Rudi’s View: Winners Are Winning For Longer

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In this week's Weekly Insights:

-Winners Are Winning For Longer
-Rudi Interviewed

By Rudi Filapek-Vandyck, Editor

Winners Are Winning For Longer

The share market being an open forum where humans combine and clash with robots and other humans, it should be no surprise Monday's announcement by the Fair Work Commision to increase by 3.75% the National Minimum Wage and all modern award minimum wages from July 1st onward has already been interpreted in opposing ways.

Forget about any prospect for RBA rate cuts anytime soon, says one share market commentator, an increase of this magnitude means the official cash rate will remain untouched until mid-2025, at the earliest.

Economists at ANZ Bank and Westpac beg to differ, however, and believe nothing fundamentally has changed (ANZ) or that the announcement is actually positive for inflation and for the RBA. Westpac had expected this year's wage increase could have been as high as 4.50%.

Clearly, the Fair Work Commission has also taken into consideration there will be tax cuts for virtually everyone from July 1 onward, and it's not like there aren't any other forms of financial support in the pipeline from both state and federal governments. This might well explain why the Commission stayed well clear from Westpac's 4.50% scenario.

Both ANZ and Westpac economists believe the RBA would be comforted by Monday's announcement. Judging from the price actions on the day, it looks like that assessment is carried by the majority of investors and forecasters.

ANZ Bank has reminded us all the RBA's latest forecasts see the local Wage Price index growing at 3.7% from the year earlier in the final quarter of 2024, and by 3.6% by the second quarter of 2025. The Fair Work Commission's statement considers the forecast return of the inflation rate to below 3% in 2025 remains intact.

Those who prefer a more negative interpretation can point to the fact this is the first time in three years when the increase exceeds recorded price inflation, so there's a surplus coming for wage earners in Australia (while Monday's decision doesn't affect all wages, there usually is a follow-through impact on wages that are not directly impacted).

A more constructive view is the freshly announced 3.75% increase remains well below the 5.75% rise in FY23, as well as the 4.6% rise in the year earlier. While this year implies a small rise in inflation adjusted incomes, real wages will still be below the level before inflation spiked higher.

All of this melts into the economic debate that weighs on general sentiment among Australian investors, also illustrated by the fact some media reports still have the RBA hiking rates while most other central banks around the globe are preparing for rate cuts. I see a lot of biased hyperbole, and a not so subtle political agenda.

I sympathise with the view that many Australian households are feeling the squeeze, while small businesses are closing their doors, and thus many among us won't go on a spending spree if we find a little bit of extra money in our purse post June 30th.

The counter-argument is today's economic impact from inflation and rate hikes is not being felt by a large proportion of the population that owns its property and welcomes additional wealth through the share market, or otherwise.

It's a polarised world, for sure, and this also polarises experts views and predictions, as well as ASX-listed companies.

Before we zoom in on what has been happening inside corporate Australia, let's first take note of what has been happening in the USA recently, as that might surprise a few readers.

Insights From US Quarterly Updates

Big Tech has been driving the American share market indices through the peak in bond yields and their economic impact to fresh all-time record highs in 2024. In the slipstream of Big Tech, market momentum has stuck with 'Growth', and 'Quality', and with 'Technology', more than it has with the lagging 'Value' stocks.

Led by 'elevated' valuations, as well as by historical analyses of Fed rate cuts, many investment portfolios are positioned for a reversal in momentum, i.e. smaller cap companies instead of large and Mega caps, but also 'value' (both 'cheap' and 'cyclicals') rather than Big and smaller Tech, or 'expensive' Quality.

Thus far, the predicted switch in market leadership has failed to materialise. There have been a number of attempts, but the dial keeps reverting back to Growth and Technology. There is one obvious explanation for this: the direct correlation with market expectations for Fed rate cuts.

As US Treasuries have delayed the timing and reduced the number of expected rate cuts this year, this has placed market momentum back in favour of those expensive-looking, large cap Growth stocks.

Underneath the surface, however, there's a second driver that equally should be taken notice of: the recent quarterly results season has yet again worked in favour of the (almost universally) maligned Mag7, as well as other Growth companies.

In simple terms: now that analysts have updated their forecasts post the latest financial results and company presentations, the pendulum for positive earnings momentum has swung back in favour of those who already were leading the share market higher in the first place.

A third explanation comes through accumulating signals the US economy continues to lose momentum, which might equally be reflected in more subdued performances and forecasts for companies whose operations align more directly with economic momentum.

As pointed out by analysts at RBC Capital recently, Value and Small Caps tend to outperform when GDP readings are above average. The opposite is currently happening, and economic data and indicators are feeding into reductions in forecasts. The March quarterly reporting season in the US has also shown many companies are still struggling with inflation, or their key customers are.

The good news, as far as inflation forecasts and the Fed's intention to start cutting rates are concerned, is companies are starting to talk about lowering prices. Another stand-out observation highlighted by RBC Capital is companies are delaying decisions about purchases and investments.

May In Australia

On FNArena's assessment, some 170-plus ASX-listed companies that are at least covered by one of the brokers monitored daily have provided an operational update in May, ranging from quarterly trading updates, to investor days and AGMs, to interim or full year financial reporting, to the dreaded profit warning that puts a few extra kilograms on top of the share price, forcing analysts' forecasts lower.

As one would expect, the Australian economy does not exist in a vacuum, and those key observations from the US mostly also apply locally. Think Xero ((XRO)), Aristocrat Leisure ((ALL)), Goodman Group ((GMG)), TechnologyOne ((TNE)), and REA Group ((REA)); all are trading on above-average PE multiples, and have been for a long while, and all have forced forecasts to rise post the release of financials, with share prices being rewarded for it.

But while the first batch of market updates communicated throughout April and the first two weeks of May had a relatively positive bias, that has noticeably deteriorated throughout the second half of the month.

On Friday, micro-cap automotive parts distributor and provider of heat transfer solutions, Adrad ((AHL)), joined a growing queue of soft trading updates marked by customers deferring purchases until the next financial year.

While it can be argued a $66m market cap company operating inside the automotive sector is not necessarily reflective of the local economy or share market dynamics generally, the past number of weeks have provided plenty of similar updates by companies including Duratec ((DUR)), Chrysos ((C79)), Big River Industries ((BRI)), and others.

As per always, smaller companies are much more affected, such is the tragedy of moving on the register too early in anticipation of the upswing that should announce itself if not later this year, than surely in 2025?

But 'small' does by no means equal guaranteed failure. Supply Network ((SNL)), which operates as distributor of after market parts to the commercial vehicle industry, delivered a much stronger-looking quarterly market update and its shares haven't sold off in the following days, even with a strong rally preceding.

Supply Network (market cap $981m) is widely regarded as the superior Quality operator in its sector. This label has been re-affirmed once more as competitor Maxiparts ((MXI)) has fared significantly worse over a prolonged period of time. Two weeks ago, Maxiparts issued a good old fashioned profit warning that has pushed the share price below $2 yet again (it has been as high as $7 in the past).

Shares in Supply Network, by the way, have surged to a fresh all-time record high. This goes to show, yet again, successful investing involves a lot more than simply picking a cheap-looking share price.

Moelis initiated coverage on Monday with a Buy rating and $26 share price target, suggesting even with a share price at record high level, this need not be the end of the journey as long as operational momentum keeps trucking on (pun intended).

As some readers might be aware, I tend to look at the share market in terms of the 'strong' versus the 'vulnerable' rather than 'expensive' versus 'cheap'.

While that doesn't always guarantee the best investment outcome, during conditions like the ones we are currently experiencing, it certainly helps with identifying and avoiding attractive-looking value traps.

Ainsworth Gaming ((AGI)) yet again has been forced to issue a severe profit warning. The share price is still well-above the 2020 low, but your typical 'value' seeker can hardly claim victory. Market leader (and more 'expensive'-looking) Aristocrat Leisure has performed significantly better, and so has the $12.8bn 'newcomer' in that sector, Light & Wonder ((LNW)) with a number of ex-Aristocrats in charge.

Such market updates can also reveal which sectors are experiencing better momentum, and which ones are not. Market updates by the banks, for example, have been better-than-expected, albeit on low expectations. But this has not stopped shares in Bendigo and Adelaide Bank ((BEN)) from surging to a fresh post-covid high (still gone nowhere on a ten-year view).

Market updates by both REA Group and smaller competitor Domain Holdings Australia ((DHG)) have been strong, so clearly that sector is not feeling the pain as are currently the casino operators, the media sector, car dealerships, labour services and parts of the retail sector. Asset management and financial services is also a sector clearly divided between Winners and Losers.

Some of today's Losers might turn out excellent opportunities when the economic upturn arrives on the back of central bank rate cuts, but that will be of later concern if/when the market has to adjust for a profit warning first.

For what it's worth, RBC Capital suggests the following needs to happen to bring the big rotation trade back in focus:

"Our work suggests that the 10-year yield needs to stop rising, the market needs more clarity and certainty around the path of monetary policy and the timing of cuts, earnings trends need improve for the broader market such that they look better than the biggest growth names, and economic excitement needs to return.

"The trigger for a renewal of the rotation trade may also come from positioning. CFTC data suggests that the large cap growth trade (as expressed through Nasdaq futures positioning) is no longer frothy. But it also doesn’t look washed out suggesting overbought conditions could return rather quickly to this corner of the market."

The FNArena Monitor keeps track of earnings releases by corporate Australia: https://fnarena.com/index.php/reporting_season/

More reading;

https://fnarena.com/index.php/2024/05/30/rudis-view-how-to-benefit-from-eofy-selling/

https://fnarena.com/index.php/2024/05/29/rudis-view-its-special-vs-cheap-but-whos-most-at-risk/

https://fnarena.com/index.php/2024/05/23/rudis-view-strategy-updates-model-portfolios/

https://fnarena.com/index.php/2024/05/22/rudis-view-rate-cuts-equal-optimism/

Rudi Interviewed

Last week, I shared my market observations and predictions about artificial intelligence and Quality stocks in an interview with Ally Selby at Livewire Markets.

That interview of more than 53 minutes (not meant to discourage anyone) is available via Youtube: https://www.youtube.com/watch?v=yDD3CKlZTM4

General feedback thus far has been constructive and appreciative.

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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).

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(This story was written on Monday, 3rd June, 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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