Rudi’s View: ‘I’m so Bearish, I’m Bullish’

This story features GOODMAN GROUP, and other companies. For more info SHARE ANALYSIS: GMG

In this week's Weekly insights:

-'I'm so Bearish, I'm Bullish'
-Corporate Earnings: Between Dr Jekyll & Mr Hyde
-Conviction Calls
-FNArena Talks

By Rudi Filapek-Vandyck, Editor FNArena

'I'm so Bearish, I'm Bullish'

Economists at Oxford Economics summarised this year's financial market's dilemma as follows: The risk of a global recession has clearly grown. It's far from inevitable, still, but orchestrating a soft landing will require luck.

It has taken this long into the calendar year -approximately seven months- but a global recession has now pretty much become the consensus view among financial institutions. Such is the conclusion drawn by Bank of America analysts following BofA's latest monthly global fund managers survey.

The July survey, reported BofA, embodies full capitulation with respondents signalling expectations for global growth and corporate profits have sunk to all-time lows, average cash levels have risen to the highest since 9/11, with equity allocation at its lowest since Lehman Bros went bankrupt in late 2008.

The BofA Bull & Bear Indicator remains at "max bearish" triggering the response: I'm so Bearish, I'm Bullish.

Market fundamentals are poor, acknowledges BofA, but overall sentiment is extremely poor, increasing the likelihood that equities and credit will rally over the weeks ahead.

Further fueling the thesis of market sentiment having sunk too deep, too quickly was the observation by analysts at JP Morgan that short positioning for US futures had accumulated to an all-time record high.

No surprise, some market commentators have made a connection with short covering to (at least partially) explain the general improvement in equity indices this month.

Volumes are dreadful, so any change in those cash levels or short positions would have had a larger-than-usual impact.

As I Tweeted last week:

"What Bear Market teaches us is there are a million reasons to sell/buy a stock; only a few are related to a specific company's underlying fundamentals. Something to keep in mind also when the next Bull Market rages on high volume."

There is also positive news to report: while most forecasters are now anticipating the arrival of economic recession, unless a great deal of 'luck' happens to interfere, general consensus believes any recession will be 'mild', more like the early 2000s rather than that dreaded 2008 precedent when the global financial system came within a heartbeat of total dysfunction.

If correct, this will have major positive ramifications for financial assets. First up: corporate earnings might prove more resilient. Secondly: central banks might not have to go full throttle for much longer, assuming inflation, as is also widely forecast, will start deflating over the months ahead.

Another reason as to why Quality and Growth equities (in particular: Quality Growth) have encountered less headwinds these past few weeks is because global bond markets have also started to reflect the general consensus that economic recession might be unavoidable over the year ahead, which is what yield curve inversion implies (shorter-duration bonds offering a higher yield than longer-duration bonds).

Whereas the valuation for your typical higher multiple Quality company a la Goodman Group ((GMG)), WiseTech Global ((WTC)) or Carsales ((CAR)) comes under pressure when bond yields are on the rise (compression of multiples), the opposite occurs when longer-dated bond yields fall in recognition of plausible recession.

While this might temporarily lift many boats from the Growth basket, the fact there might be a recession on the horizon implies most Growth stocks remain at risk of operational disappointment either in the upcoming results season, or in February next year.

A cautious investor, therefore, wouldn't stray too far away from Quality, Solid and Defensive, lest he/she has a particular short-term trading strategy.

Corporate Earnings: Between Dr Jekyll & Mr Hyde

Viewed from afar, the upcoming results season in Australia will be rather unusual in that it might arrive too early in the down-cycle for investors to properly assess the resilience of a company's client base, profits and margins.

This is also the view of some commentators in the USA who believe the Q3 season over there might turn out only the first in a series of accumulating deterioration in company fundamentals.

Whereas an oft mentioned number, both here and in the USA, is -20% for corporate earnings, it's pretty much a given this is too large a reduction to be fully incorporated into updated forecasts throughout July and August. If -20% proves to be accurate, we won't know until much later, maybe as late as this time next year.

Confronted with this set-up, investors globally have not hesitated to de-risk their positioning, and to de-risk heavily. Shares in commodity producers, earlier in the year seen as the beez kneez when inflation-protection seemed on everybody's mind, have given up all their gains plus some over the seven weeks past.

Similarly, prices for gold, copper, oil, iron ore and the like have all declined over that period and most prices are now trading below analysts' forecasts, from a sizable premium previously, further adding downward pressure to consensus forecasts for corporate earnings.

As also illustrated by this month's quarterly production reports, many producers have found it difficult to meet guidance and/or expectations due to bad weather, staff absenteeism, rising costs and production shortfalls. The fact commodity prices are now in many cases below previous forecasts keeps the pressure to the downside, at least until the general mood towards the sector improves.

To illustrate how fast and how fierce the general de-rating has been for the ultra-cyclicals in the share market: the ASX200 Resources index was up nearly 25% in April, and more than 20% up by late May, but the index is now negative when measured from January 1.

The irony is that many in the local sector, be they BHP Group ((BHP)), Woodside Energy ((WDS)) or Whitehaven Coal ((WHC)), stand ready to pay out more dividends to shareholders than the banks or insurers, and with plenty of additional excess cash flows on top to have analysts speculating about share buybacks and special dividends forthcoming.

History shows there is no hiding in commodities leading up to an economic recession, and this time around many questions remain about what exactly China is up to. But a large number of investors has stayed true to their conviction that this time is different and selected commodities including coal, gas and lithium will prove resilient even in case of a recession because of specific supply limitations. 

Others might reason: who exactly is selling down a stock that has a prospective dividend yield of 42% and 31% respectively for this year and next, as is the case for Coronado Resources ((CRN))? But also: how long exactly can these shares stay at the current beaten-down level?

For what it's worth: some commodity analysts now believe the risk has shifted to the upside now that commodity prices and share prices have sharply corrected. A general view about only a mild recession coming next feeds into such optimism.

One of the local sectors that has disappointed investors since April are the ASX-listed gold producers. Not only has the narrative about buying gold as protection against inflation not held up this year (see link to video below), further adding to the general disappointment have been numerous profit warnings and sub-par production updates marred by rising costs and other headwinds.

Sector analysts at Ord Minnett, in a sector preview to August, believe this sector might not yet be done with issuing disappointing market updates. On Monday, with copper-gold producer OZ Minerals ((OZL)) yet again disappointing with lower revenues and higher costs, this prediction proved rather prescient indeed.

Note: OZ Minerals had already downgraded guidance in June and the share price had been shellacked in response, probably explaining why the punishment on Monday remained limited to circa -3%.

Ord Minnett believes market sentiment towards Australian gold producers is now "extremely low" but, reports the broker following a number of company visits throughout Australia, green shoots are emerging for the sector.

Ord Minnett suggests once forecasts have been re-based following the upcoming reporting season, there will be an opportunity to get on board as even the Quality names in the sector are trading at large valuation discounts.

Ord Minnett's sector favourites are Northern Star Resources ((NST)), Gold Road Resources ((GOR)), Silver Lake Resources ((SLR)) and Red 5 ((RED)) respectively for large-cap, mid-cap (2x) and small-cap exposure.

Another sector that looks poised for more disappointment in August are online consumer-oriented business models, in particular those which benefited from covid and lockdowns previously. Again, analysts will not accept these business models, carried by multi-year mega-trends, are now indefinitely ex-growth, but shorter-term more pain seems but logical.

Retailers and various other consumer-oriented companies have had it tough so far in 2022 as investors prepared for weakness in property prices putting pressure on household spending. Again, the August reporting season might come too early to properly assess the strengths and weaknesses for companies in this segment.

Shoe retailer Accent Group ((AX1)) issued a profit warning on Friday, showing investors' fears are not completely unfounded, and the share price got punished hard on the day despite already having halved since November last year. On Monday, buyers are moving in and the share price remains well-above its trough from June.

A positive signal for patient bargain hunters?

A similar observation can be made for Insurance Australia Group ((IAG)) whose shares are very much in demand on Monday, having sold off on Friday following yet another disappointing market update for which this insurer has accumulated a chequered track record.

There will always be investors who seek refuge in a share price that has fallen deeply enough, rather than owning shares in higher valued business models that are of a lesser risk of disappointing in August. It is but one reason as to why a season that will bring out the best and the worst out of ASX-listed companies, is poised to offer different opportunities to different types of investors.

Taking a general macro-view, earnings forecasts are now falling across the globe, but they have as yet not gone into negative territory. The implication here is that corporate profits might prove more resilient than those forecasting -20% decline are giving them credit for.

This is the optimistic view of global strategists at Citi who, despite preparing for economic recession, believe earnings forecasts most likely will surprise in a positive manner, which would also translate into less downside for equities in general.

Citi's optimism is consistent with in-house top-down modeling, which suggest 0-5% global EPS growth is possible for both 2022 and 2023.

Others are not as optimistic, with Macquarie, for instance, declaring equities in Australia or the USA look "cheap" when measured against historical PE multiples, but not when, as Macquarie strategists assume, corporate earnings might fall by up to -20% by this time next year.

Applying this rough assumption to current US forecasts, and multiplying by a recession-appropriate 16x multiple average, suggests to Macquarie the S&P500 might have to visit the 3300 level before resuming the next uptrend.

Others, like the strategy team at JP Morgan, believe that falling forecasts in 2022 are building the next platform from which equities can rally higher again, because lower forecasts are easier to beat and history shows equities trough well before the last earnings forecast cut has been put in place.

JP Morgan, too, believes weakness in corporate earnings should remain limited this year as nominal GDP in the USA, and elsewhere, remains positive.

On my personal observation, analysts in Australia have started reducing their profit projections, but more so for FY23 than for the current running year. This makes a lot of sense, also given most fiscal years end on June 30th in Australia. But what this also implies is that FY22 financial results are not the real story this August.

Share prices might still rally or sink following the release of FY22 financials, the further-out trajectory will likely be more closely linked to the changes in consensus forecasts in response to the release.

It might complicate matters just a tad more than usual this year (as a great FY22 result might still not prevent forecasts to be cut, and vice versa).

One final positive observation: the local share market's average dividend yield has climbed back to 5% on the back of lower share prices. I suspect many a local retiree will be very pleased about that.

****

Regarding gold: I explained this year's conundrum for gold at last month's Australian Gold Conference. Here's the video (30 minutes):

https://www.youtube.com/watch?v=J7IzgE5eQ0k&t=4s

Conviction Calls

Ord Minnett has used mid-year to nominate Top Picks and Least Preferred exposures.

For the local energy sector, the broker has nominated Woodside Energy ((WDS)) -Top Pick- and Worley ((WOR)).

For local consumer-oriented companies the nominations are Endeavour Group ((EDV)) -Top Pick- and Wesfarmers ((WES)).

In the healthcare sector, Top Pick is ResMed ((RMD)) while Integral Diagnostics ((IDX)) is considered a No-Go.

Among miners, the favouritism resides with South32 ((S32)) while Sandfire Resources ((SFR)) sits at the opposite end of the broker's sector ranking.

In the local REITs sector, Mirvac Group ((MGR)) is seen as the best buy, while GPT Group ((GPT)) is handed the wooden spoon.

Among diversified financials, Ord Minnett's favourite is AUB Group ((AUB)) while Least Preferred is Challenger ((CGF)).

The preference for AUB Group over Steadfast Group ((SDF)) seems to be related to the latter's recent outperformance and subsequently higher valuation.

(Most of the work done behind the scenes is by JP Morgan, with Ord Minnett white-labeling the research).

****

Analysts at Morgan Stanley have started to communicate their highest confidence winners and (potential) losers from the upcoming August reporting season.

They find themselves in a bind when looking at Adore Beauty Group ((ABY)), strongly arguing the online beauty platform operator has a long-term promising future ahead, but shorter-term there could be disappointment lurking.

Headwinds are also there because twelve months ago this was one of the covid-beneficiaries, and that makes comparison this time around a tough hurdle to overcome.

Increased competition, margin pressure, tough comparisons with last year… enough to make Morgan Stanley nervous ahead of the upcoming FY22 release, to be expected in late August.

On the other hand, the broker is optimistic about Data#3 ((DTL)) with company management releasing a positive update recently. Morgan Stanley sees continued strong operational momentum.

What's quite astonishing about the Data#3 nomination is the broker officially only commenced coverage of the company less than a week earlier.

The same positive conviction applies to TPG Telecom-spin off Tuas Ltd ((TUA)) which is Morgan Stanley's preferred telco on the ASX.

Morgan Stanley is cautious on Dicker Data ((DDR)), short-term, because of supply chain risks. Longer-term there is no such caution as also proven by the broker's Overweight rating.

The highest concern ahead of August has been reserved for InvoCare ((IVC)) with Morgan Stanley analysts isolating multiple threats and risks for the funeral services operator.

One of the observations made is the company is no longer communicating its market share with investors; this is one metric that has not gone the company's way in recent years. Poor weather is likely to have impacted as well.

****

Market strategists at Macquarie are still of the view that profit resilience needs to be sought after in the face of next year's economic slow down, with the potential for a global recession.

If we had to pick just one Outperform stock from each sector that has our confidence in likely earnings resilience during a period of recession, stated the strategists on Monday, they'd nominate the following:

-Steadfast Group
-Goodman Group
-The Lottery Corp ((TLC))
-TPG Telecom ((TPG))
-NextDC ((NXT))
-CSL ((CSL))
-Coles Group ((COL))
-Transurban Group ((TCL))
-Amcor ((AMC))
-Newcrest Mining ((NCM))
-Origin Energy ((ORG))

****

Recent strategy update by Shaw and Partners:

"Borrowers should refrain from locking in longer term loan interest rates at prevailing levels as it is likely that the RBA will not raise rates as far as the market is currently pricing.

"House prices are likely to continue to fall as rates rise, credit growth will slow from the current 9.2% level and bank share prices will struggle to move ahead."

And also:

"We maintain a defensive stance in multi-asset portfolios and await the slowdown in global growth and tightening of financial conditions to ease before becoming neutral and then constructive on growth assets."

****

Morgan Stanley recently lined up seven reasons to Buy Top Pick Whitehaven Coal, irrespective of the coal miner's stellar run this year (still ongoing).

1. June-quarter production performance was strong
2. Legal proceedings regarding Narrabri Stage 3 extension can be conducted without significant production disruptions
3. FY23 free cash flow yield on the basis of current spot prices is simply enormous; 82% on Morgan Stanley's modeling
4. FY23 dividend forecast is, on the same basis, enormous too; 21% says Morgan Stanley
5. High spot prices make the current valuation look extremely cheap; FY23 EV/EBITDA is 0.2x on spot
6. The company's net cash is forecast to rise to $3bn in FY23, allowing optionality for significant capital management
7. Morgan Stanley rates the stock Overweight and lifted its price target to $8.50 from $7.75 (shares are at circa $6.16)

****

Stockbroker Morgans' Core Model Portfolio has trimmed its exposure to Macquarie Group ((MQG)), as that stock had grown to an "excessive weight" in the Portfolio. Morgans is also expecting a lesser-year for the Golden Doughnut, while still expecting Macquarie remains a great holding for the longer-term.

Post share price weakness for BHP Group the Portfolio has bought extra shares in the Big Australian.

Morgans' Growth Model Portfolio has also sold some shares in Macquarie, for exact the same reason, while selling out of Megaport ((MP1)). The latter decision was made with pain in the heart, judging from the commentary explaining the move.

Morgans sees equally compelling opportunity among growth companies on the ASX that offer less risk and are of higher Quality. Currently on the Watchlist are:

-Seek ((SEK))
-REA Group ((REA))
-Domino's Pizza ((DMP))
-IDP Education ((IEL))
-Reliance Worldwide ((RWC))
-PWR Holdings ((PWH))

Additional commentary: "Feedback from our institutional clients suggests that many are now willing to dip their toes into the highest quality and oversold growth names among the small-mid caps."

****

Strategy update by Wilsons:

"It may be the case that the market settles into a groove where the outperformance of the growth or value style is less marked than it has been in recent years.

"We retain exposure to all 3 investment styles –growth, value and quality – although our current style preference is quality."

FNArena Talks

My latest interview with Peter Switzer:

https://www.youtube.com/watch?v=Zd64jzYG3Us&t=1629s

(This story was written on Monday 25th July, 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).

****

BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $480 (incl GST) for twelve months or $265 for six and can be purchased here (a subscription to FNArena might be tax deductible):

https://www.fnarena.com/index.php/sign-up/

Click to view our Glossary of Financial Terms