ASX Market Update 9th March 2021

ASX200 (XJO)

· Despite ending the week with two days of losses the XJO managed to inch out some gains of 37.50 points or 0.56%

· Our high for the week was on Tuesday of 6,870.70 and our low was 6,660.50 on Friday.

· Last week was the first weekly improvement for the XJO for a month.

· For the year, the XJO remains 1.88% in the black.

Market Commentary

As you may recall I wrote about my top risks to markets this year in my first note to you all back in January. Second on that list was rising yields, and we are just starting to see that play out. The US 10yr treasury yield now sits at 1.57% after bottoming at 0.50% last year and was 0.90% when I last spoke with you all. It is a similar story with Australian 10yr yields sitting at 1.85%, with a low of 0.55% and 1.07% when we last spoke. These are some very punchy moves by yields in the space of just 5 weeks as we have seen the US +67bps and the Australian move +81bps. We also saw shorter term yields on 2- & 3-year bonds move aggressively last week, but they were quickly quelled by the RBA with some yield curve control measures. Moreover, we had the Fed chair Powell speak last week and he did nothing to subdue the run-on yields as some would hope. The Fed is now in a blackout period whereby it doesn’t speak publicly again until 18th March, at its next meeting. This means we could see these run-on yields continue for a couple of weeks yet.

So why does this matter and why am I emphasizing it so much? I have said it many times to you over the years that bond yields & rates rule financial markets. They determine how much debt costs to how assets, such as equities, are valued. They are integral to equity market’s movements and why we are seeing a such volatility now and a preference for Value stocks over Growth. Higher yields are generally bad news for equities in the short term. It means analysts must possibly start forecasting higher debt costs into cash flows moving forward and lowering the price to equity ratio’s stocks trade on. This is true for growth related stocks, such as tech. Remember how stocks have been trading at a premium to historical price to earnings ratios over the last couple of years due to rates being at zero? Well now possibly the opposite is true, and equities are being brought back in line with more historical averages. This will not happen overnight, but over the course of years.

Over the last week or so we have seen the following moves in the major indices here and in the US:

- XJO -1.93%

- XAO -2.57%

- Dow Jones -0.50%

- S&P500 -2.88%

- Nasdaq -10.54%

As you can see the Nasdaq is by far the worst performer because it is weighted towards growth and stocks valued on higher PEs. The S&P500 has also underperformed due to roughly a 20% weighting towards the 5 top tech stocks as well, thus the selloff carries over. Believe it or not these are healthy moves on markets as we see some rotation and an indication of better things to come. Markets are looking past the pandemic and contractions in economies now and trying to find a new normal. Looking past a time where we have unconventional monetary policy and a market that is priced more economic conditions rather than cheap debt. It is positive news that yields are moving up as they are factoring in much better times ahead, and in the case of inflation expectations, rising official rates and inflation. Thus, when all is said and done, we could be in for some more volatility and even that 10-20% correction. It would be considered an extremely healthy correction and an excellent opportunity to accumulate positions in quality stocks if it indeed does occur.

The Chinese market, Shanghai Composite, is raising some eyebrows as well as it enters a mini correction. It is 7.4% below its highs made just a few weeks ago, as the Chinese Government tightens credit conditions restricting availability. This has seen some economic indicators soften as well, such as PMIs, as concerns grow that the best is behind us. For me, and many analysts, its thought that its more the government keeping things in check and making sure they do not run too hot. If conditions started to deteriorate too much, then they would simply turn the taps on again. I feel they are more looking to the private sector to stand on its own two feet now and help the economy grow. Trade data remains solid with refined copper imports +4.7% for the year, iron ore +17% and oil +9.64%. They did soften in February slightly but that is not uncommon as economic data is skewed due to the Chinese New Year break. China themselves have said that they are expecting economic growth of 6%+ for 2021 but most analysts are forecasting growth around 8-9%.

I am a buyer of China on weakness and especially Chinese Tech. The ETF by Betashares, ASIA, is probably the best exposure to Chinese technology stocks. It holds the 50 biggest tech stocks in Asia ex-Japan. It hit highs of $14.20 but has softened to $11.65 recently. This mirrors the sell off in tech in the US with a 17.96% retracement. I believe there is much more upside in tech for Asia due to the fact a lot of these companies are less mature and still very much in their growth phase. You are also talking exposure to over a third of the globe’s population giving them an enormous market to expand in to. I would hold off until we see some consolidation in tech in both China and the US before entering but see it as a long-term play.

Market Outlook

Over the short term there is some real downside risk. If we cannot hold the 6,600 (blue) level, then we are a solid chance of falling to 6,200-6,300 (purple). That would be a solid 10% fall from our recent highs. Like I said earlier a healthy correction. Recent strength we have seen in the XJO has been sold off as the trading days drag on, which is not a good sign. There could be some exhaustion here which may lead to a sell off or at least some sideways movement.

Even locally we have seen the value over growth theme play out. In February, according to Morgan Stanley, value stocks rose +2.57%, whilst growth saw a contraction of 0.62%. This means sectors such as financials, resources and energy performed extremely well whilst sectors such as tech, healthcare and discretionary retail suffered. I am still very bullish on the XJO moving forward over the next couple of years. I believe I have mentioned it before Morgan Stanley now believes FY22 EPS to be at the same level they were forecasting in January 2020 before the pandemic. It will be as if the pandemic didn’t even happen from an earnings perspective. Its also thought now that FY21 earnings will see 34% growth, taking it back to pre-pandemic levels. Again, the system is awash with cash and cheap credit being supported heavily by fiscal and monetary measures. This will help propel our economy forward with a very domestic, demand driven, recovery for local goods and services. Add in a housing construction boom and you have the perfect storm for bullish market conditions.

Getting exposure to the overall value play on the XJO is difficult as we do not have the options our US counterparts do. You could go overweight sectors such as financials, resources, energy etc. in your personal portfolio. This can be a bit tedious and harder to manage. The other options is to add one or two value based ETF’s to your portfolio. I have some suggestions below.

VVLU- This is a Vanguard actively managed value-based ETF that has been listed on our market for some time now. It invests in international equities with a value bias. At the moment it has 1402 holdings with 67% exposure to North America. Fees are low at 0.28% and is trading around $52.45 close to pre-pandemic highs. More info can be found here https://www.vanguard.com.au/personal/products/en/detail/8202/Overview

VLUE- This is a very new ETF that is yet to list but is due to list this week. This is managed by VanEck and is to hold 250 international equities (ex-Australia) with a value bias. Not much information out at the moment on this ETF but is one to watch as well. More info can be found here https://www.vaneck.com.au/blog/blog-post/new-international-value-etf/

IJR- This is not a value-based ETF but one with a value theme regardless. It is managed by Blackrock and tracks the US S&P Small-Cap 600. It invests in the 600 small cap stocks listed in the US. US small-caps tend to perform better during times with rising yields and inflation and are put into the value basket even though they aren’t officially there. Again, more info can be found here https://www.blackrock.com/au/individual/products/273426/ishares-s-p-small-cap-etf-fund

As I mentioned above these options are a simple way of giving your portfolio some value exposure without the need to manage individual stocks. As always, these investments do not suit everyone and the above should be considered general advice only. It does not take into account your personal circumstances and you should seek professional advice before making any investment decision.

Small & Mid-Cap Focus

Last time I gave you ten investment ideas in large-cap stocks I felt would perform well over the coming twelve months and further. Below I will discuss some small & mid-cap stocks I feel will perform well over that same period as well. Again, I want to reiterate the General Advice disclaimer above and note that these investments are of a higher risk nature.

Sims Metals Group (ASX: SGM) $14.82- These guys are a simple business. They are into metal recycling including ferrous and non-ferrous metals. They will buy scrap metal, process and purify it, separating it into its core base metals and then on sell it into the markets. Earnings have struggled over the last decade and really have been all over the place. This is mainly due to the underperformance in commodity prices. Pre-GFC they saw profits grow from $142mill to $388mill due to the bull run in commodity prices. This is because when commodity prices lift then the prices SGM receive for their product also improve greatly. SGM have consolidated and have become a much more streamlined company improving their profitability moving forward. It’s no secret I believe we are in a sustained commodities bull market again and thus this will benefit SGM over the next few years. I believe we can see highs we saw last in 2018 around $19/$20 per share, which also correlates with the last time copper saw its last sustained move upwards as well.

Flight Centre Travel (ASX: FLT) $17.47- This is an obvious play in a recovery in global travel, in particular the US and corporate travel. We must ignore the last year of earnings for obvious reasons and are probably looking towards FY23 for any signs of recovery. As we all know though, the markets are always looking forward and its only 2 years away. Over one third of FLT earnings come from the US now and the US is expected to open and recover quicker than expected. Vaccines are rolling out fast with 75% of over 65s expected to be vaccinated by the end of March. We also know US citizens are not afraid to get back into the skies either as travel data for Thanksgiving 2020 saw more flights than that of 2019, during the middle of a pandemic. I also expect to see corporate travel make a quick recovery and its currently 40% of FLT’s TTV. In Australia we have the world’s second busiest flight path in the one between Melbourne and Sydney. This will benefit FLT as companies send their employees in the air again as survey’s are now showing a preference to have the office environment return as the work from home situation has become too difficult. FLT have always been a very well-run company and have seen continuous earnings growth over the last decade. I believe they return to that. They have $1.2bill in runway this no need to raise capital again and if they can return to 2011 EPS levels of around $1.50 by 2023/24 then they are only trading 11x earnings here.

Auswide Bank (ASX: ABA) $6.56- Australia’s tenth listed banks but with a market cap of around $300mill, so exceedingly small in size. Have gone under the radar for a while but since 2015 have been growing their business strongly. Its roots are very much set in QLD with 71% of its loan book there, but they are expanding quickly into NSW & VIC. Have always been very prudent with their money management and despite the falling earnings and struggle for credit growth of the bigger banks these guys have been able to do the opposite. FY1H21 its loan book grew 13%, NPAT +21% and NIM 6bps to 2.01%. This along with customer deposits +11%, ROE 12% and falling costs make ABA very attractive. Based on FY21 forecast earnings they are trading a mere 12x PE here with a forecast yield of 5.8%. Due to their small size it is easier to grow their book at a faster rate then larger institutions it also makes them a very attractive takeover target to a mid-tier player. Its an easy way for a BEN or BOQ to add $3.5bill in loan book value in high quality loans that I doubt would see objection from governing bodies. With the housing market expecting a strong 24 months this will benefit ABA as well. I expect ABA growth to outpace the big banks by large margins and is excellent value down here.

Domino’s Pizza (ASX: DMP) $86.15- DMP is one of Australia’s great success stories and is probably the most technologically advanced food company within the country. Over 76% of sales come from online sources, with the incorporation of AI into their food preparation, quality, and delivery services. Earnings have grown at CAGR 22% for the last decade maintaining margins and increasing their market share in Australia, EU & Japan. Japan is where most of their growth will come as they expect to triple their footprint there in the next decade. In fact, when sales were struggling after two years in Japan, head management moved to Japan to get a better understanding of the market and culture. Now the business is booming. The targets DMP have set for themselves over the next 5 years per annum are 3-6% same store sales growth, 7-9% store additions, and capex at $60-$100mill. Thus is they are able to hit these figures then earnings growth should see double digits per annum growth as a consequence. The fact that they turn to technology so much to improve their business and grow margins is what impresses me most here. Also cracking a Japanese market which has proven to be tough, even for the likes of KFC, impresses me most.

Gold

Finally, I just want to touch on Gold before I wrap up. A few weeks ago, I wrote about Gold being a favored investment option for 2021 on the proviso that yields remained in check. Obviously, this has not occurred, and yields have run away, and Gold has suffered. Thus, for me at this point Gold is an Avoid. I see no reason to be invested in Gold whilst yields seem to be going higher, and in the short term, the USD too. Gold loses its appeal as a safe haven asset when the risk-free rate of investment, US treasuries, start rising. It also more concerning when Gold in AUD is underperforming further. At this point in time, I cannot see a reason to be in Gold. There will be a time, I think, when inflation is running consistently above the mean that Gold becomes attractive again, but that may be some time away. Technically and fundamentally, it could not look uglier for Gold and I’m not in the business of catching falling knives.

Having said all that there may be a trade opportunity in Gold if the Fed come out with a more dovish stance on rates soon which will coincide with oversold signals I am seeing technically. We will have to wait to see how it all plays out.

This is where I will close it out again for this week. Its great to see a vaccine roll out so quickly across the globe and our turn has just started. Things are returning to normal locally as I start to get meeting requests with BDMs across the country that are face-to-face. My March & April are filling up very fast. As I have said before I expect the economy to open up swiftly in the second half of the year.

Our eldest started Kindy a few weeks ago in what was an emotional experience for us. Its wonderful and I’m so proud seeing him grow up and make his way into the world. Its also sad as the realization hits, he’s not our little baby boy anymore. He has taken it well though and there have been hardly any tears upon drop offs and he’s making new friends. In fact, I think his little brother has been upset the most as he walks around the house saying how much he misses his bigger brother on Kindy days. The house does feel a lot emptier and quiet without him.

Footy season is back next week, which I am thoroughly looking forward to. I do not expect much out of the Crows this season, but I cannot wait to get back to Adelaide Oval with 40k others and just watch live footy. It’s something I really missed during 2020 and its another great example of society getting back to normal.

Well, I hope you all have a wonderful and safe week. I will speak to you all very soon. Go Crows!

heath@hlminvestments.com.au

0413 799 315

Important Notice

Any advice in this article should be considered General Advice only and does not take into account your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.