Rudi’s View: A Bear Market Anomaly That Confuses

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In this week's Weekly Insights:

-A Bear Market Anomaly That Confuses
-Australia; The Peak Is in!
-The World Is Changing
-June Index Changes
-Rudi Talks

By Rudi Filapek-Vandyck, Editor

A Bear Market Anomaly That Confuses

2022 is not your garden variety share market, but the weirdest anomaly surely must be in stockbrokers' recommendations for individual ASX-listed companies.

As at the end of April, and with the ASX200 still within reach of its all-time high, total recommendations for the seven stockbrokers monitored daily by FNArena on 437 individual stocks comprise of 60% Buys (and equivalents) versus less than 35% in Hold/Neutral ratings and Sell ratings close to 5%.

What makes this set-up so unusual is that, historically, such a large percentage in Buy ratings, and respective low percentages for Hold and Sell recommendations, points to bear market conditions for the local share market.

The numbers are well out-of-whack with long term averages since FNArena started compiling these data back in 2006. The only precedent over the past 16 years occurred in 2011 when financial markets were gripped by anxiety that debt-laden Greece might turn into the bombshell that would cause the implosion of the European Union.

That scenario ultimately did not happen, but until that confidence-fueling declaration made by ECB president Mario Draghi in July 2012, financial markets could not shake off the threat of a worst case outcome. Thus share markets didn't go anywhere. Stockbrokers in Australia responded by issuing ever more Buy ratings, which at that time peaked above 60% of all recommendations. Sell ratings, similar to today, bottomed at 5% – the lowest percentage recorded throughout the 16 year period.

Note that during the GFC, the total percentage of Buy ratings peaked closer to 55%, as occurred again post-GFC in 2010. Both in 2008 as again in 2010-2011 such extreme readings in broker recommendations ultimately provided a positive signal for favourable entry-points for investors, though in both cases a healthy dose of patience was still required.

If we assume today's signal will equally prove as positive as back in 2011 and 2008, how then can we explain the key difference in price action? Back in 2008 shares were going through the worst bear market in living memory and in 2011 investors had to bide their time until the ECB president inspired a strong rally that quickly closed the gap between moribund share prices and intrinsic valuations.

If we are in a bear market in 2022, the typical pattern thus far in Australia is predominantly showing up through extreme volatility. The past four months have seen a number of sharp sell-offs, but equally of sharp recovery rallies. Year-to-date, and after a mildly negative April performance, the ASX200 is close to unchanged for the calendar year thus far. Over the past twelve months its performance stands at a positive 8.40%.

But the ASX has been outperforming most of its peers globally. Global equities, as per the S&P Global BMI proxy, are now down -11.55% calendar-year-to-date and compared with twelve months ago the performance is a negative -5.37%. The S&P500 in the US is down -9.65% since the start of 2022, and holding on to a narrow 3.94% gain left for the twelve months past. The tech-laden Nasdaq has lost more than -21% to date in 2022.

Underneath the resilience shown by the ASX200, there are plenty of negative experiences to report upon. Former BNPL runner up in Australia, Zip Co ((Z1P)) is now down -70% in three months and down -86% over the past year. Once popular fintech EML Payments ((EML)) is down -48% in three months and -72% over the past twelve. The once universally held in high esteem, Platinum Asset Management ((PTM)) has lost -60% in value over the year past, and is now at risk of being booted out of the ASX200.

Shares in online retailer Kogan ((KGN)) tanked more than -15% over successive days since its latest market update revealed yet more disappointment. Less than one year ago, Kogan shares changed hands for $13 a piece, today they are trading at around $3.80 for a fall of close to -70%. Top50 member ResMed ((RMD)) has equally failed to meet market expectations and the result, including post-quarterly update disappointment, is for a loss of -30% since September last year.

The experience has been equally disheartening for the likes of Aristocrat Leisure ((ALL)), Life360 ((360)), Tyro Payments ((TYR)), Domino's Pizza ((DMP)), Codan ((CDA)), and many others, while the likes of Whitehaven Coal ((WHC)), Sims Group ((SGM)), Nufarm ((NUF)), GrainCorp ((GNC)), Allkem ((AKE)), Perseus Mining ((PRU)) and Flight Centre ((FLT)) offset with stellar gains.

Maybe it is this extreme polarisation that is fundamentally responsible for why stockbroker ratings are signalling bear market conditions while the index is not reflecting it?

Taking an optimistic view, this would make sense if prices for commodities -both bulk and industrial as well as agricultural- continue to surprise on the upside over the year ahead. Note, for example, recent market updates for the likes of Nufarm and GrainCorp provided upside surprises, while dividend expectations are only growing for miners such as Whitehaven Coal and -even- Allkem.

On the other hand, there's equally an argument to be made that many of the non-cyclicals on the ASX are looking firmly over-sold, similar to what was the general situation back in 2011 and in 2008. Investor appetite for companies such as Aristocrat Leisure, Dominio's Pizza and ResMed is currently close to non-existent, but that doesn't tell us anything about the future outlook or intrinsic valuations.

The statistics concerning broker valuations and price targets compared to where share prices are trading today are showing an even rosier picture than the ratings do. Consider, for example, only 65 of the 437 ASX-listed shares covered by the seven stockbrokers are currently trading above their consensus price target.

If we raise our benchmark to a gap between share price and consensus target of at least -10%, this only removes 150 of the 437 stocks, leaving 287 (circa 66%) that look undervalued-by-a-margin. More than 100 stocks are currently trading -33% or more below their target.

Sure, there will be more than the occasional blooper that turns out very-cheap-for-a-very-good-reason, but I also suspect these numbers are so heavily skewed because underneath the local share market's optical resilience, there has been a lot more pain inflicted and damage done than is widely reported or given credit for.

So what might reinvigorate market sentiment towards share prices for, say, City Chic Collective ((CCX)), James Hardie Industries ((JHX)), Nine Entertainment ((NEC)), NextDC ((NXT)), and Netwealth Group ((NWL))?

A positive result before or in August might be a great starting point as targets and valuations are but a mathematical outcome of what is currently being projected for the year(s) ahead. However, similar to 2011, it remains a genuine possibility that macro threats and considerations will continue to weigh on overall market sentiment.

We've now had the bond market reset and the inflation scare; next up will be global growth slowing plus the unknown consequences of liquidity withdrawal. For the above signals to provide the same positive message to investors as they have done in the past, corporate earnings in Australia must show resilience in the face of ongoing operational challenges.

Having said so, and as shown by ResMed last week, operational disappointment is not something that is solely reserved for small cap companies of lesser quality. In which case it becomes all-important for investors to consider whether it is worth holding on for the longer term (maybe even purchasing additional shares on weakness).

A worst case scenario will be a repeat of the 2008 experience, when, as shown on the graphic above, total Buy recommendations consistently floated between 50% and 55% of the total but, as became increasingly apparent throughout that year, the forecasts supporting those ratings and price targets were too rosy, upon which the bear market unfolded.

Which is why the macro picture remains all-important in 2022. Plus, I'd keep on arguing, a more conservative portfolio approach because we'd want to avoid profit warnings as much as we can.

Australia; The Peak Is in!

Australia has joined the high inflation club, as one commentator put it recently, and the result will be sooner and faster RBA rate hikes, likely starting with a 15bp lift this week, to 25bp.

Economists at Westpac have taken their time, but they too have now joined the sooner & faster forecast for RBA tightening this year.

The more important message, however, is that fast forwarding by the RBA will instill an impact on the domestic economy. First up, consumer spending will be hit, but Westpac thinks consumer spending shall remain healthy on the back of previous policy stimulus.

A larger impact is expected on property prices. Westpac is now forecasting Australian dwelling prices to decline for three years in a row, starting with a decline of -2% this year, followed by a further -8% in 2023, and a further -1% decline in 2024.

The end result, points out Westpac, is that dwelling prices, when adjusted for inflation, will see no net change over five years to 2024.

And while the outlook for household spending remains positive, Westpac is equally resolute in that "Both higher prices and higher interest rates will be a significant squeeze on household incomes."

Housing markets in Sydney, Melbourne and Hobart are expected to experience the worst falls, as these three capital centres have been the major beneficiaries from low interest rates in recent years.

The obvious risk: "if significant pockets of financial stress start to emerge in the household and business sectors".

Raising its prior forecast by 25bp, Bill Evans and Matthew Hassan project the RBA will stop lifting its cash rate at 2%.

The World Is Changing

The most appropriate way to view the world is probably through the adage that change is the sole certainty an investor can rely upon, in particular post Western sanctions on Russia as the country remains at war with the Ukraine.

But change has consequences, including for financial markets.

Analysts at Danske Bank have tried to assess the most plausible scenarios for the decade(s) ahead, as well as their macro impacts.

Under a scenario whereby the world is moving towards another Cold War between the USA and allies on one side and Russia-China and allies on the opposite side, investors should brace for structurally slower growth and higher inflation, suggests the research.

A second scenario whereby globalisation is reduced, but not to the same extreme as in scenario one, sees reduced growth and a rather mixed outlook for inflationary pressures.

A return to the prior globalisation trend, scenario number three, would be the most preferable outcome as it reinstates higher trend growth while lowering underlying inflation.

Under scenario number one the US dollar would lose its global currency status, with the renminbi developing as its key counterpart on the opposing side, while spending on defense will rise significantly, commodity prices will stay higher-for-longer, but the transition towards greener forms of energy will accelerate too. Slower growth in combination with higher interest rates will impact many, including housing markets generally.

It probably won't surprise anyone that scenario number two is seen as the most likely, with some de-coupling occurring between the USA and China and with smaller 'blocs' forming across the globe. Governments will once again become an important driver for R&D and most changes relate to specific countries and sectors.

Overall, the pros and cons very much look similar to scenario one, but less pronounced and potentially for shorter times. One prime example is inflation with Danske Bank intimating current global tensions can potentially keep supply side problems in place for longer, but eventually, assuming the world is not steering towards another Cold War, these will be resolved, and thus inflationary pressures shall diminish.

It goes without saying the same principles apply to scenario number three which would ultimately reinstate all the major trends apparent pre-2020, including exceptionally low inflation and bond yields. This scenario is probably the most unlikely of the three.

June Index Changes

Changes to local share market indices can -at least temporarily- have a noticeable impact on share prices as small cap stocks can be swooped higher by even the slightest attention from institutions, while the same impact can be felt in case companies are being dropped from the ASX200.

Historically, the heaviest impact is usually felt by stocks leaving the ASX200, while any changes to the ASX20, ASX50 or even the ASX100 usually remain without noticeable consequences.

Looking forward towards the June index rebalancing by Standard & Poor's, and taking into account the latest announcements regarding spin-offs and acquisitions, analysts at Wilsons suggest the June announcement from S&P might be a rather short one.

It is very likely, on Wilsons' pre-assessment, there will be no changes announced for the ASX20, ASX50 and the ASX100. Sure, the analysts have lined up a small number of potential changes, but they are all being labelled as "unlikely".

Which leaves us with the ASX200, historically the most important influence on small cap share prices.

Wilsons thinks it's probable S&P will announce Polynovo ((PNV)) is to be dropped from the index in June, along with Tyro Payments ((TYR)), Platinum Asset Management ((PTM)), Appen ((APX)) and Codan ((CDA)), while it is also seen as possible that Clinuvel Pharmaceuticals ((CUV)) and St Barbara ((SBM)) will be removed too.

Wilsons analysis suggests the vacancies will be filled through the inclusion of Core Lithium ((CXO)), Johns Lyng Group ((JLG)), Brainchip Holdings ((BRN)), New Hope Coal ((NHC)) and Coronado Global Resources ((CRN)), with Charter Hall Social Infrastructure REIT ((CQE)) and West African Resources ((WAF)) nominated as "possible" additions.

In the run up to the June rebalancing, a demerger at Tabcorp Holdings ((TAH)) and the full acquisition of Link Administration ((LNK)) are expected to cancel each other out, leaving the ASX200 with 200 members.

S&P is scheduled to announce any changes on Friday June 3rd, which will subsequently be implemented after the market close on Friday June 17th.

Rudi Talks

My first ever interview by James Whelan for the BIP podcast (35 minutes):

https://play.acast.com/s/the-bip-show/aussie-equities-when-is-too-many-buy-recos-too-many-w-rudi-f

(This story was written on Monday 2nd May, 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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