to genuinely become worried until 50% of the checklist is in the red or flashing yellow (caution), which currently is not the case. But the checklist consists of 20 items only and thus further deterioration in 1 or 2 additional items might push total warning signs past 50%.

An inverted US bond curve, in combination with widening high yield credit spreads, would do exactly that.

Citi has a year-end target for the S&P500 of 4700 and the strategists take it as a positive the index has now pulled back after reaching that level late last year. Another positive is seen in the fact that earnings forecasts in the US have thus far proven to be remarkably resilient.

The offset is that historical analysis by Morgan Stanley suggests share prices will likely start trending south before analysts get busy lowering their forecasts.

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For what it's worth, JP Morgan's global markets strategy team led by Marko Kolanovic has been among the most bullish this year, and there the decision was made to take profits, but to remain bullish nevertheless.

JP Morgan has redirected its bullish view towards Emerging Markets and commodities and energy. Its year-end target for the S&P500 is 4900, down from 5050 prior.

It is Kolanovic & co's view that strength in commodities will persist, whereas the speculative parts of markets have already tanked, while geopolitical risk is expected to subside.

The overall negative sentiment, as also expressed in this month's BofA global survey, is seen as yet more evidence the path of least resistance remains up.

For further reading, recent Weekly Insights updates:

Real Market Support Is Invisible:

–https://www.fnarena.com/index.php/2022/04/07/rudis-view-real-market-support-is-invisible/

Preparing For August:

-https://www.fnarena.com/index.php/2022/03/24/rudis-view-preparing-for-august/

What's With Liquidity?

When market strategists make forecasts, it usually is based on the predicted pace of growth, combined with factors such as inflation, interest rates and the likely valuation (i.e. market multiple) investors might be prepared to pay for corporate profits.

But what about liquidity?

If liquidity has been a positive factor during the decade past when all major central banks were increasing global liquidity, then surely it must be taken as a negative when central banks such as the Federal Reserve are now preparing to reduce it?

I used a recent online presentation by JP Morgan Asset Management to ask the question to global market strategist Kerry Craig.

His response proved pretty much in line with my own thoughts on the subject, and what I have been including in my presentations this year, such as at the recent national conference from the Australian Investors Association (AIA).

Reducing global liquidity, reckons Craig, will hit those assets most that have been a prime beneficiary. His attention is foremost focused on the more spurious and speculative parts of financial markets; think small-cap technology businesses with no profits or cash flows, and potentially even crypto-currencies and NFTs, and the like.

Craig sees reducing liquidity as yet another reason as to why investors must dial back on their speculative behaviour and focus on less-speculative, quality businesses that generate and grow profits, and have the pricing power to sustain this through what looks like a tougher environment ahead.

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A local press release by Martin Currie Australia has chief investment officer Reece Birtles singing from the same song sheet, with emphasis on a more challenging inflation-environment which separates companies who can pass through input price increases from those who cannot.

Examples highlighted by Birtles:

-Packaging manufacturer Amcor ((AMC)) has seen higher costs but it has been able to increase prices without losing sales;

-Due to the essential nature of the goods they sell, Woolworths Group ((WOW)) and other supermarket businesses are doing a solid job of holding their gross profit margins by passing through the rising cost of goods;

-Accelerating inflation has been a positive for Scentre Group’s ((SCG)) regional and super-regional shopping centres. They have high tenant occupancy and rental contracts with CPI-adjusted lease renewal mechanisms;

-Many infrastructure and utility companies also have CPI-linked contracts. Gas pipeline company APA Group’s ((APA)) operating expenses are a modest part of revenues, while revenue contracts are typically long-term take-or-pay with CPI-linkage mechanisms. As inflation increases, the dollar value of cashflow will increase;

-Banks face elevated risks as households come under pressure from higher costs and interest rates. But the banks are well provisioned, as are households, and their net interest margins will rise as interest rates rise. On balance, higher rates are positive for banks.

The press release finishes with the statement: "Australia has very high-quality financials that will benefit from rising rates and resources companies that will benefit from the Russia disruption and the demand for net-zero transition. Now, more than ever, is the time to allocate to value."

Conviction Calls

Wilsons has added Telix Pharmaceuticals ((TLX)) to its selection of Conviction Calls. Apart from a long-standing positive view on the company's Illuccix product (prostate cancer imaging), and deep pipeline of adjacent diagnostics and therapies, the fact the share price halved between mid-January and late March proved one important factor as well.

Companies that remained on the list are ARB Corp ((ARB)), Collins Foods ((CKF)), Ridley Corp ((RIC)). Aroa Biosurgery ((ARX)), Immutep ((IMM)), ReadyTech ((RDY)), Plenti ((PLT)), and City Chic Collective ((CCX)).

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A recent strategy update by UBS suggests the AUD may well be on its way to US80c on the combination of a stronger economy (one that benefits from higher commodity prices) and an equally outperforming share market, where commodity producers are an important and prominent feature.

But what are the implications of such a strong currency appreciation for individual stocks?

UBS's initial tip is that some retail and auto-related companies might see some margin relief as they sell locally but with lots of foreign currency impact on the general costs of doing business.

Examples include Adairs ((ADH)), Eagers Automotive ((APE)), GUD Holdings ((GUD)), Premier Investments ((PMV)), Super Retail Group ((SUL)) and Temple & Webster ((TPW)).

The BIG Surprise, however, sits on top of the broker's list of who's to benefit most from such a firm 10% appreciation of the AUD/USD. On UBS's calculations, Xero's ((XRO)) earnings would receive a boost of no less than 20%, followed, at length, by the likes of Qantas Airways ((QAN)), and News Corp ((NWS)).

On the negative side, there are plenty of more surprises with OZ Minerals ((OZL)) identified as the currency's biggest victim (-37%), followed by Northern Star ((NST)), Evolution Mining ((WVN)), Allkem ((AKE)), Gold Road Resources ((GOR)), Whitehaven Coal ((WHC)), and Origin Energy ((ORG)).

The obvious observation to make is these forecasts do not take into account that higher commodity prices can more than compensate for the loss in translation from currency strength.

On a broader, portfolio angle, UBS is sticking with a cyclical bias and has thus upgraded the mining sector to Overweight. Energy remainss Overweight while Technology, Media & Telecoms (TMT) has been upgraded to Neutral.

Financials has been downgraded to Neutral as UBS observes there is less valuation appeal following the strong start to the new calendar year. With earnings momentum deteriorating for healthcare companies, that sector has now been downgraded to Underweight.

UBS is equally Overweight Consumer Discretionary as Australian consumers are not expected to moderate their spending this year.

Special Note: the Special Reports section on the FNArena website (paying subscribers only) contains our very own 'The AUD and the Australian Share Market' report, with the added remark this report was put together in 2013.

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Goldman Sachs added three local software companies to its coverage, which led to fresh Buy ratings for ReadyTech Holdings and TechnologyOne ((RDY)) while mini-TechOne, Objective Corp ((OCL)), received a maiden Neutral rating.

The generally positive view is premised on the "long duration structural tailwinds for cloud software and digital transformation in an expanding cloud software TAM" states the report.

TAM stands for total addressable market for those readers not familiar with the typical analyst lingo.

Target prices are respectively $5.00, $13.90 and $19.05.

Goldman Sachs equally initiated coverage on WiseTech Global ((WTC)) which generated yet another Neutral rating with a price target of $53 while the broker grabbed the opportunity to reiterate its Buy recommendation for Xero; price target $133.

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Shaw and Partners has stuck its neck out, big time!, and declared this year's sell-off in technology stocks a gift for investors who'd like to grab "exceptional opportunities' that only come along during exceptional bear markets, such as 2020's covid-crisis and the Nasdaq-meltdown in March 2000.

As a reminder to investors, and to underpin that bold statement, the broker makes the observation that; "Structural trends for growth companies remain in place and in many cases are accelerating". These trends include:

-Public cloud
-Shift to digital
-Shift to consumption and usage based models
-Proliferation of interconnected devices
-Ecommerce
-Digital payments
-De-fi lending
-Gaming
-Disruptors

Still not convinced?

"We firmly believe that over time, growth should dominate returns and we continue to remain positive on our companies under coverage, which we have selected for long term outperformance."

As well as:

"The major determinant of share price performance over time isn’t the multiple you pay, but the growth you get."

Shaw's top three for the sector consists of Aussie Broadband ((ABB)), Monash IVF ((MVF)), and Hub24 ((HUB)).

The broker adds share prices of Dubber ((DUB)) and Family Zone ((FZO)) are considered well below fair value.

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Shaw and Partners Large Cap Model Portfolio currently consists of the following constituents: BHP Group ((BHP)), Evolution Mining ((EVN)), Goodman Group ((GMG)), Macquarie Group ((MQG)), Metcash ((MTS)), National Australia Bank ((NAB)), REA Group ((REA)), Telstra ((TLS)), Woodside Petroleum ((WPL)), and Xero.

The broker's selection of recommended small cap stories comprises of: Antipa Minerals ((AZY)), Boab Metals ((BML)), Coventry Group ((CYG)), Elders ((ELD)), Family Zone, ReadyTech Holdings, Silk Logistics ((SLH)), SmartPay ((SMP)), SRG Global ((SRG)), and Strandline Resources ((STA)).

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Mining sector specialists at Morgan Stanley in Europe have selected their most favoured and least favoured global exposures, with a few ASX-listed companies making their lists.

Newcrest Mining ((NCM)) and Mineral Resources ((MIN)) both made the global most preferred list, while BlueScope Steel ((BSL)) made it onto the most preferred list specifically for steel manufacturers.

The least preferred list has one ASX-listed name: IGO (IGO)).

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The aforementioned Shaw and Partners has also made the effort to highlight to investors the local healthcare sector should be considered a major beneficiary of society coming to terms with covid and reverting back to more 'normal' conditions, otherwise known as the re-opening trade.

Stocks specifically highlighted by the broker: Monash IVF, Healthia ((HLA)), Apiam Animal Health ((AHX)), and Capitol Health ((CAJ)).

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Something to think about from MFS portfolio manager and global investment strategist, Robert Almeida:

"Over the past 500 years, financial market manias have come like the tides: The incoming tide wipes out everyone who bets against it. Later, however, the outgoing one wipes out those who bet with it. The late-1990s and the US housing bubble of the mid-2000s are prime examples of this pattern.

"Most recently, anyone who was underweight low-quality cyclicals (major beneficiaries of the stimulus described above) and high P-E “concept” assets, such as biotech or cloud companies, significantly underperformed passive strategies. But in my view, we’re closing in on high tide and investors who bet on it rising further will get their comeuppance while those quality companies who compound above-average margins on a secular basis will assert market leadership.

"When uncertainty is high like it is today, investors may want to concentrate on owning assets where cash flow visibility is clearer and where the products are mission-critical and underowning assets where profits are dependent on factors outside of companies’ control or on unproven concepts."

FNArena Talks

The Australian Investors Association (AIA) has made available video recordings of the recent National Conference including the Plenary Panel that closed off Day One, which also includes yours truly.

Accessing the video (54 minutes) requires setting up a free account with Vimeo, while the video itself will only be available until June 30th.

https://vimeo.com/697284937

Rudi Presents

This Thursday morning, 11am, I will be presenting (in person, on stage) to members of the Australian Shareholders Association (ASA) in Sydney. Place of action is the Sydney Mechanics School of Arts at 280 Pitt St.

Slides of the presentation can be downloaded via SPECIAL REPORTS on the website.

The following week I will do it all again to member of the Investors Group of University of 3rd Age (U3A) in Toowoomba, via Zoom, on April 27.

(This story was written on Monday 19th April, 2022. 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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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $450 (incl GST) for twelve months or $250 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index.php/sign-up/

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