Rudi’s View: February – Reason For Optimism

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

In this week's Weekly Insights:

-And Off We Go…
-When Dumb Money Is Savvy, And Smart Money Is Not
-A Lesson From History
-The January Share Market Barometer
-February: Reason For Optimism
-2021, The Year Of Earnings Recovery
-Conviction Calls
-FNArena Webinar

By Rudi Filapek-Vandyck, Editor FNArena

And Off We Go…

The new calendar year has only just begun, but January already delivered turmoil, volatility, momentum switches, and plenty of calls about overvalued share markets to keep any investor on the edge of his/her seat.

If this is the blueprint for the year ahead, then 2021 will be surprising, volatile and unpredictable, though not necessarily all at the same time.

Looks like February this year will continue the trend of the years past in that domestic corporate results season is not solely about results versus forecasts; there is once again plenty happening on the macro-level to overwhelm whatever should be concluded from corporate financial performances.

One trend is remaining intact and that is FNArena's daily coverage of analysts' assessments of released financial results. Our Monitor can be accessed via the website:

https://www.fnarena.com/index.php/reporting_season/

(Paying subscribers have access to past Monitors stretching back to August 2013).

Two observations stand out already: corporate results between September and December delivered many more "beats" than disappointments and there's broad optimism the February season will continue this trend.

Three early reporters thus far -IGO, HRL Holdings and ResMed- all provided signals current market expectations might be too low. Equally noteworthy, only one of these three -IGO- saw price targets rise post results release.

I think there is probably a message in there, though both HRL and ResMed shares are trading well below consensus target.

When Dumb Money Is Savvy, And Smart Money Is Not

I returned from holidays with a sense that financial markets needed a timely reset, which is usually what happens when groups of humans are having a jolly good time for too long without interruption.

I am by far not the only one who expressed such a view, but let me get my message straight: I am talking about a temporary pull back in an uptrend that has further to go. So no Doom and Gloom or Fall of the Cliff scenarios are on the cards as far as I am concerned.

Which, by the way, doesn't mean that individual shares and/or whole portfolios cannot get badly hurt in the short term.

While it is always a guess and a giggle about what exactly might cause exuberant market sentiment to turn (valuations on their own seldom do), it appears this year's left field correction trigger has come from the fresh cohort of millennial day traders who decided to take on the mighty hedge funds on Wall Street.

While doing so, these fearless youngsters painfully exposed the ones who like to refer to themselves as "the smart money" are, in reality, a lot less smart.

I know there are a lot more sides to this story, and many more complications will be explained and exposed in the days to come, but call me Mr Simplistic if you need to, but sitting on a significant short position in a stock that has 75% of its capital shorted (or more), how exactly is this still a smart move?

Long story short: billions have gone up in smoke as hedge funds had no other choice than to cover their short positions with share prices doubling, tripling, and more. As this ate into their capital, those funds were subsequently forced to sell other assets, which then pulled the whole market, and in response the rest of the world, to a lower level.

And this is just one part of this story.

For good measure: it is well possible this might prove but one festering problem of many more that can surface as equity markets weaken and become more volatile, in particular since valuations are not cheap and investment gains have been plenty, but I'd be inclined to treat persistent and substantial weakness as an opportunity to allocate more cash into this market.

If one's fully invested: these are excellent times for portfolio re-shuffling.

A Lesson From History

One of the more interesting assessments of what is currently happening in financial markets was published by technical analysts at US-based stockbrokerage Oppenheimer.

The opening sentence of their latest market update says it all:

"February has historically been the poorest-performing month of a post-election year, and this weakness has typically been bought ahead of strong returns into July."

Oppenheimer states while there are easy identifiable pockets of bubble-like behaviour, such as in cryptocurrencies, renewable energy companies, cloud computing, IPOs and, dare they say it, deeply shorted stocks on Wall Street, this is to date not representative for broader markets in general.

For what it's worth, I agree with that assessment. Though we all know when things go awry in the US, there's no escaping inside the Australian share market, even if there are far fewer pockets of sheer unbridled investor exuberance locally.

Oppenheimer's view is that those who are complaining about markets being in a bubble have forgotten what a real bubble looks like. For instance, the 3-, 4-, and 5-year returns for the S&P500 are currently 32%, 65%, and 101%, respectively. For comparison, these readings were 93%, 135%, and 204% into the index's March 2000 peak.

The underlying conclusion: don't expect a bubble-like collapse without bubble-like returns first.

The fact so many investors remain sceptics while equity indices climb the wall of worry is enough indication to Oppenheimer's team there is no bubble euphoria gripping global markets.

In terms of pull back, Oppenheimer's technicals suggest the closer the S&P500 approaches 3600, the more attractive buying back in becomes.

The team of chartists does suggest small caps are more overbought than large caps, and thus more vulnerable to larger sized pullbacks.

Bottom line: we're having a mid-cycle correction. It's far too early to call the end to this party.

The January Share Market Barometer

The above mentioned Oppenheimer research report also contained interesting background into the share market performance during the first month of the year, and whether this provides any indication about what investors should expect for the remainder of the calendar year ahead.

In most years, January takes off on a positive note and this corresponds with a positive return for the whole year, under most circumstances. For example, for the 93 years since 1928 US equities in the form of the S&P500 index have performed positively in 71% of the time with an average gain of 6.4% (median 8.4%).

For the years that started off with a positive return in January, the percentage rises to 78% positive returns overall with an average return of 8.6% (median 11.1%).

For the years that started off with a negative January performance, the percentage falls to 60% positive returns with an average return for the full year of 2.9% only (median 2.5%).

It yet remains to be seen whether there is any value to draw from these statistics with Oppenheimer rightfully pointing out last year equally opened with a negative return for January, yet by year-end the S&P500 had gained 16.4%.

February: Reason For Optimism

The in-between earnings season running from September until late December might have already given away the big surprise awaiting investors in February, but general optimism among analysts and professionals has been building that corporate results are likely to come in the form of more beats than misses, and with the need for increased forecasts continuing to fuel investor optimism.

All shall be revealed over the next four weeks, of course. And suffice to say: there will still be the occasional shocker that triggers a serious shellacking of the share price.

What is markedly different this time around is analysts are continuously upgrading their forecasts. If this is not triggered by rising commodity prices or by improving sector prospects, it is being triggered by corporate market updates. Think discretionary retailers. Think financial platforms. Think Buy Now, Pay Later service providers.

Ord Minnett Senior Investment Analyst Sze Chuah reports this big shift in market dynamics has led to market consensus for FY21 growth in earnings per share (EPS) to lift from a negative -2.2% to a positive average of 11%. Note: this average has predominantly been carried higher by banks and resources companies, but irrespectively the trend and investor optimism are very palpable.

At least until hedge funds in the US quickly turned into forced sellers of large cap equities…

Ord Minnett has lined up its favourites for a positive surprise in February: CommBank ((CBA)), Rio Tinto ((RIO)), Amcor ((AMC)), James Hardie ((JHX)), Vocus Group ((VOC)), and Sonic Healthcare ((SHL)).

Candidates likely to disappoint include Crown Resorts ((CWN)), Flight Centre ((FLT)), Qantas ((QAN)), and Sydney Airport ((SYD)), predicts the broker. Travel restrictions have remained in place, hence.

Do note: if current market forecasts prove correct and the average EPS in Australia has declined by -19.5% in FY20, and FY21 will see a rebound in the order of 11%, this still implies overall profits remain well below FY19 level, and the market will need at least another year to fully catch up with the losses incurred by the global pandemic.

Sze Chuah doesn't think it's unreasonable to expect the -19.5% for FY20 will be recouped in the following two or three years.

2021, The Year Of Earnings Recovery

Calendar 2021 will be the year of earnings recovery in a broad sense, analysts at Macquarie agree with Ord Minnett and others. Such positive outlook for corporate earnings should, all else remaining equal, translate into a positive environment for the share market overall, suggests Macquarie.

Most favourited stocks leading into the February reporting season are: Telstra ((TLS)), Nine Entertainment ((NEC)), Star Entertainment Group ((SGR)), Ramsay Health Care ((RHC)), and Downer EDI ((DOW)). All these have suffered from the pandemic last year and are poised for a firm recovery next, on Macquarie's analysis.

Macquarie also likes BHP Group, Rio Tinto and Fortescue Metals ((FMG)), for their prospective dividends, while Qantas has been singled out for a likely dividend disappointment.

In a broad sense, this year's global optimism on top of the post-covid recovery should see limited downside risk for equities, but with rising bond yields, predicts Macquarie. This will dramatically change dynamics for equities in that the momentum now favours cheaper priced 'value' stocks, away from richer priced Growth & Value.

Among covid-losers (Macquarie's own terminology), and outside of the five candidates mentioned earlier, Macquarie likes Healius ((HLS)) and Suncorp ((SUN)) with the added notion the latter might report a weak set of financials this month, but Macquarie would treat share price weakness as a buying opportunity.

In the basket of Quality stocks, Macquarie still very much likes James Hardie and Charter Hall ((CHC)). Among the covid-winners, the broker's three favourites are Harvey Norman ((HVN)), Woolworths ((WOW)), and Domino's Pizza ((DMP)).

Embedded deeper inside the research report, Macquarie expresses some reservations about Zip Co ((Z1P)) and Bravura Solutions ((BVS)), both expected to disappoint for different reasons in February, while AGL Energy ((AGL)) is described as a "structural short".

Resources are projected to generate the strongest sector growth in FY21, but not in FY22 (negative forecasts thus far) while Property Trusts remain the Big Laggards this year, following the negative performance in FY20. The come-back sector this year is, however, the banking sector with three consecutive years of negative EPS growth to be transformed into a positive outlook.

See also:

-Why Worry? https://www.fnarena.com/index.php/2021/01/28/rudis-view-why-worry/

-Share Market Outlook 2021: Swings & Roundabouts https://www.fnarena.com/index.php/2021/01/21/share-market-outlook-2021-swings-roundabouts/

-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

Stockbroker Morgans believes plenty of opportunities abound in today's share market. One need not look any further than the list of "Current Best Ideas" that has been updated ahead of the February reporting season. This list contains no fewer than 45 ASX-listed stocks.

Stocks mentioned include Aristocrat Leisure ((ALL)) and Coles Group ((COL)), as well as Macquarie Group ((MQG)), Westpac ((WBC)) and Orica ((ORI)), not to forget BHP Group ((BHP)), ResMed, NextDC ((NXT)), and Incitec Pivot ((IPL)).

A few of the lesser known names include Booktopia Group ((BKG)), Universal Store ((UNI)), Kina Securities ((KSL)), Strandline Resources ((STA)), and HomeCo Daily Needs REIT ((AQR)).

Equally important, perhaps, is the fact the market strategists only recently added Booktopia, Universal Store and HomeCo Daily Needs REIT. Key ASX20 removals include Amcor and Rio Tinto.

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The team of Quant analysts at Credit Suisse has tried to identify major surprises for the February reporting season in Australia and the one stand-out observation is the team has identified only one candidate that is likely to both disappoint in financial performance and receive a negative share price response – Appen ((APX)).

Credit Suisse's fundamental analysts are still in doubt about top line growth, plus AUDUSD is adding to the company's headwinds.

A few other candidates are seen delivering not so good financial results, but the quant analysts are not anticipating a firmly negative share market response. Those companies include Altium ((ALU)) and Iress ((IRE)), and to a lesser extent Infomedia ((IFM)), WiseTech Global ((WTC)), and Ansell ((ANN)).

Candidates likely to deliver a positive surprise and receive a positive reward include Coles Group, JB Hi-Fi ((JBH)), Harvey Norman, Audinate Group ((AD8)), Aurizon Holdings ((AZJ)), Sonic Healthcare, Charter Hall, and Goodman Group ((GMG)).

Kogan ((KGN)) is equally mentioned, but the Quant analysis is not sure about the subsequent share price response.

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Ord Minnett has updated its Super 7 list; stocks that stand out from the pack and should reward investors handsomely in the year ahead, a call made with High Conviction:

-Charter Hall
-James Hardie
-National Australia Bank ((NAB))
-Rio Tinto
-Santos ((STO))
-Super Retail Group ((SUL))
-Transurban ((TCL))

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At Wilsons, the overriding view is that analysts' forecasts for the year ahead will be proven too conservative in light of improving conditions for Australian companies.

Wilsons has updated its Australian Equity Focus List ahead of February, with the expectation that none of the current inclusions are likely to issue a profit warning or deliver such a negative surprise that analysts need to go back to the drawing board and re-assess their positive view… with the sole exception of Appen.

Similar to analysts elsewhere, Wilsons fears the stronger Aussie dollar might weigh on the company's guidance for the year ahead this month. Appen is still included in the selection.

The selection of stocks essentially represents Wilsons' highest conviction recommendations and currently comprises of ResMed, News Corp ((NWS)), Macquarie Group, James Hardie, CommBank, Northern Star Resources ((NST)), Transurban, CSL ((CSL)), BHP Group, Aurizon Holdings, OZ Minerals ((OZL)), National Australia Bank, Seven Group ((SVW)), Super Retail Group, Santos, Goodman Group, Reliance Worldwide ((RWC)), EML Payments ((EML)), Worley ((WOR)), Aventus Group ((AVN)), Aristocrat Leisure, Telix Pharmaceuticals ((TLX)), ANZ Bank ((ANZ)), and Xero ((XRO)).

FNArena Webinar

FNArena is organising an online webinar with myself providing an introduction to the website and service provided, followed by a general update on financial markets in early 2021.

There is an opportunity to ask questions beforehand (see below).

To participate in this webinar, use the link provided below and follow the steps to install and sign in to Zoom.

Date of this webinar: Monday, 8th February 2021, 7.30pm (Canberra, Melbourne, Sydney time).

Duration: about 1 hour, of which:

-First part (30 minutes) consists of a general overview to the FNArena website and the service provided, helping subscribers to maximise their usage and benefits;

-Second part (30 minutes) provides an assessment of what is happening in financial markets, why, and a deeper look into the February reporting season

Registration beforehand is required (simply follow the steps as Zoom will take care of it). This webinar will be recorded and made availabe via the website shortly after the event.

If you have questions or topics you would like to see covered, use the messaging system on the website or send an email to info@fnarena.com

Details about this event:

Topic: FNArena – webinar

Time: Feb 8, 2021 07:30 PM (Canberra, Melbourne, Sydney time)

One hour incl Q&A. The first half will be dedicated to the FNArena website. How to best use the service and find what you are looking for, etc. The second half will zoom in on the state of financial markets, trends & strategies and the February reporting season.

Join Zoom Meeting
https://zoom.us/j/94038372572?pwd=c3FFTlZ2VUNnQTFMeS94SGtydUhRQT09

Meeting ID: 940 3837 2572
Passcode: 584321

Looking forward to welcoming you all in what will no doubt be an enjoyable and informative meeting. Let the questions roll in!

(This story was written on Monday 1st February, 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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