ASX Market Update 20th July 2023

Global Market Commentary

Chart: S&P 500 as at 19/07/23

The S&P500 continues with a ‘rip your face off’ rally that continues to defy the most fundamental logic. Again, in an environment with many headwinds to face in 2H 23 and the fact the rally is purely an earnings multiple expansion I’m not sure I am willing to buy an SPX trading at 19x forward earnings with a cash rate at 5%+. The risk/reward isn’t there for me. Since the breakout of 4,195 the SPX is +8.6% in less than 2 months and up 18.6% for the calendar year to date. This is despite it being in the midst of an earnings recession. One quirky stat to help explain the rally this year is the following. In pre-election years the S&P500 is, on average, up 17%. However, when the year before is negative, as 2022 was, then the average jumps to 24.6% and it’s never been negative.

How do we explain the current rally? Well, it has been become more apparent in the last month or so the US economy is showing resilience. Especially in the consumer. Retail sales last night again showed strong spending in services with travel and entertainment, seeing healthy rises. We also have a stubbornly strong labor market with the unemployment rate sitting close to all-time lows, but still with an underlying weakness creeping in. All the chatter in markets now surrounds the likeliness of a ‘soft landing’ for the economy. One that seeing a slowing of the economy but without dipping into recession. Goldman Sachs this week dropped its chances of a recession from 25% to 20%. It peaked at around 35% making them more bullish than consensus. The chart above shows this and shows that consensus believes there is a 50%+ chance of a US recession in the next 12 months still. This will likely come down in the next few weeks.

*Chart courtesy of @FactSet

US Q2 earnings season has just kicked off with the consensus expecting a 7%+ fall in earnings for the quarter. I will note, as the chart above depicts, companies tend to outperform estimates by around 8.4% come actual earnings. We saw this in Q1 with estimates of -6% in earnings for only it to be down 2.5%. Analysts get so bearish the closer it gets to earnings and the bars are set so low we can’t help but get mostly earnings surprises.

As per the trend Q2 earnings have started strongly. It’s mostly been the banks thus far who have all beat on top and bottom lines. This has mainly been on the back of interest income that has exceeded expectations. Loan growth is still stagnant or going backwards, however impairment provisions are not being revised upwards at this stage either meaning the banks are seeing less risk moving forward.

*Chart DXY as at 19/07/23

The USD has seen some material weakness over the last few weeks, as per the DXY chart above, as rates have either peaked or are tipped to peak soon. This is despite a 25bps hike being fully priced into markets as of last night for the next meeting. As it’s a comparative index it also shows rates expectations in places like the EU, UK & Japan are much higher moving forward than the US. This lower USD does benefit commodity prices though and we have seen a bounce in most industrial metals during this time.

*Chart: NASDAQ100 as at 19/07/23

Finally, just a quick footnote for the NASDAQ. There will be a special rebalancing done within the index to reduce the weighting of the top five stocks. Currently Microsoft, Apple, Nvidia, Amazon & Tesla make up 43.8% of the NASDAQ. After the rebalance, this will be reduced to 38.5%. This is not a first for a US index and has happened before in 2011 & 1998. Basically, these stocks have become too big and have too much influence on the direction of the index as a whole and could distort the bigger picture. The NASDAQ is up a staggering 45% this year and most of this can be attributed to these top 5 stocks. This isn’t expected to have a material impact either way on price movements, but it could make it harder for the NASDAQ to continue this rally. This rebalance will occur before open on the 24th July.

S&P/ASX 200

Chart: S&P/ASX 200 as at 20/07/23

The XJO has performed with a little more volatility than our US counterparts in the last few weeks. We have seen soft Chinese macro data drag us down with US macro ‘hopium’ lifting us back up again. It was a strong week for the XJO last week as we were up almost 3.5%, but this basically offset the losses from the week before when we were off more than 3%. It’s a tough market to trade here in Australia vs the US. We are severely underperforming, only up 4% for the year vs their 18%+. I do predict though that this will narrow in the 2H 23 as the US runs into a few headwinds and we get the tailwinds of China stimulus and economic strength + move past our consumer slump.

The Australian economy continues to deliver mixed signals, like the US, but most pointing to a significant softening in the economy. Consumer spending seems to be dropping off and our savings rate diminishing. Yet figures only released today show a robust jobs market still with 33k jobs added, unemployment at 3.5% but lower participation. In fact, that is a theme globally. The quarterly & monthly CPI data the RBA receives before its next meeting in August will be critical to a rates decision. The way I see it now is its 50/50 as whether they hold or hike.

*Chart: Ansell as at 20/07/23

The XJO has been relatively quiet in corporate news to start the new financial year but do expect a few earnings updates as we move into our main earnings season in August. We did have Ansell ($ANN) give us an update this week that saw its stock dive around 15%. FY23 guidance is now for an EPS of US117-118c, which is the middle of guidance given in February and the lower end from August 2022. They state FY23 saw solid organic growth in mechanical & chemical gloves, but a destocking in inventory in their healthcare unit provide a negative impact + price reductions. FY24 doesn’t get much better for them with destocking and lower prices in healthcare to continue to impact earnings. They are also citing currency impacts as a headwind. Industrial is expected to see continued growth. As a response to this they will reduce production in the healthcare unit to help stabalise inventory levels and prices. This will be a temporary negative impact. They will also let go of some employees + invest more heavily in automation to help improve EPS moving forward. They expect that these incentives will cost $40-$50mill but will end up saving them $46mill pa by 2026. FY24 EPS is now expected to come in at US57-77cps including all the new costs and incentives, without its 92-112cps.

I like ANN’s business model, structure and sector they operate in. Rubber gloves are a very niche area with high barriers to entry with very long dated, sticky and high compliance contracts made with customers. Also, the volume of product ANN can produce is extremely hard to replicate. This seems like a one-off hit to their bottom line to right the ship and improve their business. I especially like the talk of automation investment. Whilst the covid era gave them a massive boost to their earnings as the globe went crazy with extra demand for gloves and PPE gear on the other side it has caused a glut in product and a normalization. Prior to the pandemic ANN saw consistent mid-single digit growth in earnings and I would expect them to return to that in FY25 and beyond.

We had mostly exited our position in ANN in anticipation of headwinds last year. Although we didn’t expect these to be so significant. Would I look for a re-entry here? It’s probably too soon and I don’t like catching a falling knife. I will wait for analyst downgrades to come through and consolidation at current prices. However, I do like ANN as a longer-term hold and believe growing profitability will return soon.

Flight Centre ($FLT) released a nice profit upgrade for FY23 with TTV back above $22bill and really close to their pre-covid $23.7bill levels. It’s been an impressive turnaround, but one we knew would eventually come. It hasn’t been totally organic as they have made a couple of acquisitions but are definitely a leaner and more globally diversified company now. What was most impressive was their corporate travel business which hit a record TTV of $11bill and well above the previous $9bill record. In brief they are expecting leisure and hospitality to continue to recover as people preference travel in their discretionary spending.

EBITDA is now expected to be $295-$305mill up from $270-$290mill, a 7% increase on the previous midpoints. They make no mention of FY24 and the start of the new financial year or if trends from FY23 are continuing. I think the real challenge is to come for FLT in FY24 with a real pinch in consumer discretionary spending yet to be felt. People may still prioritize travel spending, but that pool will grow smaller. I am very wary of anything heavily linked to consumer spending for the next 6-12 months. There is still $264bill of fixed rate mortgages to be rolled over this year and full effect of rate hikes are yet to be felt. I was a happy buyer at $14-$15 on FLT, as we did and glad to be exiting around these prices. Hopefully they give a FY24 update on August 30 when they report their results but at 60+ times FY23 and 22x FY24 forecast earnings I am not a willing participant here.

*Chart: Mineral Resources as at 20/07/23

In the final bit of corporate news for this update we see Mineral Resources ($MIN) basically tear up its downstream agreement with Albemarle which was highly detracting for earnings especially in a falling lithium prices market. They will regain 50% exposure to the Wodinga lithium mine whilst handing full control of the hydroxide plant to Albemarle and receive $380-$400mill for this. They will then look to market their own lithium product in China next year and look at their own downstream value adding options. This is positive news for MIN and gives them greater control of earnings moving forward. The stock jumped up to 7% on the back of this. I have been a buyer of MIN in recent weeks and continue to do so around current prices. Earnings and FCF take big leaps in FY24-25 and debt will be significantly reduced. MIN will trade a mere 7x FY24 earnings here with up to a 10% yield depending on who you ask. They remain my favourite exposure to lithium and resource stock overall.

I will wrap up this week’s update here as we have covered some good ground. The weeks ahead should get more exciting as US earnings accelerate and Australian earnings begin. Will be lots of new to cover. Personally, the school holidays are almost over, and it upsets me a little. I love having the boys home and being able to hang out with them. They have recently jumped into the world of Pokémon, collecting the cards and watching the shows. I never really got into it as a kid so it’s a whole new world I will have to learn about. Go long Nintendo? One thing is for sure, the house will get too quiet again next week when they return to school. Olivia continues to grow up way too fast. She has four teeth now and can sit upright by herself. Not crawling yet but I am sure that’s not too far away. I hope you all have a wonderful & safe end to the week. I will speak to you all soon. Go Crows!

“Why are your pupils the last part of your body to shut down when you pass away?

Because they dilate”

PS Enjoy the Dad Joke 😊

heath@hlminvestments.com.au

0413 799 315

Important Notice

Any advice in this article should be considered General Advice only and does not consider 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.