Rudi’s View: A Market Narrative Delayed

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In this week's Weekly Insights:

-A Market Narrative Delayed
-Conviction Calls & Best Buys
-Rudi Unplugged – The Video

By Rudi Filapek-Vandyck, Editor

A Market Narrative Delayed

Four months ago, the outlook for equities and bond markets looked as straight as an arrow: inflation was decelerating and the Federal Reserve and other central banks were preparing for rate cuts later in the year.

That's all investors needed, and wanted, to know.

Suddenly, and noticeably, the narrative has changed in April. And share markets the world around have given up most, if not all of their gains year-to-date in three weeks of trading. On Friday, the main indices in Australia dipped into the negative, ex-dividends, for the running calendar year thus far. The Nasdaq, can you believe it, has only 1.80% left from January 1st.

While the downsloping trajectory for inflation was never going to be a straight line, equity markets only paid attention when the US bond market forced them to. It is easy to blame Mr Bond for the removal of most share market gains from the prior three months, though the risk of an all-out war in the Middle East has made market participants more risk-averse too.

Rising bond yields in response to higher-than-predicted inflation readings in the US have equally swung market momentum in equities back in favour of resources and other more cheaply-priced cyclicals, while the same combination is not favourable for smaller-cap companies generally.

The latter is an important observation at a time when all and sundry seem to be focused on finding the next ten bagger among cheaply priced, lagging, small cap stocks both in Australia and in the US.

As also highlighted during a presentation by JP Morgan strategists in Sydney last week, smaller cap companies in general suffer more when the cost of capital remains high. And while economic forecasts are being upgraded for key economies following on from the latest statistics -a positive both for cyclicals and small caps- history suggests what really puts a rocket under share prices for small caps are interest rate cuts and falling bond yields.

According to the latest switch in market narrative, inspired by moves in government bonds, there's no longer any prospect for imminent rate cuts. There may not even be one single cut in 2024.

While we can never be 100% certain about what might be revealed in the next set of economic statistics, history equally shows it is dangerous to extrapolate first quarter data and trends into the rest of the year, and beyond. For what it's worth: I personally still believe the most likely scenario remains for lower inflation ahead, but also for slower growth, and the longer bond yields remain high, and central bankers on hold, the more likely this scenario will play out.

It's the timing of things that is much more difficult to predict.

So, with the major indices in Australia down more than -4% so far in April, and indices in the US down by between -4.5%-6.7%, should investors be fearfull of something more sinister brewing for financial markets this year?

The big unknown remains the situation in the Middle East, which understandably has made investors more cautious. Once upon a time, all it took was the assassination of Archduke Franz Ferdinand in Sarajevo to start a global war that predominantly debilitated countries in Europe. Let's hope the current conflict is not our era's trigger point for something similar. At least both Iran and Israel seem to be messaging they're happy to show off their hairy chests, with little desire for substantially more.

As far as the script for the remainder of 2024 goes, more delays in seeing inflation in the US fall have certainly the capacity to unsettle markets, in particular if US bonds would give up on the prospect of Fed rate cuts. Add sluggish economic growth and the worst of all scenarios could play on investors' mind: stagflation.

In the same breath, all it takes is one favourable inflation reading and the general market mood could well switch to positive yet again.

Modeling US equities

Probably fair to say, general uncertainty and volatility in market moves are but par for the course for the time being. And while debates among investors will continue unabated, strategists at RBC Capital have tried to model a variety in outcomes this year, and what they could mean for the S&P500 index.

In case of one lonely Fed rate cut, delivered late in the year at the December meeting, the RBC Capital modeling shows -all else remaining equal- the S&P500 could well finish the year between 5050 and 5200, also depending on what exactly happens to corporate earnings.

The index closed a little below 5000 on Friday.

In case the Fed won't even cut once in 2024, and bond yields remain higher-for-longer, the modeling suggests fair value for the index between 4900-5000.

The worst case scenario is if higher inflation forces the Fed to deliver more rate hikes. Under those dynamics, the index could well revisit 4500.

In the short term, RBC Capital market strategists stick to their view the current share market correction should remain inside the -5%-10% range, unless a wider war breaks out or the US economy falters.

The second most important input for all of these scenarios are corporate earnings. Here the observation stands most companies that have reported to date in the US have seen share prices weaken post financial update, even if earnings and sales beat expectations. This might tell us more about current sentiment and/or market positioning than it does about the earnings and company prospects.

The quarterly results season in the US is stil in its infancy, so let's wait and see what trend prevails as more results are released. Australian investors have Unibail-Rodamco-Westfield ((URW)), ResMed ((RMD)), and Newmont Corp ((NEM)) to focus on later this week.

Strategists have been warning about overheated sentiment and position crowding for a while. What we are experiencing this month is at least partially related to the unwinding of previously too popular momentum plays in the US.

Modeling The ASX

Whatever happens in the US does impact on the ASX, but the Australian market has room to move in line with its own local dynamics, in particular when worse-case scenarios don't happen.

UBS strategists last week revised their year-end target for the ASX200 to 8000, up from a prior 7660, as risks have generally switched in favour of more upside, on their assessment.

ETF provider VanEck is usually among the more positive forecasters and its latest update on the local market suggests the index may well see 8300 by year-end, on continued resilience for discretionary retailers, supported by migration, and a catch-up performance from undervalued gold miners and AREITs.

VanEck does warn, in line with just about everyone else, shares in Australian banks seem overvalued and vulnerable to a correction. Sector analysts at Citi have put all seven local banks under coverage on Sell.

In summary: uncertainty creates volatility as the previous blueprint for inflation, bonds, central bank policies and financial markets is being scrutinised more closely, and while this opens up all kinds of what ifs, it does not by default derail the narrative that has previously guided equity markets off their lows; inflation is still more likely than not trending lower, and central banks are still preparing for rate cuts.

The most likely scenario is this process will simply develop more slowly than previously hoped for.

Investors might also appreciate the fact current dynamics in the US look more like an exception/aberration while central banks in Europe and in Canada are sending clear signals they are getting ready to cut. Emerging economies have already started with the central bank of Mexico the most recent on March 21.

Here's how Michael Brown Senior, research strategist at Pepperstone formulated it on Monday:

"[…] with the policy backdrop remaining supportive, as the next move from the Fed remains almost certain to be a cut, just later than most had expected, and with the economy continuing to grow at a solid clip, the medium-term path of least resistance continues to lead to the upside, with the aforementioned 'Fed put' likely to continue to give investors confidence to seek to buy the dip, and increase exposure, particularly as geopolitics becomes less of a market driver."

Those mentioned year-end projections for indices locally and in the US also reveal why just about every institutional investor's wish list for 2024 includes a broadening of the prior narrow and concentrated rally.

For more reading:

–https://fnarena.com/index.php/2024/04/17/rudis-view-shaky-sentiment-ahead-of-corporate-updates/

–https://fnarena.com/index.php/2024/04/10/rudis-view-lessons-observations-from-asx-all-weathers/

–https://fnarena.com/index.php/2024/04/04/rudis-view-in-search-of-the-holy-grail/

–https://fnarena.com/index.php/2024/04/03/rudis-view-investor-worries-gold-westpac-and-conviction-buys/

–https://fnarena.com/index.php/2024/03/27/rudis-view-facts-fiction-about-gold/

Conviction Calls & Best Buys

Shaw and Partners Research Monitor for the June quarter shows the broker's ASX100 Large Caps Model Portfolio currently consists of the following ten members:

-Aristocrat Leisure ((ALL))
-Domino's Pizza ((DMP))
-Evolution Mining ((EVN))
-James Hardie Industries ((JHX))
-Pilbara Minerals ((PLS))
-Qantas Airways ((QAN))
-ResMed
-Suncorp Group ((SUN))
-Treasury Wine Estates ((TWE))
-Xero ((XRO))

Preferred exposures among 'emerging companies' (smaller caps) are:

-Abacus Storage King ((ASK))
-Bannerman Energy ((BMN))
-Black Cat Syndicate ((BC8))
-Global Lithium Resources ((GL1))
-Helloworld ((HLO))
-Metro Mining ((MMI))
-Retail Food Group ((RFG))
-Vista Group ((VGL))
-Tyro Payments ((TYR))
-Webjet ((WEB))

****

UBS's most recent strategy update revealed the broker has adopted a higher-for-longer view on inflation and bond yields, and this has triggered a number of changes for the Model Portfolio and Best Stock Ideas.

In short, UBS has reduced exposure to REITs, infrastructure and technology -all are victims when bond yields rise instead of falling- while increasing its liking of the energy sector; a prime cause of inflation.

Scentre Group ((SCG)) has been added to UBS's selection of Least Preferred stocks on the ASX. The shopping mall owner has joined the ASX ((ASX)), Bega Cheese ((BGA)), Bank of Queensland ((BOQ)), CommBank ((CBA)), Cochlear ((COH)), Domain Holdings Australia ((DHG)), Super Retail ((SUL)), and Vicinity Centres ((VCX)).

The list of Most Preferred stocks has been extended through the inclusions of BlueScope Steel ((BSL)), Santos ((STO)), Suncorp Group, and Treasury Wine Estates. Have been removed from the list: Transurban ((TCL)), Universal Store ((UNI)), Webjet, and WiseTech Global ((WTC)).

Remain selected as UBS's Most Preferred stocks on the ASX:

Among Resources:

-AGL Energy ((AGL))
-Orica ((ORI))
-Origin Energy ((ORG))
-Rio Tinto ((RIO))

Among Financials:

-AUB Group ((AUB))
-Computershare ((CPU))
-nib Holdings ((NHF))
-QBE Insurance ((QBE))

Among Industrials:

-Coles Group ((COL))
-CSL ((CSL))
-Harvey Norman ((HVN))
-Reliance Worldwide ((RWC))
-Seek ((SEK))
-Telstra ((TLS))
-Worley ((WOR))
-Xero

Rudi Unplugged – The Video

Silly me! I ask for questions and suggestions, produce a video and then forget to include it in last week's Weekly Insights.

For those readers not yet familiar with my research: post the GFC that ended in March 2009, I started specifically researching why certain companies are better in dealing with downturns and crises and eventually developed the concept of All-Weather Performers; companies that generate shareholder rewards no matter what the cycle does.

It's essentially a quest to find the highest quality growth companies in a share market that is predominantly populated by low-quality wannabes and old timers that had their glory days in the past, plus lots and lots and lots of companies for whom the cycle determines what's in store for shareholders.

The list of companies identified as All-Weathers has remained relatively stable over the past 15 years, and as one would expect, it's not an extensive selection either. From 2015 onwards I also identified the once-in-a-lifetime experience of unprecedented technological changes for societies and financial markets, which led to the addition of lists that seek to identify the highest quality companies among the up-and-comers from the new tech era.

All those lists, including a few more, are available 24/7 to paying subscribers via a dedicated section on the website: https://fnarena.com/index.php/analysis-data/all-weather-stocks/

Last week, a video update was published: https://fnarena.com/index.php/fnarena-talks/2024/04/11/rudi-unplugged-10-april-2024/

In the run up to this latest update, I had asked for questions and feedback, which features in the video. As it is the intention to not make such updates too elongated (we're all time constrained in modern days), some questions remain unanswered, including various suggestions put forward about potential new All-Weather inclusions.

Some brief format responses to some of the suggestions made:

-Data#3 ((DTL)): I view Data#3 as a reasonably well-managed typical software services provider that is enjoying the positive momentum of the technology sector worldwide. Not nearly as exceptional as has been TechnologyOne ((TNE)).

-JB Hi-Fi ((JBH)): Retailing can be extremely cyclical which can upset even the best in the sector, which is why my list of All-Weathers does not include any pure retailing companies. JB Hi-Fi, it has to be said, is one of the best in the sector, and not necessarily only in comparison with local peers. Quality counts when it comes to long-term investing.

-Infratil ((IFT)): An important component of being selected as an All-Weather Performer is an indisputable track record. Many companies can have a number of years of positive performances, but can they last the equivalent of a corporate marathon? I think Infratil's track record falls well short, even though the share price graph is suggesting otherwise. I concede: I have not given Infratil much attention to date, given it's NZ-headquartered and listed and trades on ultra-low volumes on the ASX.

-Light & Wonder ((LNW)): The new kid on the block in Australian gaming has won a lot of hearts and minds over the past twelve months or so, but let's first find out what the longer term holds. On average, businesses do enjoy a period of positive momentum, in particular after restructuring and new management, but to become a true All-Weather that track record has to span over many more years. The local sector leader, Aristocrat Leisure, has been performing for over ten years now and I still haven't included it as an All-Weather. Aristocrat has been included as a 'Prime Growth Story' and that track record looks poised for many more years of robust growth.

-Macquarie Technology ((MAQ)): The outlook for data centres is incredibly buoyant, which is why I remain of the view that the likes of NextDC ((NXT)) on the ASX remain poised for positive surprises over many more years. Unlike NextDC, Macquarie Technology is not a pure-play, but the positives are likely to dominate the more sedate telecom legacy business. I've now added this stock to my selection of 'Emerging New Business Models'. AI is going to dominate the future for all of us; investors better get on board.

-Nick Scali ((NCK)):  See also JB HiFi. Nick Scali stands out as probably one of the best in the sector locally. Again: long-term portfolios will learn how to appreciate corporate quality when given enough time to prove itself.

-PWR Holdings ((PWH)): Full of promise, and it is difficult to argue against the fact management and the business have proven themselves since listing in late 2015. Thanks for reminding me. I have now added this stock to my list of 'Emerging New Business Models'.

-Reece ((REH)); I like the suggestion as this is without any doubt one of the quality names inside the home renovation segment on the ASX. Because property markets are inherently cyclical, with the recent past probably more exception than the rule, I'd be reluctant to include a quality performer such as Reece, but this company definitely deserves to be highlighted, even if it's not a true All-Weather.

-RPM Global ((RPM)): Once upon a time, Monadelphous ((MND)) was included in my very first selection of All-Weathers. Then I learned when the sector turns to dust, as the customers suffer from cyclical downturns, there's no support underneath the share price as revenues and earnings disappear in a flash. RPM Global is finally growing into its long-held promises, but an All-Weather? Unlikely.

-Sonic Healthcare ((SHL)): I've always underestimated the number four in the local healthcare sector, which is probably understandable given the quality and performances achieved by CSL, Cochlear and ResMed. Sonic is equally an international top-notch performer, though its network is more vulnerable to price pressures and consumer behaviour, while international expansion is heavily reliant on making further acquisitions. In particular the latter keeps Sonic out of my selective list.

-Brickworks ((BKW)) and Washington H. Soul Pattinson ((SOL)): I have no defence. Both should probably have been included in my selection long time ago. It's the cyclical nature of the core assets that is still guiding my personal bias today, but shareholders have only reaped rewards from staying the course. Impressive, to say the least.

The above mentioned video lasts some 20 minutes. Enjoy. For good measure: the stocks mentioned above do not feature in the video.

As per always: all feedback remains welcome.

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(This story was written on Monday, 22nd 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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