Rudi’s View: Key Picks, Best Buys & Conviction Calls

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By Rudi Filapek-Vandyck, Editor

Global economic growth is slowing and, if forward-looking indicators can be relied upon, momentum remains poised for further weakness, possibly into the final quarter of 2024 and beyond.

How is an investor best to respond?

One strategy update that attracted a lot of attention this week stems from UBS advocating Australian banks over resources stocks. Are bank shares expensive? Yes, they are. Are resources share prices ‘cheap’? Yes, they have underperformed a lot this year. But UBS clearly takes the view economic growth is not ready yet to bounce back and thus more weakness may well be in store for BHP Group ((BHP)) and its peers.

The strategy modeling at Citi, oriented more globally than UBS’s ASX-centric view, draws a different conclusion which may also be guided by the fact Citi’s in-house conviction remains for an economic recession to announce itself later this year in the land of Harris versus Trump.

Reduce your exposure to risk assets is conclusion number one from the Citi modeling, which translates into reduced exposure to equities and to credit. Underneath those recommendations, however, things become a lot less straightforward, or so it seems. For starters, Citi’s model advocates portfolios should move Overweight commodities, but not energy, through oversized positions in precious metals and base metals.

In terms of equities, US and UK markets are preferred, while Citi shuns Emerging Markets. There’s no specific mentioning of Australia, but one can probably safely assume the ASX sits in the same basket as Hong Kong, Singapore, et cetera.

In case that economic recession does arrive, alongside rate cuts from central banks, an Overweight exposure to government bonds seems but appropriate, Citi’s modeling shows. It goes without saying, share markets are priced for a soft landing, and will receive some kind of a shock if/when Citi’s forecast for economic recession proves correct.

As I wrote myself earlier this week: plenty of expert voices around that believe Citi’s prediction will not materialise.

As it happens, the FNArena inbox received a missive from Ninety One this morning stating the above mentioned risk has already well and truly been priced in for Emerging Markets assets and with the Federal Reserve about to embark on loosening US monetary policy, the USD should start weakening and this, historically, tends to bode well for Emerging Market equities.

No doubt, Citi would counter-argue economic recession is likely to strengthen the greenback (reduced risk appetite favours safe havens) so maybe the best conclusion to draw is this debate remains unresolved still, just like the US presidential election.

Ninety One also argues Emerging Markets enjoy structural tailwinds, robust earnings growth, compelling valuations and the USD is currently trading near a twenty-year high.

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Strategists at Morgan Stanley see too many contradictions in today’s markets, and this almost guarantees a big pick-up in volatility as sometime, somehow those contradictions need to be brought back in line.

The current set-up is US bond markets are positioned for many more rate cuts than is feasible under a soft landing scenario, i.e. the bond market agrees with Citi there is likely an economic recession on the horizon.

US equities, on the other hand, are carried by analysts forecasting 13% profit growth over the next six quarters; twice the normal rate.

Economic growth is slowing, Morgan Stanley points out, let’s have no doubt about that, and the US labour market is cooling. Assuming the bond market is too cautious and slow economic growth remains the most likely outcome, not negative economic growth, this still leaves the strategists with the incling that current growth forecasts seem too high.

Their advice: balance portfolios between defensives and cyclicals, growth and value, large caps and small caps, and apply maximum diversification. Share market momentum is anticipated to move away from the Mag7.

Taking a global view, Morgan Stanley’s Best Ideas for portfolios are US financials, energy, healthcare, Japan, real assets and infrastructure investments. The strategists are ultra-cautious on small caps with rates still high, economic momentum weakening and US consumers being squeezed.

Peers at UBS highlight the conundrum as follows: when the bond yield curve dis-inverts this benefits small cap companies as they mostly bear floating debt, but then worsening economic conditions present themselves as a serious headwind.

Morgan Stanley sees the S&P500 range-trading between 4700-6100 with a June-2025 target of 5400. Similar as at Citi, fixed income is the most preferred exposure. Goldman Sachs is more optimistic, targeting 5400 for the S&P500 in three months, 5600 in six months and 5700 this time next year.

For Australia, Morgan Stanley’s forecast is for slight improvement in economic momentum, but still below-trend, and nothing spectacular. Morgan Stanley’s mid-2025 target for the ASX200 is set at 8100, with a bull case scenario of 8701 and a bear case alternative of 5631.

Prime problem for the local bourse is hardly a pulse in terms of earnings growth while the forward-multiple is 17.3x, well above the long term average of 14.7x and the 10-year average of 15.9x. Equity valuations are also deemed “expensive” relative to the historical relationship with bond yields.

The average dividend yield for the ASX200 is circa 3.6% versus the historical average of 4.5% since 2000. It is Morgan Stanley’s view local share prices have disconnected from underlying forward earnings.

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In line with the observations above, strategists at Macquarie note bond markets and commodities are both signalling much worse conditions ahead than is currently assumed by equities. Macquarie is not quite sure whether economic recession is unavoidable, pointing out the signals available remain still quite diverse and leave plenty of room for debate on the matter.

Macquarie’s model portfolio remains Overweight equities with a preference for ‘Quality’ and US markets. Australia is expected to lag.

Another preference is for non-correlated assets that can hedge against downside risks, such as infrastructure  and hedge funds.

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For those investors allocating beyond ASX-listed equities, Morgan Stanley has released its short list of Vintage Values 2025; mid- to large cap US listed companies that can be held for 12 months for superior investment return:

Amazon.com
Apple
Bank of America
Boston Scientific
Constellation Energy
Eli Lilly
GE Vernova
General Dynamics
Lineage
Live Nation Entertainment
M&T Bank Corp
Nvidia
ServiceNow
Visa
Walmart

In a world wherein just about everyone’s average holding period is constantly in decline (or so surveys show us) I find it quite refreshing to see a researched attempt to select 15 companies that can be bought and not looked at for the next year (if not longer).

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Coming out of the August results season, Citi’s team of REITs analysts highlights the signs are there for many AREITs to be experiencing a peak in finance costs. This signals a turn-around might be approaching and indeed a case can be made this is already starting to show up in share prices.

Citi remains of the view some segments are better positioned than others, and the preference lays with sub-sectors that enjoy favourable supply and demand conditions, such as Industrial and Alternatives (land lease and self-storage), while any recovery should benefit residential and fund managers in the sector.

Highlighted Top Picks include Scentre Group ((SCG)), Stockland ((SGP)), Goodman Group ((GMG)), National Storage ((NSR)) and Ingenia Communities Group ((INA)).

While conditions for Office markets are improving, Citi still won’t go there. (Play the theme through diversified REITs, say the analysts).

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As has become tradition, Morgan Stanley analysts have communicated their Key Picks among ASX-listed small and mid-cap companies post the August results season. Have thus far been chosen:

-Accent Group ((AX1))
-Jumbo Interactive ((JIN))
-ARB Corp ((ARB))
-SiteMinder ((SDR))

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Stockbroker Morgans saw investors warming towards a better outlook for consumer spending ahead in August, with companies highlighting better conditions towards the final days of FY24, but financial results undershot against the broker’s forecasts nevertheless.

Morgans’ Key Picks post August are Beacon Lighting ((BLX)), Super Retail Group ((SUL)) and Universal Store ((UNI)).

Peers at Jarden continue to favour companies with long share runways, expansion plans and improving return on invested capital (ROIC). Companies that fit the mould include Flight Centre ((FLT)), Webjet ((WEB)), Temple & Webster ((TPW)), Universal Store, Woolworths Group ((WOW)), Treasury Wine Estates ((TWE)) and Domino’s Pizza ((DMP)).

Jarden remains more cautious on more mature businesses facing increased competition.

Morgan Stanley retains a preference for staples as the valuation gap with discretionary retailers has widened too far. Morgan Stanley has Overweight ratings for Woolworths Group and Endeavour Group ((EDV) and Underweight ratings for Wesfarmers ((WES)), JB Hi-Fi ((JBH)), Harvey Norman ((HVN)) and Super Retail.

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Citi’s two favourite exposures to the local healthcare sector are now Australian Clinical Labs ((ACL)) and CSL ((CSL)).

The five least liked exposures are (from the bottom up) Pro Medicus ((PRO)), Nanosonics ((NAN)), Cochlear ((COH)), Fisher & Paykel Healthcare ((FPH)) and Healius ((HLS)).

Macquarie’s local healthcare favourites are CSL, ResMed ((RMD)), Regis Healthcare ((REG)) and Intregral Diagnostics ((IDX)). Least preferred are Cochlear and Sonic Healthcare ((SHL)).

For online retailers, Citi’s favourite is Temple & Webster ((TPW)) with Kogan ((KGN)) Sell-rated and least preferred.

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Macquarie’s Quant team has identified those defensive names on the ASX most likely to benefit from falling interest rates, including:

-Aristocrat Leisure ((ALL))
-Codan ((CDA))
-Coles Group ((COL))
-Fisher & Paykel Healthcare
-GWA Group ((GWA))
-Harvey Norman ((HVN))
-Netwealth Group ((NWL))
-Pro Medicus
-REA Group ((REA))
-ResMed
-TechnologyOne ((TNE))
-Ventia Services ((VNT))
-WiseTech Global ((WTC))

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Barrenjoey has updated its Top Picks:

-Insurance Australia Group ((IAG)) among financials, as well as GQG partners ((GQG)) and Westpac ((WBC))
-Xero ((XRO)), Pexa Group ((PXA)) and Dicker Data ((DDR)) in the technology sector
-Vicinity Centres ((VCX)) and Abacus Storage King ((ASK)) among REITs
-South32 ((S32)), Lynas Rare Earths ((LYC)) and Perseus Mining ((PRU)) among miners and Strike Energy ((STX)) in the oil&gas sector
-ResMed
-Metcash ((MTS))
-Aristocrat Leisure
-Reliance Worldwide ((RWC))
-Brambles ((BXB))
-Seven Group ((SVW))

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Jarden’s Best Ideas among emerging companies (small and mid-cap) has ballooned to 20 inclusions:

-IPH Ltd ((IPH))
-Temple & Webster
-EVT Ltd ((EVT))
-Dicker Data
-Universal Store
-Nick Scali ((NCK))
-AUB Group ((AUB))
-Webjet
-Integral Diagnostics ((IDX))
-Capricorn Metals ((CMM))
-Michael Hill ((MHJ))
-NRW Holdings ((NWH))
-Light & Wonder ((LNW))
-Pointsbet ((PBH))
-National Storage
-Ingenia Communities
-Karoon Gas ((KAR))
-Domain Holdings Australia ((DHG))
-Pepper Money ((PPM))
-Telix Pharmaceuticals ((TLX))

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As promised in Weekly Insights on Monday, the full list of stockbroker Morgans’ Best Ideas, freshly updated post the August results season:

-The Lottery Corp ((TLC))
-CSL
-QBE Insurance ((QBE))
-Woodside Energy ((WDS))
-GQG Partners
-WH Soul Pattinson ((SOL))
-ALS Ltd ((ALQ))
-Reliance Worlwide
-Beacon Lighting
-Amotiv ((AOV))
-Universal Store Holdings
-Elders ((ELD))
-Acrow ((ACF))
-Maas Group ((MGH))
-Karoon Energy
-ResMed
-NextDC ((NXT))
-Mach7 Technologies ((M7T))
-Camplify Holdings ((CHL))
-Superloop ((SLC))
-Treasury Wine Estates
-ClearView Wealth ((CVW))
-PolyNovo ((PNV))
-Flight Centre
-BHP Group
-Rio Tinto ((RIO))
-South32
-Dalrymple Bay Infrastructure ((DBI))
-Cedar Woods Properties ((CWP))
-Dexus Industria REIT ((DXI))
-HomeCo Daily Needs REIT ((HDN))
-Qualitas ((QAL))

Have been removed from the pre-August selection: Coles Group ((COL)), Inghams Group ((ING)) and Avita Medical ((AVH)).

Recent additions are The Lottery Corp, Reliance Worldwide and PolyNovo.

This week’s Weekly Insights: https://fnarena.com/index.php/2024/09/11/rudis-view-asking-the-important-questions/

(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.)  

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P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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