Rudi’s View: Rate Cuts Equal Optimism

This story features DICKER DATA LIMITED, and other companies. For more info SHARE ANALYSIS: DDR

In this week's Weekly Insights:

-Rate Cuts Equal Optimism
-All-Weather Model Portfolio
-Model Portfolios, Best Buys & Conviction Calls

By Rudi Filapek-Vandyck, Editor

Rate Cuts Equal Optimism

This might surprise a few readers, but the Australian share market is up more than 3% ex-dividends since the start of the calendar year.

Assuming the remaining six weeks or so don't include any major sell-downs or crises, the ASX looks en route to posting a double-digit return including dividends for the financial year ending on June 30th.

With another ten days or so to go, May's total return may well exceed March's 3.30%, all else remaining equal, with a new all-time record high seemingly within reach.

Yet, anecdotal evidence, including from the database of subscribers here at FNArena, suggests the mood among investors is a lot more sombre. Daily trading volumes on the local bourse are nothing to crow about.

All that talk about the Albanese government's latest budget poking the resident inflation bear is clearly weighing on people's minds, as does, probably, the rise in anecdotal evidence that higher-for-longer interest rates (bond yields) are creating a recession-like environment for the vulnerable parts in society.

The latter, by the way, is an international phenomenon, not just in Australia.

The neighbourhood in which I live and work has lost two restaurants in the space of two weeks. There are a number of empty commercial spaces that are not being filled with new tenants. It's rough out there if you happen to be on the wrong side or in the wrong place.

But such anecdotal observations have been around for more than twelve months now. The pace at which they enter the official statistics, both locally and in the USA, has been excruciatingly long-winded.

Meanwhile, the negative correlation between bond markets trying to guess the next move in central bank policy, as well as the timing of it, has injected a lot more volatility, and uncertainty, into equity markets.

Up one day, down the next. And then everyone has an opinion about inflation, the underlying statistics, government failures, corporate greed, and hapless central bankers.

It's far too easy to get lost inside the daily noise on social media. But also, why are markets so resilient when there's so much uncertainty and risk around?

Made In Australia: Inflation

Let's start with this month's big bugbear: the Chalmers budget that puts $300 in every household's pocket, spread out over the next four quarters. Surely that's inflationary and will keep the RBA on hold for much, much longer?

Hold on. That may look like the general conclusion, and certainly parts of the local media are doing their utmost to keep that message alive, but as per usual: details matter.

The government is actually not sending out any cheques like what happened during covid and the GFC. Lowering everyone's electricity bill by -$75 a quarter will push down official CPI readings in the coming quarters. On some calculations, official CPI numbers may well decline by up to -0.70%.

That's a big fall. And it will impact on general perception and sentiment. The crucial question is whether Chalmers & Co's statistical trickery won't come back like a boomerang and lift inflation elsewhere?

Some of the smarter economists in the country (Westpac, Barrenjoey) believe there remain valid reasons for this not necessarily to become the outcome. Plenty of books and economic surveys assure us people treat money differently in line with how they receive/perceive it.

No cheque in the mail might well translate into no additional spending. Plus the most needy are most likely to opt for basic necessities, where demand is far from super-charged, and probably will be further in decline by the time the government's support arrives. The wealthier recipients might not even notice, and not spend extra at all (or spend more overseas).

In summary: contrary to general sentiment, the government's goal of forcing Australia's official CPI numbers down by hook or crook might well succeed, irrespective of current skepticism. If/when it does, it will be a major positive and allow the RBA to start cutting the official cash rate. This can still happen later in the year.

(Of course, there's a whole lot more going on, but economies are always a confluence of multiple drivers and impacts, and I've simply picked the most obvious one.)

While bond yields falling and rising in the US are keeping equity investors on the edge of their seats, the irony is general sentiment is switching towards central bank rate cuts later in 2024. As one global macro report that entered my inbox this week summarised it: The Rate Cuts Are Coming!

The key remaining topics of debate, or so it appears, are when exactly and how severely exactly will be the impact on economic growth and corporate profits from the current higher-for-longer environment?

Some market watchers believe the ECB will move first. Canada might follow next. The Fed might not be ready until September.

No wonder traders are watching currency markets like a hawk. That's where the earliest impacts will take place. In FX, small moves can have outsized consequences.

Corporate Updates Keep Momentum Positive

Central bank rate cuts have a positive effect on economies, but not immediately.

Investors positioning for a stronger economy, and for the next recovery in corporate profits, are currently operating in No Man's territory where risk remains tangible and share prices might well head lower before they are ready for the next up-trend.

Last Friday gave us two profit warnings, with both tech distributor Dicker Data ((DDR)) and jeweller Michael Hill ((MHJ)) forcing analysts to adjust future estimates lower.

On Monday, as I am writing Weekly Insights, shares in agri-conglomerate Elders ((ELD)) opened lower, but have subsequently recovered on yet another weaker-than-forecast corporate performance.

Shares in Elders already got punished in April, when management guided short term expectations lower. On Monday, investors are drawing confidence from management's forecast the bottom for operational momentum is in place and conditions should start to improve soon.

If anyone cares to read Dicker Data's market update from Friday, the company spends a lot of energy in explaining how its business stands to benefit from GenAi, but not until the second half.

Corporate updates in May are literally separating the stronger businesses from the weak and vulnerable, but price action in May is suggesting investors are cautiously starting to prepare for better times ahead, see also Elders on Monday, while not all fast-growers are automatically rewarded for their operational momentum.

Things look similar in the USA where, on balance, the recent quarterly reporting season has seen earnings estimates noticeably rise, but bifurcation in corporate dynamics remains obvious.

Utilities in the US have now joined technology companies as beneficiaries of GenAi, through increased projections of future power consumption on the back of exploding demand for more data centres. The problem many an investor has with the technology sector is that valuations in many cases look far from 'cheap'.

Thus far, earnings growth and earnings revisions on the back of corporate updates have kept solid support under most share prices. In Australia, the same strong dynamics remain in place for, among others, Goodman Group ((GMG)), ResMed ((RMD)), REA Group ((REA)), and Aristocrat Leisure ((ALL)); recent market updates have forced more upgrades upon already firm looking growth forecasts.

Some of the cyclical stalwarts, including Incitec Pivot ((IPL)), Orica ((ORI)) and Newmont Corp ((NEM)), are equally eliciting renewed market enthusiasm with their financial updates.

This week awaits corporate results from James Hardie ((JHX)) and Nufarm ((NUF)), but also from Webjet ((WEB)), TechnologyOne ((TNE)), and Xero ((XRO)), in the slipstream of Nvidia results in the US.

Sentiment has been buoyed both by macro-optimism (rate cuts are forthcoming) and by, on balance, positive operational updates and forward-guidances from companies in Australia and elsewhere.

The drawback is this market optimism continues to push share market indices in and out of technically overbought positions, which no doubt is yet another source for constant investor anxiety.

Australian Banks

Australian bank shares haven't gone anywhere for 15 years (CommBank ((CBA)) is the exception), but they have been among the local outperformers off last October's market bottom, with leading sector analysts questioning 'valuations' when the outlook for cash profits and dividends is unlikely to dramatically change for the better.

Recent corporate results for the sector did prove better-than-expected, admittedly on subdued forecasts, with boards approving increased dividends and share buybacks to keep shareholders on side.

Underneath the supportive headlines, however, there were plenty of signals that the pressure remains 'on' for the sector, in particular for those business segments that service Australian households.

It is also becoming increasingly clear the sector ex-CommBank has long ignored the need to invest in technology and other aspects of the banking business, and that will turn into a financial headwind for the years ahead. At least one broker, Macquarie, can see scenarios on the horizon that might make current dividend payouts unsustainable.

What banks in Australia are showing investors is there are multiple reasons as to why share prices can be bought. It doesn't always have to be in connection with earnings, or dividends, or even improving conditions. Macro considerations inspired by the fact that banks globally are back in focus as investors start preparing for central bank rate cuts are the dominant force this time around.

Except when the sector is out-of-favour because of specific idiosyncratic reasons, I have long considered Australian banks the ideal barometer of local investor sentiment. In line with MegaCaps and technology stocks in the USA, I think we can fairly conclude investor sentiment is very bullish in the here and now.

This does not, however, automatically mean markets are cum an imminent serious downward correction, as the main carrot of central bank rate cuts, lower bond yields, lower inflation, and low odds for an economic recession remains intact.

Elevated multiples, potential delays and alternative scenarios, and a heavily polarised market does suggest market volatility is likely to remain higher-for-longer. It's simply the nature of the beast.

FNArena's reading of broker ratings, with the balance currently sitting at 55.62% Buys and equivalents, against 34.87% on Neutral/Hold and the remaining 9.51% in Sell ratings, would historically imply the local share market is operating inside a bear market environment. In the present context, however, those numbers are merely a reflection of the extreme polarisation that dominates the ASX.

That polarisation might well require rate cuts, lower bond yields and better economic data before reverting back to a more 'normal' set of numbers with Neutral/Hold ratings in majority.

All-Weather Model Portfolio

I regularly forget to update on the FNArena-Vested Equities All-Weather Model Portfolio, as my mind focuses on writing Weekly Insights, I guess.

For the record: it's not because the performance numbers are something that should be best left unmentioned. Quite to the contrary.

As investors are encouraged to have at least a three-year horizon, the return pre-fees of 11.26% per annum looks a lot better than the index's total return, including dividends, of 7.16%.

Paying subscribers are reminded they have 24/7 access to my curated lists under the All-Weather Stocks section of the website. The Model Portfolio picks and chooses from these lists, though doesn't own all stocks mentioned, with approximately 20 stocks held most of the time.

Recent strong performers include Goodman Group, NextDC ((NXT)), ResMed and Aristocrat Leisure while Woolworths ((WOW)), IDP Education ((IEL)) and Dicker Data have been on the receiving end.

The philosophy and methodology behind my specific strategy is explained through multiple eBooks and Special Reports, available through the Special Reports section, as well as via regular analysis and thematic updates on All-Weather Performers via Weekly Insights/Rudi's Views.

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi's Views for the archive going back to 2006 (not a typo).

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, 20th May, 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).

Click to view our Glossary of Financial Terms