Rudi’s View: Yield Is Back

This story features HOMECO DAILY NEEDS REIT, and other companies. For more info SHARE ANALYSIS: HDN

In this week's Weekly Insights:

-Yield Is Back
-Watch The Corporate Calendar
-CSL & ResMed – Under Pressure
-Best Ideas & Conviction Calls

By Rudi Filapek-Vandyck, Editor

Yield Is Back

Twelve months ago, a temporary peak in global bond yields provided the green light for a strong relief rally in share markets. That relatively close relationship has remained in place since, up until last week.

Prior to last week, the relationship between bond markets and equities looked straightforward and simple: bond yields up, equities down; bond yields down, equities up.

This close relationship explains why any form of bad news has proved positive for equities since, for example, rising risks for US regional banks and the subsequent Fed response resulted in lower bond yields.

Equities up.

We will need to see a convincing signal that Israel's war on Hamas is not leading to a much broader geopolitical conflict in the Middle East before equity markets can show the same knee-jerk response to retreating bond yields this time around, which, fingers crossed, will be the case.

But maybe the most important signal from last week is that falling bond yields are not under all circumstances a positive for the direction of share markets. The next challenge might come with much slower economic momentum, which also should lead to lower bond yields, but not by default to rising share prices.

Having made this point, it is but fair to acknowledge bond markets have not been straightforward predictable this year. In particular the strong upward move throughout September and into October had taken many a market observer by surprise. The US bond market might still be the Biggest Gorilla on the planet, its many fundamental drivers vary, and there always remains room for surprise.

Bigger picture though, higher bond yields are a form of tightening, thus placing more pressure on the US economy. It's only common sense that all the talk of higher-for-longer and the subsequent move up in longer-dated Treasuries is narrowing the odds for the US economy to run out of steam in the quarters ahead.

However, if 2022 and 2023 have proven one thing it is that timing is just as important as the underlying trend. Get your timing off and the market has a tendency to prove you wrong, and to punish you handsomely for it too. At least, until that trend announces itself.

The Big Disappointments in the past two years include the notable underperformance of defensives, quality growth and the smaller cap segments of the share market. And those who positioned for lower bond yields have been taken to the cleaners over the past number of weeks.

There's a lot of talk of "reluctant buyers", if not of a general "buyers strike" when it comes to US Treasuries. The fact so many investors in fixed income are left with negative returns and bruised souls would explain a lot of what has occurred. When bond yields rise rapidly it means bond prices are selling off.

The past two years mark some of the worst experiences for fixed income investors in our lifetime; possibly the worst ever. As things stand, 2023 will be the third consecutive year of negative return (mark-to-market). This has never before happened, ever.

One conclusion to draw is that fixed income is making a comeback, in general terms, irrespective of whatever might transpire in the short term. Over in the US, high-yielding corporate bonds are now offering yields of 9%-plus and as GMO's Jeremy Grantham opined recently, if one's worried about large-scale corporate debt defaults next year, imagine what the impact would be on the share market generally.

The one thing to point out is a corporate bond is essentially a contract to pay back the full amount upon expiration, plus all obligatory intermediate payments, effectively cushioning the investor from fluctuating prices as long as he/she holds until maturity. This is not the case when one buys an ETF that combines a multitude of such bonds.

High-yielding corporate credit trades like equity. Something to keep in mind for investors looking to explore this freshly emerging opportunity.

The local share market by now equally offers a multitude of high-yielding options, but the risk versus return proposition is not always as straightforward. The graphic below shows what has happened to valuations for ASX-listed REITs (chart courtesy of ETF provider VanEck).

The problem with Office REITs trading at significant discounts is the uncertainty surrounding future valuations for office assets that might no longer be in as high demand in the years ahead. Higher costs to service debt are shaping up as the key growth limit for many a REIT locally as well as internationally.

The threat for retail assets is, of course, a big dip in consumer spending, even without an economic recession. The offset remains that current discounts are likely to prove excessive.

As reported previously, this is why HomeCo Daily Needs REIT ((HDN)) is included in the FNArena/Vested Equities All-Weather Model Portfolio. On current pricing and forecasts, the annual yield is in excess of 7%, and expected to rise.

Bigger picture, while the exact timing is far from certain, Economics 101 suggests both inflation and economic growth should weaken (further) on tight financial conditions and this in response will eventually lead to lower bond yields.

This should also take care of at least part of the discounts currently priced in for corporate credit, REITs and other assets, all else remaining equal.

Watch The Corporate Calendar

One thing that can potentially change the Mexican stand-off between bond yields and geopolitical risk and share markets are corporate results and market updates. In the US a fresh corporate results season is unfolding and all eyes will be zooming in on ongoing strong growth reports from the market leading Megatech companies.

In Australia, November is traditionally the month when local investors zoom in on the banks, but increasingly there are more updates from companies through quarterly trading reports, AGMs and investor days.

Thus far the current season hasn't been great with the FNArena Corporate Results Monitor classifying five out of 16 results to date as a "miss" (31.3%), but this need not be indicative of what is yet forthcoming. Just like the weak FY23 performance from Bank of Queensland ((BOQ)) cannot be seen as representative for the sector generally.

Judging from analyst reports recently, two sectors that stand out in terms of positive expectations remain travel and insurers. For the latter, the prospect of an El Nino period holds the potential for a big boost with recent research by Jarden flagging upside of no less than 20% for FY24 EPS forecasts for both Suncorp Group ((SUN)) and Insurance Australia Group ((IAG)).

This week also sees miners and energy producers starting to release quarterly performance updates. While both sectors remain bound to what happens with commodity prices, individual updates (can) still matter. Jarden has identified Beach Energy ((BPT)) and Cooper Energy ((COE)) for potentially weak quarterly performances.

In general terms, investors and analysts are seemingly anticipating most companies in those sectors have started the new financial year in a not so strong fashion. Citi analysts reported from last week's LME Week the general consensus sees a subdued outlook for metals in the next 6-12 months.

The situation for crude oil and LNG remains, as they say, fluid.

Will local gold producers finally put their margin headwinds in the past? The debate remains alive. Analysts at UBS have singled out lithium producer Pilbara Minerals ((PLS)) for potential major disappointment (due to lower-than-forecast realised product pricing).

Stockbroker Morgans has alerted its clientele to the upcoming investor day from Tyro Payments ((TYR)) scheduled for October 18. Can management deliver a positive surprise? Further out, Data#3 ((DTL)) organises its own investor day on November 16.

CSL's ((CSL)) presentations to analysts on Monday did not weaponise its shares against further weakness on the day. At last week's AGM, management had simply reiterated FY24 EPS guidance for growth between 13%-17% in constant currency terms.

As November draws closer, investors can look forward to the final spike in local corporate results, including ResMed ((RMD)) on October 27, Janus Henderson ((JHG)) and Amcor on November 1, Square ((SQ2)) and Macquarie Group ((MQG)) on November 3.

Xero ((XRO)), REA Group ((REA)), Aristocrat Leisure ((ALL)), Nufarm ((NUF)), GrainCorp ((GNC)), Webjet ((WEB)), TechnologyOne ((TNE)) and three of the Big Four Banks, among others, report financials later in the month.

The FNArena Calendar offers scheduled events for the four weeks ahead: https://www.fnarena.com/index.php/financial-news/calendar/

CSL & ResMed – Under Pressure

A number of subscribers have approached me in the weeks past, some very worried about what has been happening with share prices of ResMed and CSL.

The short answer is hedge funds and other market participants are looking for victims of the new anti-obesity "wonder drugs" from Novo Nordisk and Eli Lilly that are conquering America by stealth.

These so-called GLP-1 drugs are, essentially, heavy-handed suppressants and those on it experience a sharp loss in appetite for food and drinks, with follow-through impacts on, for example, snacking, gambling and even shopping/spending in general.

Extrapolate the impact and just about every consumer-oriented business might be impacted. Amcor packages food. Domino's Pizza ((DMP)) delivers fast food. The average food-related business in the US has seen its share price dive by -26% in recent weeks. The impact has been far worse for targeted companies in healthcare.

The heaviest impact on the ASX has thus far been reserved for healthcare companies ResMed, Fisher & Paykel Healthcare ((FPH)), and CSL. All on the assumption their businesses and future growth will be heavily impacted by the growing popularity of GLP-1 weight loss drugs.

The one precedent that comes to my mind is that of the arrival of online giant Amazon in Australia. Once investors got wind of Amazon's intention to set up shop in Australia, share prices of retailers and consumer-oriented businesses were sold off indiscriminately. Because, you know, Amazon was going to grab their customers and destroy their businesses.

Open up long-term price charts for ASX-listed retailers and one can clearly see the Amazon effect kicking in from the second half of 2016 until mid-2018. By then it had become obvious investors' fear had come way too early and it had been priced-in way too much.

While I have no means to accurately predict the future, I do see strong similarities with this year's GLP-1 fascination.

I do intend to write a deeper dive into both company's (mis)fortunes, also given all three, including Fisher & Paykel Healthcare, are part of my research into All-Weather Performers in Australia. I prefer to include the latest insights stemming from this week's investor presentations by CSL and the upcoming Q1 release from ResMed.

In the meantime, how to respond to downward pressure on share prices is a personal choice. Share prices and company fundamentals do not always run in the same direction. Plus, there's no arguing with algos and traders who simply want to see the share price as low as they can get it.

Earlier in the month I dedicated a whole Weekly Insights to this dilemma: https://www.fnarena.com/index.php/2023/10/04/rudis-view-to-sell-or-not-to-sell/

Best Ideas & Conviction Calls

While general scepticism is growing about the short term potential impact from generative AI on most technology companies, sector analysts at Barrenjoey have lined up their most preferred among ASX-listed tech companies:

-Wisetech Global ((WTC))
-Seek ((SEK))
-Megaport ((MP1))
-Pro Medicus ((PME))
-Iress ((IRE))

****

Commodity analysts at Canaccord Genuity have lined up their preferred exposures to the lithium theme:

-Allkem ((AKE))
-Latin Resources ((LRS))
-Green Technology Metals ((GT1))
-Ioneer ((INR))

In line with expert voices elsewhere, Canaccord analysts do not exclude further weakness for lithium pricing in China, but they do believe following serious share price weakness the sector on the ASX is yet again offering "value" for investors who can look through short term price volatility.

Over at Goldman Sachs, the short term preference lays with IGO Ltd ((IGO)) -because of its positive cash generation while most others remain in the negative- while the best medium term growth prospects are believed to be Allkem's.

The team at Morgan Stanley cannot get past the prospect for more weakness in lithium pricing and has all ASX-listed exposures on an Underweight rating.

Macquarie remains a pur sang supporter of the industry with Pilbara Minerals ((PLS)) the broker's number one preference. Patriot Battery Metals ((PMT)) is believed to offer the most upside on exploration medium term. Both Piedmont Mining ((PLL)) and Galan Lithium ((GLN)) are considered deep value.

****

Both ResMed and CSL are considered as "oversold" and have thus been added to Wilsons' selection of Most Preferred Direct Equities in Australia, alongside Amcor, APA Group ((APA)), and South32 ((S32)).

Wilsons' research has also identified a number of stocks that are trading below fundamental value, including Select Harvests ((SHV)), Rural Funds ((RFF)), and Clinuvel Pharmaceuticals ((CUV)).

For quality businesses with a clear, identifiable long term growth trend, Wilsons refers to Ridley Corp ((RIC)), TechnologyOne, Aroa Biosurgery ((ARX)), Lovisa Holdings ((LOV)), and Tourism Holdings ((THL)).

For those with a more speculative risk appetite, the analysts suggest Immutep ((IMM)) and Neuren Pharmaceuticals ((NEU)), with Beach Energy ((BPT)) suggested as one idea from the Resources sector.

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(This story was written on Monday, 16th October, 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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