Rudi’s View: Market Momentum Switch, A Messy Affair

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In this week’s Weekly Insights:

-Market Momentum Switch: A Messy Affair
-Conviction Calls
-Dividend Traps & Opportunities

The Economic Recovery, A Messy Affair

By Rudi Filapek-Vandyck, Editor FNArena

Under more “normal” circumstances, we’d all be talking about the economic recovery by now, with follow-on consequences for government policies, central bank focus and a decisive switch in momentum for specific segments of the share market.

But these are not, by anyone’s standards, “normal” times.

Irrespectively, if we observe price action for global equities over the past six or seven weeks, combined with forecasts and market commentaries from experts and global strategists, there is unmistakably a preference building for cyclicals and cheaply priced laggards in search of the next engine for outperformance and outsized returns.

The face value reasoning behind this anticipated switch in market momentum is built on two pillars:

-Pandemic “winners” and new era technology have become a crowded trade (everyone is in on it)

-The ‘value’ part of the share market is too cheaply priced, in particular on a relative comparison

So, what will shift momentum out of winners and into the laggards?

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A recent market report by Macquarie emphasised that, when economies recover from the depths of an economic recession, it is always the turn for cyclicals to shine, because of their leverage to improving economic dynamics, and the return of “growth”.

For anyone who understands how investing works, and how financial markets operate in relationship to the real world out there, such a summary contains nil surprise.

One of the attractions of cyclicals and more vulnerable business models is that, by the time the economy starts picking up, their share prices have been clobbered to pulp in response to the preceding fall-of-a-cliff downturn.

The combination of extremely cheap share prices with improving prospects for growth is an enormously powerful, and attractive, proposition for investors looking over the horizon.

Most deep and gut-wrenching bear markets occur in combination with an economic recession; hence every recovery out of those bear markets has been led by banks, miners, energy companies and small caps.

But what caught my attention in Macquarie’s report was the -apparent- requirement to underpin the case that the above straightforward order of events still applies.

Analysts at Macquarie had gone back in time and isolated four major economic recessions. And every time the pattern coming out of each of these four recessions has been similar, they emphasised; no exception.

Why, I wonder, why is it that Macquarie’s analysis of past patterns post economic recessions needs to be supported with extra-details and emphasis?

Is it because today’s investors do not understand the correlation between economic recessions and how the subsequent recoveries benefit different types of companies than the ones who outperform when confronting the recession head-on?

Or is it because investors have so much fallen in love with highly valued, outperforming, modern era technology companies, they simply cannot focus on anything else but those beloved ones?

Or is it maybe because there remains a healthy dose of market scepticism about the exact shape (speed) of the economic recovery that as yet hasn’t announced itself yet, other than the initial bounce from the absolute bottom?

It’s probably a combination of all of the above.

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One starts to realise financial markets are not necessarily what they appear to be at face value when strategists at Morgan Stanley -reported proponents of the V-shaped recovery scenario- feel the need to explain to their clientele that V-shaped recovery actually doesn’t look like a genuine V.

Morgan Stanley’s V looks a lot more like the Nike logo -the swoosh- with a much more elongated, drawn-out right-hand part after the bounce from the bottom.

It just so happens to be, this is the most preferred forecast by analysts and strategists on Wall Street.

Where the discrepancy kicks in is through the anticipated response by investors and by financial assets.

Morgan Stanley thinks the prospect of economic recovery, though not as strong as, say, post GFC, will make investor focus switch to companies benefiting from the improvement, even if it is not as strong as hoped/precedents/forecast.

Morgan Stanley also believes that, in combination with unprecedented central bank liquidity and significant government stimulus measures, the forthcoming economic recovery will create price inflation and force bond yields (long end) higher.

If correct, such a confluence of factors has the potential to create a strong self-perpetuating switch out of this year’s winners and into the laggards and the cyclicals, led by banks and energy and mining stocks.

Clearly, there is still a lot of scepticism surrounding the so-called “reflation” trade as all attempts to ignite this major switch have been nothing but largely unsuccessful since late August.

Sure, frothy valuations here and there inside the technology sector have deflated somewhat, but that was always bound to happen at some stage, and banks have finally moved off their price bottoms, but Telstra hasn’t, and QBE Insurance still looks “sick”; same for Nufarm, IOOF Holdings, not to mention Unibail-Rodamco-Westfield.

On the other hand, share prices for Ardent Leisure ((ALG)), SeaLink Travel Group ((SLK)) and Event Hospitality and Entertainment ((EVT)) have started to move strongly upwards.

All in all, the past six-seven weeks have created a lot of volatility, without a clear, lasting or dominating pattern in share markets, making the month of September, above all, a rather messy affair.

Incidentally, if you are worried about the second wave in the global pandemic impacting on economies and companies, as is the global strategy team at Citi, you’d be avoiding cyclicals as they remain most vulnerable to set-backs.

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Maybe the simplest way to put a rocket under the Big Portfolio Switch in global equity markets is through the successful development of a vaccine that allows humanity to revert back to life as we all knew it pre-2020.

Sure, financial markets would soon come to realise developing a vaccine is one thing, and sharing it with billions of people worldwide is quite another, but the sheer prospect of beating the virus and being able to move on seems like a guaranteed path to keep investor hopes and anticipation elevated for a prolonged time.

Which is why the likes of Morgan Stanley have their team of healthcare specialists operating on constant alert for just about anything that can generate positive newsflow regarding covid-19 and a potential vaccine.

According to that team’s most recent updates, the expectation remains that one of the leading contenders in this global race can start Phase III trial preparations by November and have a potential vaccine ready by late March-April next year.

This means the outcome of the US presidential election might not even be the most important news event in November. At least for the short term.

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To read more about what sectors and stocks are most likely to benefit from portfolio rotation:

https://www.fnarena.com/index.php/2020/09/23/maximising-returns-in-a-new-equity-cycle/

See the Conviction Calls in the following Weekly Insights:

https://www.fnarena.com/index.php/2020/09/17/rudis-view-plenty-of-clouds-diverging-scenarios/

Idem for the Conviction Calls in the preceding Weekly Insights:

https://www.fnarena.com/index.php/2020/09/10/rudis-view-august-2020-lifts-price-targets/

Conviction Calls

Stockbroker Morgans this month added six fresh additions to its list of Best ideas; buy-rated stocks that come with a higher-than-average level of confidence these will be among the highest returning exposures on the ASX over the coming twelve months.

The six newbies are (in no particular order) QBE Insurance ((QBE)), Magellan Financial ((MFG)), Nufarm ((NUF)), Volpara Health Technologies ((VHT)), Catapult Group ((CAT)), and Mach7 Technologies ((M7T)).

Stockbroker Morgans makes a regular appearance in this section and as I explained before, whereas most peers come up with a small, selective list of conviction calls for investors looking for the next profitable idea, at Morgans the total selection of Best Ideas these days involves no less than 47 companies.

Those 47 suggestions involve cheaply priced energy stocks and other cyclicals, such as Santos ((STO)), Woodside Petroleum ((WPL)), Ramelius Resources ((RMS)), and Incitec Pivot ((IPL)), though it has to be noted the bias is unmistakably in favour of beaten down oil and gas producers.

The next group is probably best defined as beneficiaries from re-opening & recovering economies, including names like Aristocrat Leisure ((ALL)), Sydney Airport ((SYD)), Westpac ((WBC)), and Super Retail ((SUL)).

There are a number of solid yield providers represented too, including APA Group ((APA)), Aventus Group ((AVN)) and APN Convenience Retail REIT ((AQR)).

Equally remarkable, I would argue, is the selection also includes lockdown beneficiaries and strong growers, such as ResMed ((RMD)), NextDC ((NXT)), Adairs ((ADH)), and Zip Co ((Z1P)).

Maybe the underlying message here is to not get fully hooked on the market’s us versus them, Value versus Growth, laggards versus winners, and instead keep the portfolio diversified across a range of themes and dynamics.

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Morningstar’s Best Stock Ideas consist of G8 Education ((GEM)), Link Administration ((LNK)), Southern Cross Media ((SXL)), Viva Energy Group ((VEA)), Westpac, Whitehaven Coal ((WHC)), and Woodside Petroleum.

Dividend Traps & Opportunities

Whoever writes the market strategy updates at Wilsons, last week shared some valuable insights for investors focused on deriving yield/income from the share market.

Don’t get suckered in by seemingly attractive looking high yielders that have no growth, is one such invaluable insight. Even income investors cannot ignore the need for growth, said Wilsons in an echo of my own exclamations and warnings since GFC.

Another piece of priceless market wisdom is the combination of yield-plus-growth acts like a powerful combination over time. In Wilsons’ view, this is why the Australian share market is one of the best performing over the last 100-plus years (backed up by Credit Suisse research) – globally!

Wilsons has used three key selection screens to identify 15 ASX-listed names that should not only grow their dividends in years to come, but seem poised to beat the market in terms of total investment return (share price gains plus income).

The three chosen filters are Growth (historical data), Yield (forecast dividends and payout ratios), and financial strength (return on equity, interest coverage, and commitment to dividends).

The 15 stocks that rolled out of Wilsons’ modeling are (divided over three categories):

–High normalised dividend growth:

-Service Stream ((SSM))
-Cleanaway Waste Management ((CWY))
-Treasury Wine Estates ((TWE))
-Aurizon Holdings ((AZJ))
-Home Consortium ((HMC))

–Growth and yield:

-Westpac
-ANZ Bank ((ANZ))
-Coca-Cola Amatil ((CCL))
-Macquarie Group ((MQG))
-Waypoint REIT ((WPR))

–Long term reliable yield plays:

-Transurban ((TCL))
-Wesfarmers ((WES))
-APA Group
-Atlas Arteria Group ((ALX))
-Amcor ((AMC))

Investors should note Wilsons’ list is definitely not without risk and seems to rely heavily on economies re-opening and recovering back to pre-pandemic growth and dynamics.

Why the decision was made to rely on growth achieved in the past is not explained in the strategy document.

(This story was written on Monday 5th October, 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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