Share Market Outlook 2021: Swings & Roundabouts

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In today's Weekly Insights (the first in 2021):

-Share Market Outlook 2021: Swings & Roundabouts
-Conviction Calls

By Rudi Filapek-Vandyck, Editor FNArena

Share Market Outlook 2021: Swings & Roundabouts

The past three months have reminded investors about that one old adage that had been largely forgotten post-GFC:

-global recessions pull cheaply priced value stocks back in focus, after share prices have been savaged first and enough confidence has returned for investors to focus on the economic recovery ahead

The past three weeks have added another layer to that recovery story:

-equity markets in 2021 might well be beholden to whatever bond markets decide lays on the horizon. Too much of a good news story is at this stage feeding into expectations of higher inflation, which translates into rising bond yields, which has kept the ASX200 in Australia inside a sideways moving channel since late November.

In order to create the proper context, investors equally need to appreciate:

-rising bond yields weigh on valuations for structurally growing, long-dated assets which mostly affects Quality and Growth segments among equities, as well as your typical bond proxies (yield stocks like REITs and infrastructure assets)

-rising bond yields re-affirm confidence in the economic turnaround which then coincides with rising energy and commodity prices, a weaker US dollar and strengthening currencies leveraged to the global resources theme (such as the AUD)

-put simply: rising bond yields switch market leadership from Growth & Quality (the previous winners pre-late 2020) to Value and Cyclicals, those stocks that would guaranteed deliver underperformance, or worse, post 2013 until late last year

The past three weeks have also shown the 2021 global recovery story won't simply be a straightforward continuation of the "take risk and thou shalt be rewarded" meme that dominated markets in 2020.

Initially, rising bond yields provide backup for the global recovery story and thus for the switch in market leadership in equities.After a while, however, rising bond yields put the breaks on rising equities, as has been happening in January.

Were bond yields to continue rising, this will force a re-valuation of assets, and thus trigger a correction in share markets affecting both Quality and Growth, as well as Cyclicals and cheaper Value stocks.

2021: More Volatility Ahead

For what it's worth, many an expert remains of the view there is no spike in inflation on the horizon, not to the extent that one should expect bond yields to surge significantly higher from present levels.

But for this to remain true investors need to adopt the view that this time is different, and that's not something that necessarily goes down well when asset prices are elevated and market sentiment is very bullish, with hints of euphoria here and there.

The most obvious prediction to make, and I know many see this as the ultimate cliche, but mix the above context with uncertainties about vaccine-rollouts, or even the efficacy of future vaccine-rollouts, and I think it's probably a safe statement to make that 2021 will be a lot more volatile than last year, ex-February and March.

Markets will pursue the theme of global recovery, unless doubt arises from weaker economic indicators, or unless too much optimism translates either into fully priced equities or much higher bond yields.

Right now, I believe equity markets have entered a phase when strong share price rallies are raising questions whether too much, too soon is being priced in for the new market leaders, while bond yields doubling since August has started catching everyone's attention. On some indicators, investor sentiment seems quite elevated, while there is no doubt about pockets of exuberance, in particular in the US.

Some disappointing economic data (such as monthly retail sales in the US) are equally cause for a pause, both in bond markets as for equities.

The past weeks have also shown that, as long as underlying market optimism remains intact, share market momentum happily swings back to Growth, Quality & Defensives out of Cyclicals & Value whenever doubt arises about vaccines, the recovery or the new US administration's stimulus intentions, and back to Cyclicals & Value when those same doubts appear less appropriate.

In practical terms, on days when mining stocks (ex-gold), energy producers and banks are rallying this usually coincides with falling share prices for companies including Amcor, APA Group, Woolworths, NextDC, ResMed and Xero, as well as the gold miners, and vice versa. In a sharp reversal from the post-2013 era, the former group of stocks has experienced noticeably more up-days than the latter group since November.

Observation number one: recent updates by stockbroking analysts are generating valuations and price targets above pre-2008 peak share prices for the likes of BHP Group and Rio Tinto. Not only does this suggest the global recovery story still has longer, and farther, to play out, it also provides a moment of reflection: it has taken these sector leaders more than 12 years to recoup the losses from share prices back then, and only if the current trend continues.

[As a side-note: BHP shares peaked at $50 in late 2007 and Rio Tinto shares near $125 but you won't find those levels in today's backward looking share prices provided by free online services including via the ASX website, Yahoo! Finance or Google Finance because -for reasons unbeknown to me- those share prices have been adjusted for dividend payouts.]

Observation number two: stockbroking analysts have started downgrading some of the stocks that have rallied hard post-November, probably signalling the easy gains from the market's momentum switch are behind us and investors may need to be more selective with their exposure to the recovery theme, at least for the time being.

On the other hand, many of the stocks best referred to as "Winners pre-November last year" have seen their share price decline by -20% or more. While share market momentum might not return in full force anytime soon for these stocks, global secular trends will be around for many more years and those share prices will look attractive again at some point, bond yields permitting.

Corporate Reports To Provide (Some) Answers

As per standard practice, the upcoming reporting seasons in the US and here in Australia next month (February) might reveal various timely insights for investors. Though it is likely market optimism regarding Australian housing markets, including construction and building materials, and consumer spending will over-rule minor operational hiccups in February and March if companies are leveraged to those favourable themes.

Though investors always look towards reporting seasons to provide both health checks and insights about new and upcoming trends, in past years broad share market trends have predominantly been determined by the macro-picture, often in contravention to specific outcomes during February and August reporting seasons in Australia.

Investment Portfolio Themes

Investors looking to re-calibrate and re-position portfolios might want to consider some of the ideas put forward by share market strategists at UBS recently.

UBS points out that bond yields remain low by historical standard, and this will continue to favour Defensive Growth as a key theme in the share market. Most preferred stocks carrying this label are CSL ((CSL)), Nanosonics ((NAN)), ResMed ((RMD)) and REA Group ((REA)).

Low bond yields equally translate into ongoing strong demand for income providing stocks. UBS prefers APA Group ((APA)), Telstra ((TLS)) and Tabcorp ((TAH)).

For exposure to the Housing theme, UBS's current favourites are James Hardie ((JHX)), CSR ((CSR)), Harvey Norman ((HVN)), Adairs ((ADH)), and REA Group too.

The Aussie has quickly risen to 77c against the US dollar, but UBS's forecast is for 78c by year-end and 82c by end-2022. Against currencies including the euro and GBP UBS's forecasts don't see much changing. Some offshore earners on the ASX thus have some more headwinds to battle with, but that should not imply they cannot be an attractive proposition. Most preferred in the UBS universe are James Hardie, Sims ((SGM)), CSL, Aristocrat Leisure ((ALL)), ResMed, and Appen ((APX)).

The global economic recovery and subsequent rally in energy and commodity prices has brought back momentum and investor interest to mining services. UBS analysts have six Buy ratings for the sector; Perenti Global ((PRN)), Orica ((ORI)), Downer EDI ((DOW)), Worley ((WOR)), Incitec Pivot ((IPL)), and NRW Holdings ((NWH)). Equally noteworthy: UBS's model portfolio has nil portfolio exposure to this sector.

And then there are the companies whose business received a fat boost from the global pandemic. UBS likes Harvey Norman and ResMed the most. Among companies whose business has been affected temporarily, the broker puts forward Tabcorp and Aristocrat Leisure.

There is a category of companies whose demand has received a structural boost and here UBS suggests Centuria Capital ((CNI)) and Appen are most attractive. Among those companies that are now facing structurally less demand from customers, UBS has singled out Qantas Airways ((QAN)) as the most attractive idea.

No doubt, the Australian Broker Call Report, updated daily on the FNArena website, will provide a few additional ideas and suggestions as stockbroking analysts further update their thoughts and modeling with the February results season approaching rapidly. As has become standard practice, FNArena will keep a close watch on the February reporting season via a daily updated Monitor.

To be continued after the upcoming Australia Day long-weekend.

See also recent updates:

–All Eyes On US Treasuries

https://www.fnarena.com/index.php/2021/01/13/rudis-view-all-eyes-on-us-treasuries/

–My Concern And Conviction Calls 

https://www.fnarena.com/index.php/2021/01/11/rudis-view-my-concern-and-conviction-calls/

Conviction Calls

Remarkable, an otherwise rather subdued sector update on Australian oil and gas producers by Citi has singled out corporate minnow Senex Energy ((SXY)) as the stand-out investment opportunity among peers.

Apart from the fact that Citi forecasts see free cash flow equaling some 8% in FY22 at the current share price in the mid-30c, the broker's price target of 44c equally suggests no over-valuation is apparent in this share price.

One quick glance at Stock Analysis shows four of the other five stockbrokers covering the stock full-heartedly agree with price targets either similar or higher than Citi's, except Morgan Stanley.

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One of the stand-out observations from the above mentioned UBS research is the share market strategists are not big fans of Ramsay Health Care ((RHC)), preferring to underweight the stock in their model portfolio.

No such qualms are embedded in Goldman Sachs's research update on Australia's most successful private hospital operator. Not only did the broker upgrade Ramsay Health Care shares to a Buy, the stock has been simultaneously added to the Conviction Buy List.

The Buy thesis revolves around the fact Ramsay's core market, Australia, has been operating largely without limitations since July which allows it to tackle a material backlog that had built-up through the forced lockdowns.

In Europe, the analysts concede considerable uncertainty persists, but here the view is downside risks are limited by existing government support.

Goldman Sachs sees scope for improved volume and margins in FY22-FY23 while noting the stock has underperformed both the sector and the broader market over 3, 6 and 12 months, with the share price valuation near the bottom of its five-year range. Consensus forecasts will need to catch up, say the analysts.

Goldman Sachs has raised its price target for Ramsay Health Care to $70.

(This story was written on Monday 18th January, 2021. 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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