Rudi’s View: February Looks Tricky

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In this week's Weekly Insights:

-February Looks Tricky
-Conviction Calls
-FNArena Talks

February Looks Tricky

By Rudi Filapek-Vandyck, Editor FNArena

2022 is already shaping up as a much more volatile and challenging year for investors, and we're still only at the beginning!

Geopolitics aside, the Big Question that is now on investors' mind is whether the January sell-off has gone too far already, or should we expect more downward pressure for longer? Equities have, broadly taken, sold off by -10%, by -20%, or by more depending on valuations, sectors and whether there has been a specific bad news event.

Even more telling is that circa 50% of the technology stocks included in the Nasdaq are now -50% or more below their share price peak from last year. Taking a broad glance over price charts, there's a fair argument to be made the correction/de-rating for global technology stocks has been causing havoc, to various degrees, for about three months now.

There will come a time when enough is enough, not because bond yields will not rise forever but because many of today's technology darlings are high quality, well-run businesses and they are still carried by megatrends. Megatrends, as I like to point out, last beyond a few rate hikes here and there and the occasional bubble in market exuberance.

Irrespectively, the market is always ready to teach investors harsh, but valuable lessons. It's our choice whether we want to learn from those experiences, or not.

In terms of technology and high quality companies, I believe one of these lessons comes through the variety in damage done to respective share prices. Why is one share price down by -50% and more while another share price has only fallen by -15% or so?

My first guess would be: a marked difference in quality and underlying operational dynamics.

There are times when such characteristics don't seem to matter, but eventually they will. Though I would caution to view this global sell-off solely as a black-and-white assessment. A great company with excellent multi-year prospects can still sell-off a lot more than -15% if its share price was bloated beforehand.

This is why successful investing isn't always straightforward and easy; it's why personal insights, knowledge and details matter. And then, of course, there are those cases where price action is completely the opposite of what it should have been.

Earlier today, I updated share price performances for my lists of All-Weather performers and prime growth stories on the FNArena website only to discover the Ansell ((ANN)) share price hadn't fallen at all up until January 28th.

Today (Monday), Ansell management issued a profit warning and the share price was punished by more than -14% in response. One could argue: this merely pulls Ansell shares in line with others such as Breville Group ((BRG)), IDP Education ((IEL)) and Fisher & Paykel Healthcare ((FPH)).

But also, Ansell's experience follows numerous others in January, signalling there is real and tangible risk out there from companies unable to cope with rising costs, supply chain challenges and covid-interruptions. ResMed ((RMD)) too could not meet market expectations on Friday, but at least its share price received a rather mild brush over on the day.

Ironically, and I am not making any of this up, Ansell and ResMed shares will end with a not too dissimilar performance throughout January. So there is a healthy dose of logic hiding behind what at times seems like a madhouse of crazy share price punishers. Or maybe I am simply reading too much into short-term price moves.

I think ResMed's prospects look a lot better than Ansell's at this stage, and many of the professionals who analyse healthcare stocks in Australia would wholeheartedly agree with that statement. And then there's the other side of the coin: small cap technology aspirant Straker Translations ((STG)) posted a stronger-than-forecast December quarter performance and its share price surged by 17%-plus on Monday.

To provide the full picture: shares in Straker Translations had pretty much halved since mid-last year. That's not an unimportant detail.

Okay, I'll spell it out: Straker Translations is not a ResMed, a CSL ((CSL)) or an Amcor ((AMC)), and within that typical technology basket, it's not of the same ilk as Pro Medicus (PME)), Megaport ((MP1)) or Xero ((XRO)), but it is possible to achieve much greater returns from companies that have so much more to prove and to achieve – in the short term.

Where things get interesting for longer-term oriented investors is that the higher quality, proven performers will at some stage stop falling and it won't be at -50% as has happened with Straker Translations and many, many others.

Successful investing goes hand-in-hand with a firm eye beyond the short-term price action, even if this oft seems illogical or counter-intuitive.

The outlook for 2022 still consists of rate hikes and higher bond yields and slowing economic growth. Equity markets have now fully taken on board the first, but what about the second?

It's going to be volatile by definition.

Short-term, I'd say the bias leans towards more negative than positive surprises for the four weeks ahead, of which the first two weeks will only see a gradual trickling in of financial results.

This almost by definition implies that portfolios will be hit sometime, somewhere, and potentially multiple times.

Two things will come in handy to successfully manoeuvre this month's tricky season:

-have cash to jump on opportunities, as well as to limit portfolio risk

-have the ability to ignore short-term price action and keep the focus beyond the immediate

The selection of potential dangers and opportunities under 'Conviction Calls' below might come in handy, but do keep in mind there is no such thing as 100% certainty.

To view my All-Weathers and other lists: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

FNArena will soon start updating the February Corporate Results Monitor: https://www.fnarena.com/index.php/reporting_season/

More handy insights might be gleaned from our weekly update on ratings, price targets and earnings estimates:

https://www.fnarena.com/index.php/2022/01/31/weekly-ratings-targets-forecast-changes-28-01-22/

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See also last week's Weekly Insights:

https://www.fnarena.com/index.php/2022/01/27/rudis-view-risks-to-consider/

Conviction Calls

Looking ahead to the February results season, Macquarie strategists see risks pointing to the downside with central banks having turned hawkish (or: less accommodative, whatever the angle) and the global economic cycle is slowing which makes for a rather powerful, but treacherous environment for many ASX-listed companies.

Those who dare to come out with negative news might be disproportionally punished, the strategists warn.

Macquarie's best ideas into results from the ASX100: Amcor ((AMC)), Cleanaway Waste Management ((CWY)), Dexus ((DXS)), Origin Energy ((ORG)), Seek ((SEK)), and Santos ((STO)).

Outside of the top100, Macquarie's preference lays with Contact Energy ((CEN)), Costa Group ((CGC)), GUD Holdings ((GUD)), Gold Road Resources ((GOR)), Megaport ((MP1)), nib Holdings ((NHF)) and Whitehaven Coal ((WHC)).

On the negative side, the broker is worried about potential negative surprises from Inghams Group ((ING)) and Ramsay Health Care ((RHC)).

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Small cap analysts at UBS are equally worried that earnings momentum is now skewed towards negative surprises with the broker's earnings forecasts already four months into a downward sloping trend.

For February, UBS is most worried about AMA Group ((AMA)), EML Payments ((EML)), Flight Centre ((FLT)), G8 Education ((GEM)), Dubber Corp ((DUB)) and Temple & Webster ((TPW)) while others might be forced to issue a negative outlook, including Audinate Group  ((AD8)), Perenti Global ((PRN)), Kelsian Group ((KLS)), formerly known as SeaLink Travel Group, Dubber, Kogan ((KGN)), and NRW Holdings ((NWH)).

UBS's favourites ("key buys") are Adairs ((ADH)), Breville Group ((BRG)), BWX Ltd ((BWX)), Corporate Travel Management ((CTD)), EML Payments, GUD Holdings, Kelsian Group, Nitro Software ((NTO)), NRW Holdings and Siteminder ((SDR)).

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While the rising real yield environment represents a tough environment for the local tech sector, sector analysts at Citi expect secular trends to continue to drive growth which should result in improving free cash flow for tech companies. Maybe their view would be best summarised as: don't throw out your babies with the bathwater, even if you're worried about rising interest rates.

Citi's key sector picks are Xero ((XRO)), Megaport and REA Group ((REA)).

Citi analysts covering the leisure sector have elevated Ardent Leisure ((ALG)) as their small cap sector favourite ahead of reporting season with borders opening, increased visitor numbers at Dreamworld and the resumption of the Main Event roll-out all seen as very promising omens for the company's future.

Operator of health centres and gyms, Viva Leisure ((VVA)), is equally rated as Buy.

Elsewhere, colleagues researching small cap retail have expressed their preference for Nick Scali ((NCK)) and Harvey Norman ((HVN)) while those on the food and beverages desk most prefer Bubs Australia ((BUB)) and a2 Milk ((A2M)).

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Local market strategists at Morgan Stanley see a solid case for near-term outperformance for resources and the broker's Model Portfolio is thus Overweight the sector. The broker believes resources companies might well enjoy multiple months of upgrades to forecasts, which usually translates into ongoing strength for correlated share prices.

One of the eye-catching changes made recently by the broker's energy desk has been an upgrade in the price forecast for Brent oil to US$100/bbl but the analysts see commodities as a protection against inflation, as well as against rising geopolitical risks.

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Software-sector enthusiasts at Shaw and Partners are making a case for renewed interest in local ASX-listed software companies, with the fierce January sell-off for the sector now having opened up great opportunity, suggest the analysts.

Their sector preference continues with Mach7 Technologies ((M7T)), Whispir ((WHP)), and Gentrack Group ((GTK)).

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UBS has set a year-end target for the ASX200 of 7800, meaning growing profits are expected to withstand a mild contraction in market multiples as bond yields rise.

UBS's portfolio preference lays with cyclicals and domestic oriented companies, with financials, energy and consumer discretionary the three most preferred market exposures. Least preferred are consumer staples, technology, media & telecom, utilities and real estate.

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Market strategists at stockbroker Morgans clearly prefer the glass half-full approach, seeing plenty of scope for local companies to surprise on the upside in February, though they do concede it is likely that cautious guidances will dominate, and this might dampen investors' enthusiasm post-result releases somewhat.

Morgans has identified 13 companies it believes are better placed than most in dealing with cost inflation and margin protection, including Aristocrat Leisure ((ALL)), Amcor, Brambles ((BXB)), NextDC ((NXT)), REA Group, Sonic Healthcare ((SHL)), and PWR Holdings ((PWH)).

It has to be pointed out, Morgans had selected Ansell as the potential deliverer of a positive surprise and that idea went quickly out the window on Monday as the company issued a profit warning.

Apart from Ansell, other counter-consensus calls ahead of February are Cochlear ((COH)), Nanosonics ((NAN)), Ramsay Health Care, Rio Tinto ((RIO)), and Australian Finance Group ((AFG)).

The broker is worried about potential earnings risk for CommBank ((CBA)), CSL ((CSL)), Rio Tinto, Cochlear, and Ramsay Health Care.

FNArena Talks

Your Editor was interviewed on Thursday last week by Peter Switzer:

https://www.youtube.com/watch?v=WHDcNFoVwdo&t=4s

(This story was written on Monday 31st January, 2022. 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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