Rudi’s View: Value Stocks & Conviction Calls

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In today's Rudi's View:

-‘Swoosh’ They Said
-V Means Value
-Value Means Australia
-Morgans’ Model Portfolios
-Buying On Weakness
-The Next Mini-Cycle
-Soon: The Central Bank Optimism Hangover
-Banks & Cyclicals
-Wilsons’ Five Convictions
-Best Ideas

By Rudi Filapek-Vandyck, Editor FNArena

‘Swoosh’ They Said

Global asset manager Aberdeen Standard reeled out its Australian chief economist, Jeremy Lawson, alongside senior investment director for Asian equities, James Thom, this week to share their views through a webinar with journalists across the globe.

Amidst fierce and contested public debates, exactly what shape should investors should expect from the post lockdown economic recovery -U, V or W?- the team at Aberdeen Standard has opted for the Nike “swoosh”.

It means: we should expect an initial strong bounce in key economic drivers like employment and consumer spending, but it won’t be back to where it was pre-lockdown. After the initial bounce should follow a long winded, gradual improvement.

It’ll take years to get back to levels of 2019 and investors should prepare for milder long-term trends, similar to what occurred post-2009.

It’s the damage that has been done to economic trend growth that keeps Aberdeen Standard in the “not-worried-about-inflation” basket.

Irrespective of all that stimulus thrown at economies globally by central banks and governments, Aberdeen Standard believes it’s the damage done that will prevail when it comes to consumer spending, trend growth, government budgets, central bank policies, and inflation.

Highly unsurprising, their general advice to investors is to not get too carried away by this month’s risk on share market sentiment and instead be picky and cautious; beware for exuberance that implies everything new shall soon be the same as the old.

The Federal Reserve is expected to leave US interest rates near zero until 2024. This so happens to coincide with Westpac expressing their view this week the RBA will equally leave the domestic cash rate untouched until “after 2023”.

V Means Value

Aberdeen Standard is far from the sole expert voice out there who simply cannot see how a V-shaped recovery can follow this year’s “Greatest of all times” economic recession, but some experts can, and some of those experts work at Morgan Stanley.

No surprise here either, if you do follow Morgan Stanley’s confidence, you should be stacking up on banks and resources stocks and add more of the beaten down industrial cyclicals to the portfolio.

A V-recovery means value stocks in equity markets will outperform, which in itself would be a major trend breach from the past 5-6 years. While Value has been on a tear already for two months or so, strategists at the firm can see this momentum switch lasting for longer.

In Australia, Morgan Stanley’s Model Portfolio has been adding exposure to the banks, on top of adding shares in Ampol ((ALD)), formerly known as Caltex Australia, Santos ((STO)), Super Retail ((SUL)), and Viva Energy ((VEA)).

Several of those stocks have been flying high recently. Champagne corks must have been flying in the Sydney CBD office on Chifley Square.

In particular if we also add the fact the Model Portfolio kept an Overweight exposure to bulk producers, as well as to gold. Interestingly, as at the end of May the Model Portfolio had given up all of its 200bp market outperformance at the peak of the March index decline, resulting in a mild underperformance.

Three stocks had been removed from the Model portfolio: Medibank Private ((MPL)), Woolworths ((WOW)) and Xero ((XRO)).

Morgan Stanley thinks increasing confidence in the post-corona economic recovery will push the ASX200 to 6200 over the next twelve months, with most of the investment returns over the period achieved through portfolio rotation into value stocks.

In similar form, Shaw and Partners CIO Martin Crabb didn’t think the local share market offered enough upside potential, even after three days of heavy selling last week and on Monday.

Crabb remains equally concerned about the steady increases in infection and death rates across the USA, and throughout Latin America.

Of course, anyone sharing Morgan Stanley’s confidence in a Big V would be worried about the return of inflation quicker than is now priced in by financial markets. But that certainly remains the debate of the century at this stage.

Value Means Australia

I don’t necessarily agree with Ord Minnett’s assessment that the relative underperformance of Australian equities in comparison with US indices can be fully explained through different sector weightings and compositions – what about capital raisings and dividend cuts?

But it’s hard to dispute the forecast made that if the world is now ready to allocate fresh money into the Value side of equities, Australia should outperform the USA.

Apart from that, Australian equities are relatively cheaper priced, the country is doing a much better job in containing the fallout from the covid-19 pandemic, and the Australian government has a lot more fire power available to jump start the domestic economy.

All music to the ears of Ord Minnett.

The strategists earlier selected five key themes to incorporate into investment portfolios;

-Flight to Quality: preferred stocks Amcor ((AMC)), APA Group ((APA)), Coca-Cola Amatil ((CCL)), Coles ((COL)), GPT ((GPT)), Rio Tinto ((RIO)), and Sonic Healthcare ((SHL));

-Dividend defenders: preferred stocks AusNet Services ((AST)), Charter Hall Long WHALE REIT ((CLW)), Perpetual ((PPT)), and Service Stream ((SSM));

-Policy Tailwinds: preferred stocks Clover Corp ((CLV)), Cleanaway Waste Management ((CLW)), Hub24 ((HUB)), and Lynas Corp ((LYC));

-Risky Business: stocks to avoid include Computershare ((CPU)), Flight Centre ((FLT)), Goodman Group ((GMG)), and TechnologyOne ((TNE)).

Morgans’ Model Portfolios

Those responsible for the Balanced Model Portfolio at stockbroker Morgans have scaled back its overweight exposure to the energy sector by reducing shares owned in Woodside Petroleum ((WPL)).

Stocks kept on the radar with the aim of buying in case of weakness include Telstra ((TLS)) and Woolworths ((WOW)).

Morgans Growth Model Portfolio also reduced exposure to Woodside, while taking profits on NextDC ((NXT)) and Megaport ((MP1)).

To reduce the portfolio’s weighting for resources, South32 ((S32)) was fully sold. More shares have been bought in AP Eagers ((APE)).

Buying On Weakness

It’s been a popular narrative this year: telling everyone how crazy this share market is in the face of many risks and uncertainties, with average Price-Earnings (PE) ratios rising well above long-term trends and averages.

Wilsons Advisory and Stockbroking doesn’t agree with this assessment (I don’t either).

Firstly, it’s a bit short sighted to put an ordinary multiple on depressed earnings, in particular when FY20 is all but done and even the more contained forecasters see a better outlook for 2021.

Secondly, with bond yields exceptionally low, and likely to stay low for longer, the equity risk premium (ERP) that shares are offering over bonds continues to look attractive.

Wilsons adds that were we to adjust the ERP by using normalised earnings for FY21, then equities look even more attractive.

The same principle applies if we compare equities on earnings yield versus bonds. Wilsons retains a tactically cautious stance, but merely because rallies have been hard and fast, while risks remain.

Underlying the strategy remains the same: buy more shares on weakness. Wilsons remains positive on the outlook for equities on a twelve months horizon, and beyond.

The Next Mini-Cycle

Analysts at Macquarie believe commodities are about to start a mini-cycle on the back of governments supporting the recovery in their domestic economies through additional spending on infrastructure and construction.

See, for example, plans that have already leaked from Canberra locally.

If Macquarie’s scenario proves accurate this is likely to support the Aussie dollar at a higher level, point out the analysts, which would be another reason to prefer resources over industrials in the Australian share market.

Many of the best performing industrials on the ASX are exporters and foreign earners and a stronger AUD would eat into offshore profits when translated for domestic shareholders.

Macquarie has thus positioned its Model Portfolio overweight resources through BHP Group ((BHP)), Fortescue Metals ((FMG)) and Rio Tinto ((RIO)) for the bulks, Evolution Mining ((EVN)) and Saracen Mineral Holdings ((SAR)) for gold, and Oil Search ((OSH)) and Worley ((WOR)) to cover the energy sector, plus Graincorp ((GNC)).

Added motivations are: commodities look cheap when compared with equities and the ratio value/growth tends to improve when countries progress out of recession.

Under different circumstances, Macquarie’s scenario would also see bond yields rise on higher inflation expectations, but this time around central bankers are expected to keep a lid on bond yields.

Plenty of market speculation around the Fed’s next move will be yield curve control. See also Japan and our own RBA.

Economists at Citi have been conducting additional analysis around potential causes and trajectory of price inflation post covid-19 and -just to make that one debate slightly more confusing- their conclusion is there is no threat of an inflation break-out on the horizon, but financial markets are pricing in too low inflation forecasts nevertheless.

Soon: The Central Bank Optimism Hangover

Just when you thought shall I lean more towards Aberdeen Standard’s projections or join V-shaped confidence at Morgan Stanley, in barges the global strategy team at Citi with a stern warning about too much optimism and this war between central bank support and economic fundamentals is far from decided.

Citi predicts a hangover shall follow with its own projections implying consensus profit forecasts for FY21 are no less than 30% too high. Value companies (banks, cyclicals) look most vulnerable.

Also: dividends are likely to fall more than profits (that’s an easy prediction to make for Australia, but maybe not so for the rest of the world).

Markets are by no means out of the woods, assures the team at Citi. Value stocks, so much desired at Morgan Stanley and Macquarie, look most vulnerable in Citi’s world.

The good news is, there was no apparent exuberance in asset prices beforehand, and Citi finds valuations are not excessive at current levels either, except maybe for some of the popular tech stocks in the US.

This lack of exuberance is a key factor as to why Citi is not anticipating Armageddon, or a repeat of Feb-March this year, plus there is a whole lotta stimulus and central bank support to support financial markets.

But it won’t prevent markets from falling, predicts Citi, it simply limits the damage.

Banks & Cyclicals

Australian equity strategists at UBS clearly do not share Citi’s view. They recently moved overweight banks and cyclicals declaring these are the sectors most likely to outperform in the short to medium term.

Where UBS and Citi are in agreement is that, longer-term, investors will continue favouring growth stocks, further supported by ultra-low interest rates and bond yields.

Shorter term, UBS has tilted away from offshore earners in Australia with the AUD expected to strengthen, and to remain strong.

UBS’s Model Portfolio has equally increased exposure to gold, with Newcrest Mining ((NCM)) preferred over Evolution Mining and Northern Star ((NST)).

Other stocks added include James Hardie ((JHX)), South32 ((S32)), Metcash ((MTS)), and Alumina ((AWC)).

UBS reduced exposure to stocks like Wesfarmers ((WES)), TechnologyOne ((TNE)) and Fisher & Paykel Healthcare ((FPH)) while completely selling out of Afterpay ((APT)) and Seven West Media ((SWM)).

Wilsons’ Five Convictions

Did someone mention something about “the damage done”?

How about the fact that Wilsons’ selection of Conviction Buys post pandemic turbulence has now shrunk to five stocks only?

Those five are: Collins Foods ((CKF)), Nuchev ((NUC)), Integral Diagnostics ((IDX)), Telix Pharmaceuticals ((TLX)), and ResMed ((RMD)).

Best Ideas

Morningstar’s list of Best Ideas has been expanded with AdBri ((ABC)) and Bapcor ((BAP)). Auckland Airport ((AIA)), Amcor ((AMC)) and Super Retail Group ((SUL)) lost their inclusion.

Other stocks remaining on the list are Avita Medical ((AVH)), Cimic Group ((CIM)), Computershare, G8 Education ((GEM)), Link Administration ((LNK)), Spark Infrastructure ((SKI)), Southern Cross Media ((SXL)), Telstra ((TLS)), Viva Energy Group ((VEA)), Westpac ((WBC)), Whitehaven Coal ((WHC)), and Woodside Petroleum.

Investors should note Morningstar’s sole focus for nomination is usually valuation (and valuation only). Plus the last update occurred in late May. Some of the stocks mentioned have seen some hefty price rises since.

(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.)  

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