Rudi’s View: Rotation Anxiety & Conviction Buys

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Dear time-poor reader: updates on stockbrokers' Conviction Calls plus extra updates post the August reporting season

In this week's Part Two of Weekly Insights:

-Conviction Calls
-Post-August Afterthoughts
-Rudi Talks
-Rudi On Tour

Conviction Calls

Rudi Filapek-Vandyck, Editor FNArena

A correction in bonds globally is causing portfolio rotation in the share market this week, with some outsized impacts on share prices in popular midcap favourites including Pro Medicus, Appen and Charter Hall. It has to be noted though, share market strategists at UBS do not seem nervous about it.

Instead, they published a dissertation this week as to why ultra-low interest rates are here to stay, and with the RBA continuing to cut the cash rate locally, UBS is strongly suggesting investors should retain a close eye on stocks that benefit from lower long-term bond yields.

The strategy team has come up with the moniker "Defensive Income and Growth", shortcut "DIG". Key sentence in the report: "Although the DIG trade has run hard already, we think that, as analysts recalibrate their valuation models to use lower risk free rates, DIG stocks will benefit more than other stocks."

UBS has identified four groups of companies that stand to benefit the most from widespread acceptance the ultra-low bond yield environment is more permanent than previously thought.

First up are pure-play defensive income stocks such as GPT Group ((GPT)), Shopping Centres Australasia ((SCP)), Telstra ((TLS)), Transurban ((TCL)) and Woolworths ((WOW)).

Less yield-exposed income names that should also benefit include Aurizon Holdings ((AZJ)), Crown Resorts ((CWN)), Star Entertainment ((SGR)), Tabcorp ((TAH)) and Wesfarmers ((WES)).

Then there are the typical Growth stocks, of which UBS's most preferred names are Altium ((ALU)), Appen ((APX)), CSL ((CSL)), Goodman Group ((GMG)), REA Group ((REA)) and ResMed ((RMD)).

Last but not least are Growth companies trading at a reasonable price, including Aristocrat Leisure ((ALL)), James Hardie ((JHX)), Lendlease ((LLC)), News Corp ((NWS)) and QBE Insurance ((QBE)).

While bond yields globally are on the rise this week, UBS still sees Australian 10-year yields falling to 50bp by year-end.

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A special mention goes out to Morgan Stanley Chief Investment Officer Mike Wilson in the US who has kept to his forecast, originally made in 2018, that the S&P500 would remain capped inside a trading range with the ceiling at 3000 points and the bottom of the range some -10% lower.

The US share market index threatened to break-out to the upside in July, but ultimately didn't. It has remained near the top end of the identified trading range since. Wilson's belief is that the bottom of the range will be revisited in the next six weeks or so.

Further out, Morgan Stanley leans very much towards a likely recession for the US economy, with Fed rate cuts proving ineffective to stop the economy from sliding further downwards.

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Having said all of the above, Credit Suisse's market strategists have been making the point that investors might be too negative on the ultimate outcome of today's monetary policy actions taken by central bankers around the world. Monetary policy is still working, argue the strategists, it just requires time.

The problem with the above statement is that the world currently is convinced that monetary policy may no longer be working and this is why bond yields are as low as they are. Financial assets are priced for a global recession, argues Credit Suisse.

The key risk is then that if such a recession won't happen, the correction that needs to go through financial assets may not be nimble or gentile. For this reason, Credit Suisse strategists suggest investors start considering owning "value" in the share market.

Names suggested include Boral ((BLD)), Whitehaven Coal ((WHC)), BlueScope Steel ((BSL)), WorleyParsons ((WOR)), Vicinity Centres ((VCX)), Scentre Group ((SCG)), Bank of Queensland ((BOQ)), Origin Energy ((ORG)), Incitec Pivot ((IPL)), South32 ((S32)), Stockland ((SGP)), OZ Minerals ((OZL)), GPT Group ((GPT)), Nine Entertainment ((NEC)), Santos ((STO)), and Suncorp ((SUN)).

If one had to divide the share market into two broad groups of stocks, separating Winners from Losers, than the list of chosen names by Credit Suisse consists mainly of Losers, which is yet another way to warn investors the outlook for financial assets can include a trend reversal from the years past, if only temporarily.

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Stockbroker Morgans' monthly update on model portfolios has revealed some additional buying of shares in Cleanaway Waste Management ((CWY)), with Morgans convinced investors have responded too harshly to the disappointing result in August.

The portfolio managers placed Link Administration ((LNK)), Woodside Petroleum ((WPL)) and Credit Corp ((CCP)) on their watch list.

The Growth Model Portfolio is watching Bingo Industries ((BIN)), PWR Holdings ((PWH)), Opticomm ((OPC)) and Volpara Health Technologies ((VHT)).

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Sticking with stockbroker Morgans: the market strategists have now also updated their short list for Conviction Buys, comprising of ResMed, Sonic Healthcare ((SHL)), Cleanaway Waste Management, Woodside Petroleum, OZ Minerals, Westpac ((WBC)) and Oil Search ((OSH)) among large caps and Volpara Health Technologies and Senex Energy ((SXY)) among small caps.

For those who equally pay attention to the changes that have been made: Woodside Petroleum and Cleanaway Waste Management are new additions and Australian Finance Group ((AFG)) is the one that disappeared since the previous update due to share price strength.

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Bell Potter analysts Chris Savage and TS Lim have updated their favourites in the local tech sector. Bell Potter's Top Three Key Picks now consists of (in order of preference) TechnologyOne ((TNE)), Catapult Group ((CAT)) and Citadel Group ((CGL)).

WiseTech Global ((WTC)) remains the lone key Sell recommendation, based purely on valuation. Note that Bell Potter's valuation for the shares is no more than $25.

The analysts do emphasise WiseTech is still regarded the best quality company in the sector, alongside Altium ((ALU)).

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Post reporting season, portfolio managers at Wilsons have added GUD Holdings ((GUD)) on the belief the share price had sunk too low. Wilsons remains a believer in the medium term outlook and sees this belief supported by signs of improving trading conditions, along with ongoing potential for bolt-on acquisitions.

Treasury Wine Estates ((TWE)) is no longer part of Wilsons Income Portfolio. Share price performance has been strong since inclusion, which has reduced the dividend on offer too much to remain included in this particular portfolio.

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The latest update on Wilsons' Conviction Calls also reveals GUD Holdings is now included, and that's the only change that occurred since the prior update before the August reporting season.

To refresh everyone's memory, the list of Conviction Calls contains 15 other inclusions: Bravura Solutions ((BVS)), EML Payments ((EML)), ReadyTech ((RDY)), Whispir ((WSP)), Collins Foods ((CKF)), Ridley Corp ((RIC)), ImpediMed ((IPD)), National Veterinary Care ((NVL)), Countplus ((CUP)), EQT Holdings ((EQT)), Pinnacle Investment ((PNI)), Noni B ((NBL)), Ausdrill ((ASL)), Mastermyne ((MYE)), and Whitehaven Coal.

Post-August Afterthoughts

In a post-August review, analysts at UBS repeat yet again what a weak performance it was from corporate Australia and small caps contributed with full gusto to the generally dismal performance.

On UBS's calculations, the average small cap profit growth performance amounts to a negative -7% EPS growth in FY19. Clear message: the lack of profit growth momentum on the ASX is not purely a large cap phenomenon.

UBS equally repeats one of my own favourite statistical observations: in Australia, contrary to the USA, small caps do not generally outperform the large caps in terms of average investment returns. Having said so, on UBS's assessment, the relative discount for small caps versus large caps has widened in Australia to the largest gap since 2012.

On pure statistical impetus, this could mean it might be a good time to add more small caps exposure to investment portfolios. UBS modelling suggests a potential outperformance of 3% relative to large caps could be on offer.

UBS research suggests investors might consider adding Appen ((APX)), Imdex ((IMD)), Myer ((MYR)), Nanosonics ((NAN)) and NRW Holdings ((NWH)). Stocks to avoid include GUD Holdings, Japara Healthcare ((JHC)), Mayne Pharma ((MYX)) and Speedcast International ((SDA)).

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Michael Knox, at stockbroker Morgans, makes the following observation in his post-August review:

"It's interesting to note the recent fall in companies growing their dividends, while the number of companies cutting dividends has stepped up slightly. We think investors need to be conscious of this creeping trend of both EPS and dividend disappointment."

Could not agree more. As a matter of fact, I intend to spend more time on this observation myself. Consider this a promise for personal follow-up.

Post reporting season Best Buy Ideas as selected by Morgans among large cap stocks are Telstra ((TLS)), Wesfarmers ((WES)), Woodside Petroleum, Sydney Airport ((SYD)), Orora ((ORA)), Cleanaway Waste Management, ResMed, Sonic Healthcare, Treasury Wine Estates, Aristocrat Leisure and OZ Minerals.

Best Buy Ideas among small caps involve Afterpay Touch ((APT)), Lovisa Holdings ((LOV)), AP Eagers ((APE)), Over the Wire ((OTW)), Kina Securities ((KSL)), PWR Holdings, APN Convenience Retail REIT ((AQR)), Orocobre ((ORE)), Volpara Health Technologies, SomnoMed ((SOM)), Otto Energy ((OEL)), Cooper Energy ((COE)) and Sundance Energy ((SEA)).

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Over at Macquarie, analysts noted the August reporting was a tough one for contractors to the resources sector. Macquarie observed a plethora in "relatively vague outlook statements".

Upon further reflection, the analysts do believe the macro picture should remain positive for the sector, with both resources companies' capex plans and the level of infrastructure spending holding up.

Macquarie only covers a relatively small selection of listed contractors in Australia. Of those, its current sector favourite is Downer EDI ((DOW)), followed by WorleyParsons ((WOR)), Cimic ((CIM)), and then Monadelphous ((MND)).

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Small cap retail specialists at Citi reshuffled their sector preferences post-August and the result is that restructuring New Zealand born jewellery retailer Michael Hill ((MHJ)) is now the most preferred small cap retailer on the ASX. Citi clearly is banking on the fresh CEO getting the execution done well.

The former sector favourite, Lovisa Holdings makes a big fall down the sector rankings to now have become the sixth most favourite small cap retailer investment opportunity in Australia. Mind you, Citi still labels Lovisa the "best long-term growth story" in the local market, at least among small cap retailers.

Michael Hill beats (in order of updated sector rankings) Baby Bunting ((BBN)), Super Retail ((SUL)), Accent Group ((AX1)), Beacon Lighting ((BLX)), then comes Lovisa, followed by Premier Investments ((PMV)), Harvey Norman ((HVN)), City Chic Collective ((CCX)) and Myer, with Nick Scali ((NCK)) closing the list.

See also Part One from earlier this week:

https://www.fnarena.com/index.php/2019/09/12/the-right-lessons-to-learn/

Rudi Talks

Audio interview about the share market this week:

https://www.youtube.com/watch?v=bdF_Ygh_nxc

Video interview with Peter Switzer:

https://www.youtube.com/watch?v=tu3tE08bL2c

(I appear around minute 11 for circa 12 minutes)

Rudi On Tour In 2019

-AIA and ASA, Perth, WA, October 1

In 2020:

-ASA Hunter Region, near Newcastle, May 25

(This Part Two story was written on 11 & 12 September and published on the subsequent Friday).

(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: info@fnarena.com or via the direct messaging system on the website).

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