Rudi’s View: Investor Worries, Gold, Westpac, and Conviction Buys

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In this week's Weekly Insights:

-Everybody Worried?
-Gold As Insurance
-Westpac, Technology Laggard
-Conviction Calls and Best Buys
-Rudi Unplugged – Send In Your Questions

By Rudi Filapek-Vandyck, Editor

Everybody Worried?

Bubble. Hype. Overpriced and overbought. These are all popular terms used by market commentators and investment experts in relationship to share markets in the US and locally in recent times.

Not a day goes by without various comparisons with the Nasdaq in 2000, Japan in the late 1980s, 1987, the Nifty Fifty era or the 1930s being made. It's not difficult to understand why investors are getting nervous, including subscribers here at FNArena.

And yet, I am not overly worried. When it comes to those aforementioned historical comparisons: my view is they are way, way, way too simplistic, with too much hyperbole attached.

Okay, after two strong quarters, as we've just experienced, it's not unusual for markets to pause and consolidate, they might even pull back, who knows? On short-term technical indicators, markets are overbought, so there's reason to expect some weakness at some point.

But I wouldn't hold my breath for a Grand Correction. I simply don't see a valid reason for this to occur, other than wishful thinking by those who want the market to undergo a big correction out of self-interest.

Things can change, of course, and the worst change to occur is rapid decelerating economic momentum alongside a further pick-up in inflation. That is a combination financial markets will not take lightly.

But thus far there's no evidence this is the scenario for the rest of the year.

I do agree with the assessments made elsewhere that the easy gains have now been made from the October lows, but this does by no means prevent share markets from posting further gains.

Markets will likely encounter more volatility from here onwards, as the path forward will become less uniform, with more side-steps and alternative scenarios to be considered by those whose job it is to make forecasts about economies and financial markets.

Underlying sentiment is still positive and likely to remain supportive as long as economies hold up, companies keep up with forecasts, inflation trends lower and the prospect of central bank rate cuts remains on the horizon.

I don't think the reducing number of potential rate cuts this year or next is the point to focus on for investors.

Markets are confident rate cuts will come. That remains the key foundation under this year's share market strength, together with technological innovation (AI, GLP-1s, cybersecurity, etc) and a surprising resilience in consumer spending and economies generally.

Goes without saying, there are no watertight certainties in financial markets, or in life generally, hence a more cautious investor can always transfer some of his equity exposure to cash.

If my comfort and confidence prove accurate, the global up-trend for equities will likely become more inclusive, meaning more money will start flowing into laggards to close the valuation gap with the share market winners to date.

Of course, nothing goes on forever, and things will change, at some point, maybe even without a warning signal first.

I am just not convinced right now is the right time to start worrying about all the bad things that can possibly happen. Let's leave that for another time.

Gold As Insurance

Last week I explained what drives gold, and how, but I did not mention the All-Weather Model Portfolio always carries some gold exposure, currently the equivalent of one stock at around 5%, through the Global X physical GOLD ETF (in AUD).

The reasoning as to why starts with the observation that, when measured over elongated holding periods, the return generated from owning gold falls in line with total return generated from local shares. But gold seldom moves in line with the local index, which implies its outperformance comes during times when equities are facing headwinds.

To some, gold offers diversification. In my world, the comparison with insurance suits best. When opting for insurance, no matter which specific kind, the buyer always hopes it never needs to be called upon, but if/when disaster strikes, it's great to know there's at least partial compensation at hand.

This is how I view gold. It's not a speculative tool for me. I may not even treat it as a genuine investment next to long-term portfolio holdings in CSL ((CSL)), Goodman Group ((GMG)), REA Group ((REA)), TechnologyOne ((TNE)), et cetera. But as a natural insurance policy, gold has a function, if one treats it as such.

The All-Weather Model Portfolio is constantly including some exposure to gold, through an ETF to keep things simple. The exposure itself is at times reduced or extended in line with the risks perceived to the world and financial markets generally.

As I often stated in the past: how much gold you own is directly related to how comfortable you are with the world and the outlook.

Back in 2020, when market mayhem hit through covid, the exposure to gold was (temporarily) increased to 11% of the portfolio. Back in 2022, when global bond markets triggered a devaluation of highly priced risk assets, the exposure was no more than circa 2%, later on increased to the current 5%.

Where I disagree with the army of true gold bugs (and financial system doom forecasters) is that I do not blindly treat gold as the natural safeguard against inflation and fiat currency pricing power erosion that must always be owned in copious amounts.

History is very clear about this: there are times when gold does not perform, and might even cause a lot of disappointment through negative returns (remember the 1990s?), plus it's a big bonus to understand how and when gold stands ready to close the gap with the share market's performance.

See also last week's update: https://fnarena.com/index.php/2024/03/27/rudis-view-facts-fiction-about-gold/

Westpac, Technology Laggard

Corporate announcements to the ASX can be read in different ways. Last week's announcement by Westpac ((WBC)) declaring the bank is (finally) ready to spend $3bn between now and 2028 to simplify, upgrade and unify technology systems across the banking network is essentially a public mea culpa for neglecting to make necessary and long overdue investments much, much earlier.

For those following the sector closely, it's hardly a secret Westpac has become the sector laggard locally, both in terms of relative valuation and total investment return, with only regional competitors lagging more.

Investors wouldn't know any of this by simply observing the shares (out)performing over the past few months, as a "cheap" looking valuation regularly offers a bigger bounce when investor money returns into the sector, but the picture of Westpac's underperformance is easily recognised when taking a longer term, multi-year view.

To put this in simple terms: when measured from late 2018, the shares have made no progress at all, when the next worst performer of the local Big Four is ANZ Bank ((ANZ)) with a share price advance in double digit percentage.

As per usual, investors holding a sample of only three of the Big Four in portfolio (because CommBank ((CBA)) shares are always "too expensive") rather don't want to know how much return they've missed out on over that period.

The answer you might be looking for is pretty straightforward: investments in technology. Or rather: the lack thereof.

Everyone intimately familiar with the various technology systems and platforms that keep these banking businesses running knows there are a lot of outdated legacies that continuously get swiped under the carpet. Because shareholders want their dividends, and it's never a great time to undertake large-scale distractions, as genuine investments in technology always turn out.

I could recall some of my personal experiences, each embarassing in their own right (for the bank, I am left with the annoyances) but maybe the best way to back up the above is through the observation that whenever an international banking analyst puts together a global sector overview of where banks stand in the ever-evolving technology race that increasingly shapes Haves and Have-Nots in the 21st century, Australian banks are never placed at the forefront of anything.

They are not the worst, but they also are nowhere near the best in the business.

In Australia, both Westpac and ANZ Bank have some catching up to do. Not only with the best-in-class operators offshore (if ever that were to happen at all), but equally in comparison with CommBank and National Australia Bank ((NAB)) locally.

The differences between the Big Four in Australia are painfully illustrated through the respective cost-to-income ratios (CTIs) because better technology equals more efficient execution and thus lower costs. On FY23 financials, CTIs for both Westpac and ANZ Bank sit on 49% with CBA and NAB on 44%.

Wait, it gets worse, as they all are struggling to keep cost inflation in check. Hence, those numbers are projected to rise first before we can see them drop. Westpac is struggling more than the others. Its CTI is projected to rise to 52%, which would make it the worst in the sector locally by an arm's length.

Knowing all of the above, why then have investors and sector analysts not been more enthusiastic about Westpac's announcement?

For starters, the bank's track record is nothing to boast about. But equally important: these are long-drawn out processes, with lots of risks and potential for negative outcomes along the way. Heavy costs come first, depressing profits and margins, with potential benefits not to be seen until much, much later.

As everyone knows, such large projects never finish on time or within budget. Investors should be prepared to learn about delays, unforeseen hiccups, and cost blow-outs. It'd be a small miracle if none of such developments were to surface over the next number of years. Take a slightly dimmer view and risks are rising for much larger investment, and a dividend cut, at some point.

After all, we are living through an era of significant technological innovation and this in itself requires businesses to spend more to stay relevant.

Success is by no means guaranteed and nothing is stopping NAB or CBA to step up their own investments in further technological upgrades in the meantime.

The recent short term share price performance put aside, it shouldn't surprise if Westpac remains the local sector laggard for much longer. This might please your typical income investor as the yield on offer might well remain the highest for longer (together with ANZ's), but not so much for those who measure in total return against the broader market.

All of this also raises the obvious question: when will co-laggard ANZ Bank bite the bullet and announce its own catch-up investment project?

Given ANZ Bank is in the process of acquiring full ownership of Suncorp Group's banking operations, that might well loom as the obvious trigger point. As shown by the example provided by Westpac; the longer these necessities are ignored and postponed, the more painful the consequences ultimately will be.

As per usual, successful long-term investing does not start with picking the cheapest option available; it's about understanding why companies deserve to trade at a discount, while others are granted a premium, and deserve it.

Conviction Calls and Best Buys

This month's update on stockbroker Morgans' Best ideas on the ASX has witnessed the removal of Mineral Resources ((MIN)) and the inclusion of Superloop ((SLC)).

Mineral Resources had been added in late January 2023 and the (negative) return has not lived up to expectations. Morgans does believe lithium prices have likely bottomed for the present cycle, but this is possibly already reflected in the share price. While there remain multiple reasons to retain exposure to the diversified miner, clearly there's now less conviction and thus the stock is no longer a Best Buy idea.

Morgans' selection now comprises of 26 ASX-listed companies, including the likes of CSL, QBE Insurance ((QBE)) and Woodside Energy ((WDS)) among large caps and Pilbara Minerals ((PLS)) and South32 ((S32)) in the local resources sector.

Among beaten-down REITs, the broker's conviction resides with Dexus Industria REIT ((DXI)) and HomeCo Daily Needs REIT ((HDN)). There are more cyclicals represented through WH Soul Pattinson ((SOL)), Karoon Energy ((KAR)), GQG Partners ((GQG)), Beacon Lighting ((BLX)), Universal Store Holdings ((UNI)), Acrow ((ACF)), and Dalrymple Bay Infrastructure ((DBI)).

Structural growth continues to attract too with ResMed ((RMD)), NextDC ((NXT)), Objectice Corp ((OCL)), Tyro Payments ((TYR)), Mach7 Technologies ((M7T)) and Camplify Holdings ((CHL)) included.

Then there's the re-opening trade, still alive more than three years after covid lockdowns, alongside temporary tactical trade ideas through Treasury Wine Estates ((TWE)), Inghams Group ((ING)), Avita Medical ((AVH)), Flight Centre Travel ((FLT)), and Helloworld ((HLO)).

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Clients of Ord Minnett have also received notice of the broker's most preferred exposures.

These include Westpac Bank, GQG partners and Medibank Private ((MPL)) in the financial sector, Ramelius Resources ((RMS)) and Sandfire Resources ((SFR)) in the mining sector, and CSL for healthcare.

In consumer staples  the favourite is Select Harvests ((SHV)), while Webjet ((WEB)) is preferred among consumer discretionary companies. Brambles ((BXB)) is the favourite among industrials, with Goodman Group ((GMG)) and Waypoint REIT ((WPR)) the two choices in the REITs sector.

For exposure to energy & utilities, Ord Minnett's preference lays with Santos ((STO)) and Viva Energy ((VEA)). In telecommunication services Telstra ((TLS)) remains the primus inter pares.

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Macquarie's Model Growth Portfolio currently consists of the following constituents (ranked by portfolio weight, largest first):

-Goodman Group
-Aristocrat Leisure ((ALL))
-Car Group ((CAR))
-NextDC
-CSL
-Computershare ((CPU))
-Northern Star ((NST))
-The Lottery Corp ((TLC))
-Flight Centre
-Cleanaway Waste Management ((CWY))
-Mineral Resources
-Pilbara Minerals
-Steadfast Group ((SDF))
-ResMed
-Pexa Group ((PXA))
-Treasury Wine Estates
-Viva Energy

Macquraie's Model Income Portfolio currently consists of (ranked by portfolio weight, largest first):

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

Rudi Unplugged – Send In Your Questions

I still need to pin down the exact date, but the previously announced Rudi Unplugged video broadcast shall be recorded over the next two weeks.

So… time to send in your questions, be they about the market, the All-Weather Model Portfolio, individual stocks of interest, the service FNArena provides, or something completely different.

editor@fnarena.com

I shall keep you all posted.

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(This story was written on Monday, 2nd April, 2024. 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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