Rudi's View | May 04 2023
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By Rudi Filapek-Vandyck, Editor
This week's "surprise" rate hike by the RBA only further strengthened the view of Canaccord Genuity Chief investment strategist Tony Brennan that investors should not misinterpret the April rally in equities as more evidence the worst of central bank tightening and US banking problems is now well and truly behind us.
Brennan has remained firm in his view this year's share market rallies are occurring on borrowed time and more weakness shall follow as market optimism meets the cold hard reality of slowing economic growth and lower corporate profits later in the year.
This week's RBA rate hike, with likely one more to follow, is simply yet more evidence for investors to remain alert and cautious, with Brennan declaring the RBA delivered a reminder of the risks that corporate profit forecasts might be cum further downgrades as economies can decelerate substantially on the lagged impact from central bank tightening.
These risks, suggests Brennan, are currently not incorporated into analyst forecasts or in present share prices.
Canaccord's macro advice has been to move portfolios Underweight equities, both in Australia and internationally, alongside Overweight allocations to fixed income, alternatives and cash. More tightening from the RBA has simply reinforced that position.
Strategists at Morgan Stanley, equally cautious for quite a long while, fully agree with Canaccord's reasoning. On their assessment, the lagged impact from monetary tightening is only just starting to rear its (ugly) head in Australia. Meanwhile, corporate earnings are still at elevated levels, and so are -generally speaking- share prices.
Not exactly an environment to dial up the risk taking.
In ongoing preparation for what is yet to come, Morgan Stanley's Model Portfolio has made a number of adjustments. Change number one is to move further Underweight domestic banks.
The Model Portfolio also further reduced exposure to A-REITs, while the previous Overweight exposure to Rio Tinto ((RIO)) has now been shifted back to Neutral (in line with the index weight) which resulted in reduced exposure to Metals & Mining. Iluka Resources ((ILU)) has been kicked out and in its place shares were bought in lithium producer Allkem ((AKE)).
Thus far in 2023, the Model Portfolio has performed in line with the index. Most positive contributions came from holdings in Newcrest Mining ((NCM)), James Hardie ((JHX)) and Iluka. Largest negative offsets came via Domino's Pizza ((DMP)), Rio Tinto and Xero ((XRO)).
The Focus Portfolio at Wilsons has equally undergone a number of changes with the aim of, yet again, trimming risk and diversifying the overall exposure to Australian equities.
Here shares in Santos ((STO)) have been sold and replaced with exposure to Worley ((WOR)), with the portfolio managers observing Worley not only offers enhanced diversification, but also more leverage to the clean energy transition theme.
Wilsons too remains cautious on the outlook for Australian banks, with the Portfolio selling more shares in Westpac ((WBC)), considered the most vulnerable to margin pressures stemming from local mortgages.
Exposure to Telstra ((TLS)) has been increased. Not only is Wilsons positive about the valuation upside within the telco's infra assets, Telstra should also enjoy a positive earnings trajectory that should prove resilient through the cycle.
Wilsons Portfolio is concentrated around the themes of Quality Cyclicals, Structural Growers, High Growth companies and Defensive Growth.
Companies representing these exposures are Macquarie Group ((MQG)), James Hardie and Nine Entertainment ((NEC)) for Quality Cyclicals, and Xero and Telix Pharmaceuticals ((TLX)) as High Growth companies.
Strategists at UBS are equally cautious. Their main conclusion is summarised in the title of this week's post-RBA rate hike strategy update: "RBA may be done with hikes… but equities set to remain in limbo for longer."
UBS thinks equities are now in a trading range and might stay in that range for a while yet.
Among the negatives that keep UBS on the 'safety first' side of the domestic share market:
-Defensive stocks look over-priced. Think Woolworths ((WOW)) and Telstra, suggest the analysts. It is their view most institutions are uncomfortable with the risks surrounding the share market in 2023 and this has led to overcrowding in defensive names which now command large premiums.
-Fund managers on average have reduced their cash levels from excessive levels last year, but cash on average still sits at 3% of portfolios, which remains high and yet again confirms UBS's view investors remain highly sceptical of the economic and market outlook.
-When analysing correlations between stocks it is clear to UBS macro factors continue to overwhelm the micro picture. With stock specific characteristics playing second, if not third fiddle, this makes stock selection for active managers even more challenging than usual.
-All of the above is seen as confirmed through the come-back in general popularity of gold.
Other observations made that deserve to be highlighted include the fact that specific sectors such as traditional media, real estate and transport continue to trade at sizeable discounts to long run average valuations (there's that general scepticism about the outlook again).
Contrary to widespread belief the Australian share market is still relatively cheaply priced, UBS counters when corrected for the distorted weight by a few large cap stocks, underlying an equal-weighted assessment shows the ASX300 is trading near the upper band of its historical range – and at 20% premium to its last 20 years' average.
That's not cheap, declares UBS, that looks expensive.
Countering any too-bearish forecasts for consumer spending, however, UBS finds Australian households still have plenty of excess savings and they intend to lower their spending, but not in a dramatic manner.
But probably the most eye-catching push-back from UBS is against the broad based market view that a pause in RBA tightening will herald a cyclical-led recovery for equities. There is no historical evidence for this to happen, counter the strategists.
Historically, what does happen when the RBA stops hiking, growth stocks outperform value and large caps outperform small caps in the six months post the final rate hike. In addition, UBS's research shows consumer discretionary and real estate stocks underperform during that period.
Sectors that typically outperform post final rate hike are insurance, technology and telecom, and healthcare.
A separate report by UBS's team of Quant analysts confirms the strategists' view underlying the share market's rally in April lay predominantly a defensive, less risk taking attitude from investors.
US strategists at Morgan Stanley also expressed a contrarian view against the ruling expectation there that a final rate hike from the Fed will be great stimulus for US equities. In truth, says Morgan Stanley, this has sometimes been the case in the past, but not when bond yields are inverted. Right now, the US bond market is very much inverted.
"(…) the "post-pause" performance of stocks has varied significantly, depending on whether the yield curve has been inverted. Equity performance has been worse when the Fed has paused with an inverted curve, which is one reason why we are more defensive."
While strategists at Citi have overall kept a more sanguine outlook for equities thus far this year, the team of mining sector specialists this week issued somewhat of a disconcerting warning having observed and analysed global earnings and market updates for the March quarter this year.
Not only have indications for earnings generally been weak for the quarter, Citi's analysts have noticed the weakness has been broad-based across the sector with most mining companies updating with weaker operational performances all at the same time; this hasn't happened for at least a few years, on the analysts' observation.
No surprise thus, mining stocks have de-rated across the globe recently. In Australia, market updates by the likes of BHP Group ((BHP)) and Rio Tinto have equally led to reduced forecasts by analysts in subsequent research updates.
Projections by in-house economists at Citi anticipate rolling economic recessions this year and next, which means there's no scenario where negative economic demand hits every major region at the same time. If this proves the case, resilient demand from China might prove essential for the sector.
Citi's mining team believes China's growth story should remain intact, as the domestic economy has become more resilient vis a vis external influences, but the analysts nevertheless believe there are risks of global downside scenarios. For now, they are happy to stick with the view that China will provide a natural 'hedge' for the sector against economic recessions in the US and Europe later this year.
Macquarie has also conducted its own research into which parts of the Australian share market perform best once the RBA stops hiking interest rates. Past RBA pauses, suggests Macquarie's research, have favoured bond proxies, defensives and large caps.
The research also carries a warning: in the past, equities often have rallied after a pause, but such rallies are typically short-lived.
In the US, Macquarie is positioned for a US recession with each of technology, media and real estate typically underperforming when negative GDP growth shows up.
The broker's Model Portfolio in Australia has made a number of adjustments in anticipation there won't be too many more RBA rate hikes, despite this week's "surprise". Elevating the healthcare sector to its largest Overweight, Macquarie's Porfolio has bought extra shares in CSL, "given its record of outperforming after RBA pauses".
Holdings in Goodman Group ((GMG)) and the ASX ((ASX)) have also been increased with both seen as major beneficiaries from falling bond yields. Orora ((ORA)), being a cheap defensive, has been granted a larger weight, and the same goes for Aristocrat Leisure ((ALL)), representing the Quality side of the share market.
Macquarie's Portfolio reduced its stake in Computershare ((CPU)) before this week's FY24 profit warning, while energy companies are considered Late Cycle cyclicals and thus their weight has been reduced too. Macquarie has been selling shares in Woodside Energy and Ampol ((ALD)).
Macquarie seems to agree with UBS's assessment of expensive defensives and has reduced exposure to Woolworths, Lottery Corp, and Steadfast Group ((SDF)).
All in all, Macquarie's view is that we are close to the end of RBA rate hikes, but a recession in the US comes next.
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)
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