Rudi’s View: Time For Quality To Shine

This story features JB HI-FI LIMITED, and other companies. For more info SHARE ANALYSIS: JBH

In this week's Weekly Insights:

-And Australia's Favourite Sector Is..?
-Rising Equities Are Getting Cheaper
-Time For Quality To Shine
-Gold's Dubious Inflation Claims
-Conviction Calls
-All-Weather Model Portfolio
-Research To Download

By Rudi Filapek-Vandyck, Editor FNArena

And Australia's Favourite Sector Is..?

What if I asked you which sector is the long term favourite among institutional investors in Australia?

Banks? Healthcare? Bulk commodities producers?

The answer will surprise you, as it is Consumer Discretionary.

Analysts at JPMorgan, who run a monthly survey among domestic fund managers and thus have access to a wealth of data, reported last week the Consumer Discretionary sector has been the most persistent Overweight in institutional portfolios in Australia.

Further adding to the sector's favourite status among institutions is the observation the average large Overweight positioning (relative to the actual index weighting) is well, well above the number two, which at present is the Materials sector.

The most convincing argument to prefer one sector over others is always the performance and here, JP Morgan reports, the justification aligns with Consumer Discretionary markedly outperforming the ASX200 over the past five years.

When I mention Consumer Discretionary most readers are probably thinking JB Hi-Fi ((JBH)), Premier Investments ((PMV)) and Eagers Automotive ((APE)), but specialty retailers only make up some 15% of the sector. 

The largest representation (40%) is reserved for Hotels, Restaurants and Leisure companies, which includes the likes of Crown Resorts ((CWN)) and Aristocrat Leisure ((ALL)), but also IDP Education ((IEL)), Webjet ((WEB)), Collins Foods ((CFK)), and SeaLink Travel Group ((SLK)).

As a matter of fact, Audeara ((AUA)), Mad Paws Holdings ((MPA)), BikeExchange ((BEX)), Harris Technology Group ((HT8)) and RedHill Education ((RDH)) are all part of Consumer Discretionary, but I doubt very much whether most institutions would know these companies exist.

Looking at the top of the sector, in terms of market capitalisations, I think the answers most among us are looking for are found in Aristocrat Leisure, Domino's Pizza ((DMP)), IDP Education, JB Hi-Fi, Breville Group ((BRG)), Lovisa Holdings ((LOV)) and ARB Corp ((ARB)), possibly also including Corporate Travel Management ((CTD)) and Webjet as the latter two would be featuring in this year's re-opening trade.

Aristocrat Leisure had become the largest and most influential representative for the sector. Aristocrat has equally been one of the best performing large cap stocks on the ASX over the past five years or so. JP Morgan confirms it has been one of few 'well-held' favourites in Australia.

More recently the index changed significantly because of the inclusion of Wesfarmers ((WES)) post divestment of Coles ((COL)). Wesfarmers is now the number one in the sector, but, reports JP Morgan, still Australia's institutions are overwhelmingly underweight the stock.

The top five for the sector, comprised of Wesfarmers, Aristocrat Leisure, Crown Resorts, Star Entertainment ((SGR)) and Tabcorp ((TAH)), now makes up 65% of the sector's weighting.

The JPMorgan Model Portfolio is Overweight the sector by 102bp through Aristocrat Leisure, JB Hi-Fi and Super Retail ((SUL)).

Rising Equities Are Getting Cheaper

Investors worried about that long-foreshadowed correction in equity markets might be heartened to read the Panic/Euphoria indicator developed by analysts at Citi has been trending downwards, even with share market indices in the US and in Australia at or near all-time record highs.

The not-so-good news, however, is that even after a sizeable retreat since the beginning of the year, that market sentiment indicator is still firmly inside the Euphoria zone.

Citi market analysts keep repeating to their clientele: based on the history of this indicator, going back to the late 1980s, there remains a 100% probability that share markets will retreat from current levels over the next twelve months, resulting in a negative return.

Offsetting the negative implications from this particular indicator, which, by the way, has had an admirable track record over the past two decades, is the fact that Citi's Bear Market Checklist doesn't seem too worried just yet.

The factor that continues to support US equities is the large percentage of positive earnings revisions that still is occuring as US companies continue reporting operational performances that beat analysts' forecasts.

Thus far in June, reports Citi, seven out of 11 sectors that make up the S&P500 are currently enjoying positive revisions to profit forecasts.

Unwilling to give up on their proprietary doom-forecaster, Citi strategists suggest maybe we should all become a lot less comfortable with these elevated valuations from the moment earnings estimates stop rising?

The irony about those valuations is, of course, that as earnings estimates continue rising, forward-looking multiples become cheaper and cheaper. Unless share prices keep rising, in which case we must agree with Citi's warning. The real danger for today's share markets is of anything happening to the outlook of ever-rising corporate profit forecasts.

In Australia, reports Shaw and Partners Chief Investment Officer Martin Crabb, the forward-looking Price-Earnings (PE) multiple for the ASX200 has been in a steady decline for months now. The primary reason is because Australian companies are equally still supported by rapidly rising profit forecasts.

On Crabb's analysis, the ASX200 is now trading on a multiple of just above 17x, which, it can be argued, is still a long way off from the long-term average of circa 14.8x. Having said so, it's also a lot lower than the 20x-plus readings from late last year. Earnings estimates in Australia have now superceded those from pre-covid 2019.

The biggest driver behind the positive trend in Australia are miners and energy companies, i.e. the resources sector with the added observation that valuations for resources stocks continue to look cheap, in particular when compared to your typical growth stock.

Crabb also observes price targets in Australia are rising more slowly than earnings estimates.

One factor that has equally been responsible for pulling back the average PE multiple for Australia's most important index has been the switch from Growth and Quality into Cyclicals and Value earlier in the calendar year.

What effectively happened between November and March is that money flowed out of High PE stocks such as CSL ((CSL)), Afterpay ((APT)) and Appen ((APX)) and into lower priced banks, insurers, mining and oil & gas stocks, and REITs.

This, on average, has had a deflating impact too.

Time For Quality To Shine

It has been the new theme that runs through portfolio re-assessments and strategy updates worldwide: economic growth momentum has probably peaked; investors should prepare for a slowing pace in the global economic recovery in the second half of the running calendar year.

How does one prepare for such event?

By adding more Quality to portfolios.

Portfolio commentary by Morgan Stanley recently tried to insert some nuance into the theme by advising investors the current cycle is not very typical by historical precedents.

Past data research has shown Morgan Stanley analysts the time for Quality to shine is traditionally during the late stage of the cycle, but this time around we've only just moved into mid-cycle, so what's the hurry?

It is Morgan Stanley's view that above-average market valuations in combination with late-cycle economic conditions still favour Quality stocks, with investors likely to start concentrating on more dependable, stable returns.

Morgan Stanley's Model Portfolios have opted to play the Quality theme through the following exchange traded funds, or ETFs, plus two managed funds:

ETFs:
-VanEck Vectors MSCI World ex-Australia Quality ETF ((QUAL))
-VanEck Vectors Morningstar Wide Moat ETF ((MOAT))

Funds:
-Capital Group New Perspective Fund
-Fairlight Global Small & Mid Cap (SMID) Fund Class A

Gold's Dubious Inflation Claims

Is gold the ultimate capital protector against inflation?

It's a narrative that is oft repeated and repeated again, but once we start researching the matter, it quickly becomes clear the gold-is-best narrative requires a lot of context and explaining.

For too many investors, investing in gold becomes an act of faith, and one that hasn't exactly been overly beneficial to portfolio returns post-2011. Thus far, 2021 hasn't been too kind either, and neither was 2020.

Research by Ord Minnett suggests the relationship between gold and inflation has become a lot less obvious since at least the 1990s. In support of previous research done elsewhere, the analysts conclude since 2001 gold has performed better during periods of disinflation, while other assets, including stock markets, have mostly outperformed when inflation accelerated.

Ord Minnett thinks this apparent contradiction can be explained by the fact that gold's attractiveness tends to rise in line with the level of global uncertainty. Simply put: when risk appetite retreats and investors start running for the hills, money seeks safety in gold. But when everything seems fine, the general interest for gold is just a smidgen above 'Not Interested'.

There's not a lot a little bit of extra inflation can add to this, unless the bond market responds in a violent manner, equities sell off and central bankers start feeling uncomfortable with the dilemma at hand.

The other factor in play are real bond yields, i.e. adjusted for inflation. History shows gold shines when 'real' yields are negative and falling. Right now, real yields are still negative but just about everyone (except a few) sees higher bond yields ahead, which translates to: negative real yields, but rising.

The opposite scenario, predicted for later this year and potentially in 2022 too (read this part out loud), is the reason as to why analysts like those at Ord Minnett don't see a bright outlook ahead for the precious metal.

Unless, of course, the Fed starts talking tapering and maybe higher yields, and share markets sell off in response, or maybe tensions between China and the US flare up again?

Looks like the outlook for gold for the time being is much more aligned with the level of uncertainty as perceived by investors globally. Rising inflation while everyone is comfortable about it won't support the gold narrative, but neither will rising inflation without volatility and some good ole fashioned blood-in-the-streets.

Although, to muddle the picture just a tad more, Ord Minnett reports gold performs at its best during mild to moderate equity market corrections. If things really go haywire, like during the GFC, the picture turns mixed at best.

All of a sudden, Goldilocks has a new meaning.

Conviction Calls

Several Wall Street firms have been publishing mid-year updates and strategy re-assessments. JPMorgan has grabbed the opportunity to highlight sector favourites and least liked exposures, some of which have been reported on in Weekly Insights over the weeks past.

To recap, and to make sure I haven't missed any of such sector updates, below is an overview of the most and least preferred sector exposures as lined up through JP Morgan's mid-year updates in Australia.

-Diversified Resources: Top Stock Rio Tinto ((RIO)), least liked Alumina Ltd ((AWC));
-Other Metals: Top Stock Newcrest Mining ((NCM)), least liked Pilbara Minerals ((PLS));
-Travel & Leisure: Top Stock Corporate Travel ((CTD)), least liked Flight Centre ((FLT));
-Emerging Companies: Top Stock Credit Corp ((CCP)), least liked ARB Corp ((ARB));
-Healthcare: Top Stock ResMed ((RMD)), least liked Nanosonics ((NAN));
-Oil & Gas: Top Stock Beach Energy ((BPT)), least liked Worley ((WOR));
-A-REITs small caps: Top Stock Waypoint REIT ((WPR)), least liked Cromwell Property ((CMW));
-A-REITs large caps: Top Stock Goodman Group ((GMG)), least liked Stockland ((SGP));
-Technology sector: Top Stock NextDC ((NXT)), least liked Hub24 ((HUB));
-Banks: Top Stock Macquarie Group ((MQG)), least liked CommBank ((CBA));
-Diversified Financials: Top Stock IOOF Holdings ((IFL)), least liked Netwealth ((NWL));
-Transport & Infrastructure: Top Stock Qantas ((QAN)), least liked Sydney Airport ((SYD));
-Building Materials: Top Stock James Hardie ((JHX)), least liked Reece ((REH));
-Gaming: Top Stock Aristocrat Leisure ((ALL)), least liked Pointsbet Holdings ((PBH));
-Contractors: Top Stock Seven Group ((SVW)), least liked Downer EDI ((DOW));
-Utilities: Top Stock Origin Energy ((ORG)), least liked AGL Energy ((AGL));
-Telcos: Top Stock Telstra ((TLS)), least liked Vocus Group ((VOC));
-Internet & Media: Top Stock Nine Entertainment ((NEC)), least liked Carsales ((CAR));
-Insurers: Top Stock QBE Insurance ((QBE)), least liked Medibank Private ((MPL));
-Chemicals & Packaging: Top Stock Incitec Pivot ((IPL)), least liked Orora ((ORA)).

Since JPMorgan started publishing the above mid-year reviews, most of the Top Picks have outperformed, but none as much as has ResMed. This, of course, happened in response to a product recall by major competitor Philips.

On the negative side, Alumina Ltd has experienced serious share price weakness but Pilbara Minerals has rallied strongly, defying JP Morgan's dislike.

-All-Weather Model Portfolio

All-Weather Model Portfolio – May Review – download here: https://www.fnarena.com/downloadfile.php?p=w&n=2F37F972-03C4-A337-8837E60473A96F5F

-Research To Download

RaaS on Betmakers Technology Group ((BET)):

https://www.fnarena.com/downloadfile.php?p=w&n=2F5792E1-D02E-C890-C4C4931FBA5492E9

RaaS on US Wagering Industry:

https://www.fnarena.com/downloadfile.php?p=w&n=2F5EB902-DD0E-A330-C4191330C2A57933

(This story was written on Monday 28th June, 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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