Rudi’s View: Keep Your Focus On What Matters

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In this week's Weekly Insights:

-Keep Your Focus On What Matters
-Conviction Calls & Best Ideas
-FNArena Talks

By Rudi Filapek-Vandyck, Editor FNArena

Keep Your Focus On What Matters

The irony about share markets is the more share prices rally, the more optimistic we all become, and the stronger the urge to join in and become part of that rally.

But as one astute market follower stated last week: such reflex makes a lot more sense when the S&P500 is below 3900, where it was late last year or in February, than it does when the index is where it is now.

At least at those lower levels the argument can possibly be made that any forthcoming recession has already been accounted for.

Now the index has crossed 4400, anyone buying today needs to keep the fingers crossed and hope there will not be a recession, in contrast to forward-looking economic indicators.

I do note, following multiple weeks of index gains, several market watchers are now warning their clients technical indicators are flashing 'overbought' warnings, which is not a reliable timing indicator, but merely a reflection of how strong and one-sided market momentum in the US has been recently.

History does suggest overly stretched market momentum signals tend to be followed up by a general market retreat, though not necessarily immediately.

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We all can come up with reasons as to why equities globally are back in rally mode. I do observe the number of investors and commentators willing to call a new bull market is steadily rising on Twitter.

I would not be surprised if we're all about to find out that institutional fund managers have been reducing their cash holdings while hedge funds have decided to cover short positions.

My suspicion is based upon the chart below from S&P Global Market Intelligence showing those global institutions have been gradually, but persistently, reducing exposure to US equities throughout the twelve months to May 31 (falling yellow trend line).

Over that period, as shown in the second graphic underneath, the S&P500 has effectively gone nowhere as each attempt to rally ran into subsequent weakness. Has this dynamic changed over the past weeks?

For a professional fund manager, nothing is as devastating as seeing markets rally while sitting with loads of cash on the sideline. This is where careers can come unstuck, irreparably and indefinitely.

Don't be surprised if cash levels generally have shrunk somewhat during this rally. This is not by default a sign of better times ahead, in share market terms. It's simply a calculated move by those worried about their job and mandates were markets to continue to surprise to the upside.

As we have all witnessed over the past 18 months; there is always room for surprise.

The Federal Reserve is partially responsible too. Not because of The Pause, which is being interpreted positively, but more so because of the central bank's ongoing injections of additional liquidity in the US financial system. Powell & Co are worried about further fallout and economic consequences from the regional banking crisis and are thus providing extra liquidity in support of US banks.

This is the real reason why more bad news has turned into good news for US, and by extension, global equities in 2023. Central bankers have discovered an extra shock absorber in the form of additional liquidity. It has worked thus far. History suggests a close relationship with equity market rallies, as the extra liquidity is funnelled into financial markets rather than in economic assets.

My worry about US markets is still the same: if forward-looking indicators, backed by historical parallels, are correct then corporate profits for US companies are facing more (not less) downward pressure in the quarters ahead. This automatically creates a discrepancy with rising share prices.

Put simply: are US indices reflecting one rosy scenario without taking into account that other, less rosy scenarios, remain a reasonable, plausible, and but viable outcome?

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The dynamics for Australian equities are not quite the same this year. Local indices have booked much smaller gains and 2/3 of all gains year-to-date stem from the current rally.

In support of ASX-listed companies, those much smaller gains (circa 3.5%) have been carried by a significantly broader participation; more than half of the ASX200 versus 20 major winners for the S&P500.

But… my concern is exactly the same. The present rally is pushing the local market's PE ratio above its long-term average… while analysts are busy downgrading forecasts. It is true, the share market does not equal the local economy, which is one of the catch phrases some of the more bullish commentators like to use.

At some point, however, the economy and share prices will converge. 

The greater the gap between the two, the larger the readjustment needs to be.

In line with the toughening conditions for companies generally, Corporate Confession Season is making a noticeable comeback in Australia, after a hiatus of 2-3 years. And as witnessed by the disappointing market update by lithium play Lake Resources ((LKE)) on Monday, it's not simply all about Australian households minding the pennies.

Consumer confidence and changing spending behaviour will likely remain at the forefront of investors' attention for a while longer. Not only are companies such as Adairs ((ADH)), Baby Bunting ((BBN)), City Chic ((CCX)), Domino's Pizza ((DMP)), Retail Food Group ((RFG)), Treasury Wine Estates ((TWE)), and Universal Store Holdings ((UNI)) issuing disappointing operational updates, sector analysts are increasingly suggesting this won't be a short process, implying risks may well extend beyond FY24.

Something investors might want to keep in mind before they decide to allocate to falling share prices.

The crucial ingredients behind these profit warnings are rising costs and lower sales – a deadly combination for vulnerable franchises. Both inventories and wages are rising, while ever more prominent promotions and discounts are necessary to entice the buyers into shopping. Businesses report ongoing headwinds from utility bills, rents, currencies, outbound freight costs, and insurance.

Sector analysts at Jarden met with more than 30 companies recently. On their assessment, the best placed in a domestic sector under duress are Costa Group ((CGC)), Breville Group ((BRG)), Coles Group ((COL)), Wesfarmers ((WES)) and Woolworths ((WOW)). Those worst positioned, and thus most vulnerable to further downward pressures, in Jarden's view, include Adairs, Accent Group ((AX1)), The Reject Shop ((TRS)), Kogan ((KGN)), and Universal Store Holdings.

Regarding Accent Group and Universal Store Holdings, I note previous consensus agreed those retailers catering for a younger audience would prove resilient, but data analysis by CommBank has suggested it is instead the older, 55-plus cohort in society that keeps spending like bandits while others feel the pinch from rents, inflation and RBA tightening.

In terms of generally defensive exposures to households in Australia, Jarden's suggestions also include Metcash ((MTS)), Treasury Wine Estates, Webjet ((WEB)), Corporate Travel Management ((CTD)), and Flight Centre ((FLT)).

Highly regarded CSL ((CSL)) last week, and multinational Amcor ((AMC)) the previous month, have shown disappointment is not by definition solely reserved for vulnerable exposures to penny-pinching consumers; even the more defensive business models can be affected. Healthcare companies in general have found the process towards normalisation post covid a lot more challenging, both for previous winners and losers from the pandemic.

Investors will note similar challenges have held back share prices for ResMed ((RMD)), Ramsay Health Care ((RHC)), Fisher & Paykel Healthcare ((FPH)), Sonic Healthcare ((SHL)), Healius ((HLS)) and many of the smaller operators in the sector.

Analysts at Macquarie have warned the wave of downgrades is about to hit corporate Australia at large given the latest NAB Business Survey revealed the value of orders received is falling across Australia. Traditionally, points out Macquarie, negative orders are a reliable signal conditions overall could turn negative within a few months.

The key word for the months ahead, suggests Macquarie, is margin pressure. Declining orders means businesses still facing inflation (and other pressures) can no longer simply pass these on to customers. The more vulnerable might need to offer discounts instead, with even larger impacts on margins.

Taking a more detailed interest into what happened during similar conditions in the past, Macquarie analysts find sectors of media, industrials, discretionary and both financial services and banks are most at risk of sizable decreases in EPS. Unsurprisingly, defensives tend to experience fewer drops than cyclicals.

Macquarie's research also suggests momentum can only reverse to positive again from the moment the RBA starts cutting the cash rate. Right now, consensus is the RBA is not yet finished with hiking rates.

Confession Season is also showing there's always room for a positive surprise. Witness, for example, the recent market updates by AGL Energy ((AGL)) and Insurance Australia Group ((IAG)) – both surprised significantly to the upside.

Could there be a few valuable signals in both? AGL Energy is recovering from possibly the worst downturn in its corporate history whereas the latter is widely considered the weaker laggard in a sector that is firing on multiple cylinders, irrespective of the threats stemming from changing climate and weather patterns.

Apart from these two, there are -of course- still companies enjoying upgrades to forecasts and valuations, as also shown each week in FNArena's weekly update on earnings forecasts, price targets and ratings, but it needs to be highlighted the bias is clearly skewed to the negative.

More companies are seeing profit forecasts and price targets suffering from downgrades than those enjoying positive revisions. Negative revisions also tend to be much larger in size. Here's a link to Monday's update:

https://www.fnarena.com/index.php/2023/06/19/weekly-ratings-targets-forecast-changes-16-06-23/

The week prior saw positive revisions for Origin Energy ((ORG)), Sigma Healthcare ((SIG)) and Aussie Broadband ((ABB)) more than offset by negative adjustments for Baby Bunting, Adairs, Cooper Energy ((COE)), Appen ((APX)), and Mineral Resources ((MIN)).

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All in all, I remain of the belief that Confession Season in Australia -two more weeks in June plus four weeks in July- is about to reveal many more disappointing market updates, especially since consumer spending is only now starting to crack.

It will not be possible to forecast and anticipate all negative updates and developments, as also highlighted by that rare profit warning from CSL.

Which is why I think the best risk-adjusted decision to make is keeping a healthy portion of the investment portfolio in cash.

Next decision to make is to assess which companies are less at risk in the year ahead, but also: which ones that unexpectedly suffer setbacks might actually be a blessing in disguise for long-term investment purposes?

The next quarterly reporting season for US companies starts in about one month. That might prove a very important test for US markets.

Conviction Calls & Best Ideas

Macquarie runs a few 'Recommended Portfolios' which, in the broker's own words, represent starting points for investors looking to populate or adjust a portfolio with either a Growth or Income focus.

According to the broker's most recent updates, both portfolios comprise of 18 stocks.

Are included in the Growth Portfolio (ranked in order of percentage weight):

-CSL ((CSL))
-Aristocrat Leisure ((ALL))
-Pilbara Minerals ((PLS))
-Mineral Resources ((MIN))
-Northern Star ((NST))
-Goodman Group ((GMG))
-The Lottery Corp ((TLC))
-Flight Centre ((FLT))
-Computershare ((CPU))
-Cleanaway Waste Management ((CWY))
-Steadfast Group ((SDF))
-ResMed Inc ((RMD))
-Carsales ((CAR))
-Ramsay Health Care ((RHC))
-Treasury Wine Estates ((TWE))
-NextDC ((NXT))
-IDP Education ((IEL))
-Netwealth Group ((NWL))

Income Portfolio:

-Telstra ((TLS))
-ANZ Bank ((ANZ))
-Suncorp Group ((SUN))
-National Australia Bank ((NAB))
-Coles Group ((COL))
-Atlas Arteria ((ALX))
-BHP Group ((BHP))
-APA Group ((APA))
-Westpac Banking ((WBC))
-Commonwealth Bank ((CBA))
-GPT Group ((GPT))
-Premier Investments ((PMV))
-Aurizon Industrials ((AZJ))
-Deterra Royalties ((DRR))
-Metcash ((MTS))
-Charter Hall Retail REIT ((CQR))
-Amcor ((AMC))
-GUD Holdings ((GUD))

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MST Marquee's market strategist Hasan Tevfik also published his ideas for income seeking investors (in random order):

-BHP Group
-Westpac Banking
-Macquarie Group ((MQG))
-Telstra
-Transurban ((TCL))
-Rio Tinto ((RIO))
-Coles Group
-QBE Insurance ((QBE))
-South32 ((S32))
-Suncorp Group
-Lottery Corp
-Medibank Private ((MPL))
-Mirvac Group ((MGR))
-Ampol ((ALD))
-ALS Ltd ((ALQ))
-Viva Energy ((VEA))
-JB Hi-Fi ((JBH))
-Chorus ((CNU))
-AMP ((AMP))
-Reliance Worldwide ((RWC))
-Deterra Royalties ((DRR))
-Waypoint REIT ((WPR))

More on Conviction Calls and Best Ideas:

–https://www.fnarena.com/index.php/2023/05/25/rudis-view-aristocrat-bhp-qantas-westpac/

-https://www.fnarena.com/index.php/2023/04/19/rudis-view-bond-market-says-regime-change-is-upon-us/

–https://www.fnarena.com/index.php/2023/04/12/rudis-view-wesfarmers-wisetech-worley/

–https://www.fnarena.com/index.php/2023/03/17/rudis-view-dominos-pizza-newcrest-qantas/

–https://www.fnarena.com/index.php/2023/02/10/rudis-view-aub-group-endeavour-lottery-corp-suncorp/

–https://www.fnarena.com/index.php/2023/02/03/rudis-view-csl-mineral-resources-ridley-readytech/

FNArena Talks

Earlier this month I gave an online presentation to members of the Australian Shareholders Association (AIA) on the Gold Coast.

The video (51 minutes) is available via the FNArena Talks section on the website, as well as on YouTube: https://www.fnarena.com/index.php/fnarena-talks/2023/06/08/recoveries-recessions-ramifications/

Paying subscribers can download the slides I used via SPECIAL REPORTS; drop down menu from ANALYSIS & DATA on the website – scroll further down when on the page.

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 19th June, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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. All views are mine and not by association FNArena's – see disclaimer 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: contact us via the direct messaging system on the website).

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