Rudi's View | Sep 27 2023
This story features RESMED INC, and other companies. For more info SHARE ANALYSIS: RMD
In this week's Weekly Insights:
-Looking For Answers
-Best Ideas & Conviction Calls
By Rudi Filapek-Vandyck, Editor
Looking For Answers
The short term outlook for the Australian share market is, at best, uncertain. This is because there are simply too many conflicting factors to pay attention to.
Last week's selling pressure on equities was caused by a general reset in bond markets following ongoing higher-for-longer signals from the Federal Reserve. When bond yields move higher, as the market prices out expected rate cuts in 2024, the direct impact is a lower valuation for equities, with some sectors harder hit than others.
This impact from left field bonds does not address the fact many an expert believes US equities in particular seem overvalued, as also explained in last week's update. Here the extra-complicating factor is that much of today's "overvaluation" can be traced back to those seven megastocks that are also responsible for most of this year's gains.
One could conclude from this there's no need to worry, assuming this apparent excess will be addressed shortly, as long as there's no direct exposure in the portfolio to the so-called Magnificent Seven, but history suggests it's unlikely to be this simple. If the likes of Apple, Microsoft and Nvidia were to pull back significantly to much lower valuations, the rest of the US market, as well as equities around the world, might simply join in on the new trend.
The risk for a deeper, broad pull back in equities has arguably become a lot more likely over the past few weeks. The local share market already corrected in excess of -4% in August, only to subsequently rally into the final week of that month. On Friday morning, -4% looked yet again on the cards for September, until the market bounced back strongly.
These moves have damaged the underlying trend signals with many a technical analyst now exclaiming global equities look "ugly" and "vulnerable" from a pure technical perspective. Seasonally, the calendar has now moved into what usually turns out is the weakest time of the year, and it generally lasts until late into October, sometimes longer.
And we haven't even touched upon the most obvious risk that is now emerging on the horizon: the next shutdown of the US government. We can all thank the broad and general disintegration of US politics for it, but the odds are very much in favour of no agreement being reached in Congress, which will deprive the Biden government of sufficient means to keep paying its bills and liabilities.
So far, not a single one of the 12 annual appropriation bills required to fund government agencies has been passed by Congress. Assuming no agreement, this impacts on roughly 25% of all government outlays. Luckily for America, spending on most major government transfer programs like Social Security, Medicare, unemployment benefits, as well as payments for interest on government debt continue during a shutdown.
Exactly how markets will respond is anyone's guess, but I'd wager major rallies remain off limits for the time being, at least until we see a conclusive political resolution on Capitol Hill.
The past decade has presented investors with two similar precedents, with prior shutdowns occurring in 2018/19 and in 2013. Both shutdowns were different in duration and impact.
The shutdown in 2018/19 lasted an eternity (at 34 days it was the longest on record) but as Congress had already passed five of the 12 spending bills, 75% of all discretionary spending had been covered. In contrast, the 2013 shutdown was shorter, but that was a full shutdown causing much larger impact immediately.
Given today's set-up looks similar to 2013's, it's probably safe to assume America might be facing yet another full government shutdown. Oxford Economics estimates some 900,000 of a total 2.3m workers could potentially be furloughed, but all workers go without pay until the shutdown ends.
As the economists explain, federal workers have always received back-pay to cover the period of the shutdown, but Congress does have to pass legislation to ensure that happens. Not all of the temporary impact on spending, by workers, businesses and the government itself, will be reversed later on.
Another consequence might be that the release of indicators and economic data by the Bureau of Labor Statistics will no longer happen. The current deadline passes on September 30th.
Rising bond yields, ugly-looking weakening technicals, seasonal headwinds and a looming US government shutdown; you'd think there's enough to keep investors on edge for the weeks ahead, but there's more:
-still uncertain what China's outlook looks like;
-ongoing strikes at American automakers;
-the resumption of student loan repayments;
-the end of post-covid childcare support payments by the US government;
-oil and gas prices are on the rise too.
The latter is a direct consequence of key producers Saudi Arabia and Russia keeping a lid on supply in order to keep the global energy market tight. In today's bifurcatied world, it can also be seen as a deliberate strategy to hurt America economically, or even as a targeted erosion of Joe Biden's chances for re-election.
Last week's bond market reset also serves as a reminder to investors the path to sustainably lower inflation numbers does not equal a down-sloping straight line and central bankers remain hellbent on not repeating the mistakes made during the 1970s when shifting too early from tightening to loosening reinvigorated inflation.
Having criticised central banks for their misguided policy and forecasts throughout 2021 and 2022, and subsequently ignored their messaging and priced in rate cuts soon after the peak in official rates, bond markets have now fallen in line with official Fed forecasts of higher-for-longer interest rates.
It would appear, at face value, direct inspiration has been taken from the so-called dot plots; median forecasts for where the decision makers at the Federal Open Market Committee (FOMC) see the official cash rate into the future. This has economists scratching their head as the irony here is, even by the Fed's own messaging, these dot plots are not meant to be actual "forecasts".
Needless to say, part of the rebuke from economists around the world now consists of historical comparisons between Fed dot plots and what actually happened next. Spoiler alert: the dot plots are pretty much useless beyond the immediate outlook. The further one moves into the future, the wider the gap with actual rates at the times projected.
Conclusion: irrespective of the bond market moves in September, we should not discount the possibility of central banks cutting rates next year. Admittedly, inflation remains a very important discussion point in this debate, and resilient economies in combination with above-target inflation readings make the latest response from bonds quite logical.
But it does call into question the Goldilocks scenario that is underpinning current market moves. Rising bond yields, as pointed out by economists last week, add more tightening even if the Fed doesn't lift the official cash rate. More pricey oil, while inflationary, also adds more pressure on spending abilities of households and businesses.
The translation of these factors combined means the odds are currently moving more in favour of economic recessions and rate cuts next year because the bond market is projecting the opposite this month. Life is full of such ironies, finance included.
Meanwhile, in the background of all of this, short positions in US bonds have risen to a mountain in contracts seldom witnessed in history. This suggests a trend reversal, whenever it arrives exactly, can be swift and violent. Central bankers will be worried about the potential for unintended ramifications.
I was also yet again reminded recently the market's obsession with a "soft landing" is simply history repeating, over and over again. A recent survey of the Wall Street Journal archives has found references to "soft landings" for the US economy tend to peak in the lead-in to the next economic recession.
Previous peaks have been registered for 2006/07, for 2000/01, 1995, and 1989. What all these past peaks have in common is that a recession eventually did follow, albeit not necessarily immediately.
For investors, I think the important message is not to get too carried away with the market's narrative of the day. What might seem like the fresh new gospel one day, can just as easily become tomorrow's self-inflicted joke.
The most plausible scenario, I continue to believe, is that economies continue to lose momentum on the back of tight monetary policies and other restraints on consumer spending. Whether they'll also suffer from "recessions", deep or mild, might just be a matter of measurement and methodology.
In terms of underlying market direction, share markets have tried to respond to multiple opposing influences through rotations in and out of opposing segments, which has kept the interest alive of short-term oriented day traders, but much less so of disappointed and frustrated investors who'd like to see trends and gains stick for longer.
As we approach the final quarter of calendar year 2023, multiple rallies and retreats, and rotations in and out of this segment and that section, has left the ASX200 with virtually no gain for the year, except for dividends paid out.
Until we see a clear positive path emerging for the economy in the US and elsewhere, or at least significantly less risks and uncertainties, the picture from the recent months may not look fundamentally different in the time ahead.
Depending on one's patience, specific strategy and appetite for risk, it may simply be prudent to have cash on the sideline. Who knows when or where that next opportunity might show up?
Best Ideas & Conviction Calls
The outlook for both corporate earnings and dividends in Australia is the worst it has been since that pandemic impacted 2020, but there's no reason for Australian investors to despair, argues fund manager Ausbil Investment Management's Chief Investment Officer Paul Xiradis.
Less dividends for investors is, above anything else, a reflection of less buoyant conditions for large cap miners, in addition to pressure on retailers and REITs. Regardless, Ausbil does agree with forecasts of lower payouts in FY24 as local companies in general are facing higher capex requirements, higher interest payments on debt and, broadly speaking, more risks and uncertainties about their operational outlook.
In some cases companies might need to prioritise paying down more debt instead of paying out the maximum to shareholders.
It is but a short term blip, suggests Ausbil. As monetary policy stabilises over the months ahead, the local economic picture should start to improve as well, and with it the outlook for shareholder dividends. Needless to say, Ausbil does not think Australia is facing the prospect of economic recession in 2024.
As far as current forecasts are concerned, Ausbil thinks investors should expect to see improving conditions for banks, miners and energy producers, which -all else remaining equal- suggests the aggregate forecasts for corporate earnings and dividends for the year ahead might prove too conservative.
Anyway, as things stand, the rather dismal looking negative -6.5% in average EPS growth for FY24 is projected to be followed by positive EPS growth of 6.1% in FY25.
Infrastructure and REITS are deemed the worst affected by higher interest rates, while the outcome for technology stocks is thought to be more diverse. Ausbil expects tech companies with sustainable cashflows and strong and growing earnings to outperform peers that remain non-profitable.
As decarbonisation remains a dominant trend, both miners and energy companies should continue to enjoy favourable dynamics. Further improvement for the Chinese economy should be another source of support.
Portfolio managers at T Rowe Price, while not outright negative, remain noticeably more cautious in the face of rising headwinds for consumer spending and corporate margins in Australia. Their so-called base case remains "bearish".
T Rowe Price sees excess savings depleting and the impact from RBA tightening accumulating further in the months ahead. If anything, relatively resilient economic growth to date will keep the higher-for-longer mantra at the RBA in place, this fund manager suggests.
Overall, Australia continues to enjoy a Neutral portfolio allocation, as does the USA, and China. Europe, where an economic recession is emerging, is the sole major market on Underweight, while Japan is the only region with an Overweight allocation.
T Rowe Price sees risk in overinflated forecasts for Japanese profits if the global economy deteriorates. Chinese growth remains poised to miss official targets, while for US equities the key risk has been identified in elevated valuations.
Assuming the Australian economy can avoid an outright recession, T Rowe Price believes the local share market seems fairly valued. While small-caps seem to offer attractive valuations, T Rowe Price counters these companies also face margin uncertainty due to higher exposure to interest rates and higher input costs.
A similar non-euphoric assessment is made of the Australian dollar; the AUD looks attractive, the asset manager concedes, but a slowing domestic economy in combination with a negative interest rate differential are not supportive of a stronger AUD in the short term.
Open the business section of one of the major newspapers in Australia and chances are you'll stumble upon the next local funds manager who's been buying shares in CPAP company ResMed ((RMD)). The share price, however, still hasn't stopped falling.
Last week, model portfolio guardians at stockbroker Morgans equally joined the trend and started buying shares in ResMed. Morgans' motivation: "[this] business has survived similar perceived threats to demand in the past and we think the 'noise' around this situation can abate".
The Core Model Portfolio has also topped up its exposure to Goodman Group ((GMG)), labeled as "best-in-breed".
Morgans' Growth Model Portfolio thinks China remains poised for underwhelming financial stimulus and economic performance. On this premise, the Growth Portfolio has decided to downgrade its weighting to Resources to Neutral from Overweight. The victim of choice to facilitate this shift is South32 ((S32)) – the portfolio sold all shares in the commodities producer.
The three largest holdings in the Growth Model Portfolio are BHP Group ((BHP)), CSL ((CSL)), and CommBank ((CBA)), followed by Corporate Travel Management ((CTD)), Macquarie Group ((MQG)), Santos ((STO)), Lovisa Holdings ((LOV)), and Aristocrat Leisure ((ALL)).
Top holdings for the Core Model Portfolio look a bit different with CSL and BHP Group equally at the top (7.5% weighting each), followed by CommBank, Macquarie Group, Westpac Bank ((WBC)), Brickworks ((BKW)), Wesfarmers ((WES)), and Santos.
One obvious reason, according to the broker, is because many investors are nowadays shunning investment in coal.
Priced at around US$170/tonne, thermal coal continues to generate strong cash flows for producers, the broker highlights, with excess cash likely to be returned to shareholders via dividends and share repurchases.
Over the longer term, Ord Minnett predicts thermal coal prices will be supported by supply constraints in Western countries due to regulatory opposition to opening new mines, as well as by robust demand from countries in Southeast Asia in particular.
The government in France has decided to close down the country's two remaining coal-fired power stations by 2027.
I have been invited to MC this year's ATAA National Conference dinner, while presenting on Sunday morning: "Investing fundamentals are not what they seem".
The ATAA National Conference this year takes place on October 20-22 inside Sydney's Sheraton Grand Sydney Hyde Park.
For more info SHARE ANALYSIS: ALL - ARISTOCRAT LEISURE LIMITED
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: BKW - BRICKWORKS LIMITED
For more info SHARE ANALYSIS: CBA - COMMONWEALTH BANK OF AUSTRALIA
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: CTD - CORPORATE TRAVEL MANAGEMENT LIMITED
For more info SHARE ANALYSIS: GMG - GOODMAN GROUP
For more info SHARE ANALYSIS: LOV - LOVISA HOLDINGS LIMITED
For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC
For more info SHARE ANALYSIS: S32 - SOUTH32 LIMITED
For more info SHARE ANALYSIS: SMR - STANMORE RESOURCES LIMITED
For more info SHARE ANALYSIS: STO - SANTOS LIMITED
For more info SHARE ANALYSIS: WBC - WESTPAC BANKING CORPORATION
For more info SHARE ANALYSIS: WES - WESFARMERS LIMITED
For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED