ASX Market Update 23rd March 2022

ASX200 (XJO)

· The XJO closed up 230.80 points or 3.27% for the week. Our low 7,063.60 on Monday and our high was 7,296.80 on Thursday.

· The XJO finished positive for the fifth week out of the last seven.

· The best & worst performing stocks for the week were: UWL +31%, SQ2 +15%, ARB +14%, AKE -6%, GOR -7% & CHN -10%

Global Market Commentary

*Chart: S&P500 as at 18/03/22

Since we last spoke the Ukraine/Russia conflict has dominated headlines, as you can imagine, but even that took a back seat last week to some important macro events. The first being the Fed raised their official cash rate by 25bps in the first hike since 2018. The fed member dot plot chart suggested another 6 hikes were expected for 2022. Jerome Powell was as hawkish as he has ever been in his speech, but the market shrugged this off and rallied hard. The consensus view is as there were no further surprises from the meeting’s commentary the market has factored all the above into markets already and are content with where things are at. The US 10yr yield rallied about 20bps last week on the back of this but has since cooled to a yield of around 2.15%. This is well off its recent lows of 1.70% when the conflict in the EU was at its worst. One concern moving forward is the gap between the 2yr & 10yr yields are closing and are only about 25bps between them now. If the 2yr were to venture higher than the 10yr yield than this is what they consider an ‘inverted yield curve’ which generally signals a recession lies ahead. Something to be wary of.

US markets have finally broken their down trends and look to be recovering from their lows. The Nasdaq entered an official bear market to start last week as it was 20%+ down from highs, but it too has since bounced and now is only 13% off its highs. As you can see from the chart above the S&P500 is trying to break above its 200dma again. Generally, this fails the first time so maybe expect some weakness there before a stronger move higher. Overall, the US markets are looking a lot healthier again.

*Chart: Hong Kong Tech Index as of 18/03/22

The second piece of macro news that got equities markets bullish were comments from the Chinese state after one of their economic meetings last week. To summarise below the Chinese Government pledged:

· To keep capital markets stable

· Vowed to support overseas stock listings

· Said dialogue with US regarding ADRs is good

· Promised to handle risks for property developers

· Clarified regulation of Big Tech will end soon.

Now there is a lot to unpack there so I think we should go through them one by one as its very important for the immediate strength of the Chinese economy and hence Australia.

1. Vowed to keep capital markets stable- Basically means they will be supporting local share markets in both China & Hong Kong via on market purchases which flows confirmed last week was already happening. The HK exchange was roughly down 40% from its highs of last year recently and saw some heavy sell offs of 5-10% in single days in preceding weeks. In fact, it traded below the 20,000-index level for the first time in 5 years before the above announcement. It’s since recovered a little and now is down roughly 30%. Now HK & Chinese markets have been hit for a few reasons that we will discuss below, but it mainly surrounds sanctions spilling over from Russia to China, Chinese ADRs having to delist in the US & property developer concerns.

2. Vowed to support overseas stock listings & ADR dialogue with US is good- China has about $US1.1trill worth of companies listed on the US exchanges. A couple of weeks ago 5 companies were identified by the SEC as in breach of their listing obligations and were at a threat of being delisted if they didn’t comply. This breach is allowing US auditors to inspect their books which of course will never happen as that is against Chinese legislation. Thus, the fear was this would eventually spill over into larger listings such as Alibaba, Tencent & Bidu. By China vowing to support these listings and that dialogue with the US is good means they are willing to work with US authorities and perhaps a compromise could be made.

3. Promised to handle risk for property developers- We all know about the Evergrande story and how it unofficially defaulted on debt a couple of times, but given their debt is 90% denominated within China they were able to manage the situation. There were a few smaller developers that had troubles as well. China vowing to support these companies obviously means they pose much less of a risk to the Chinese and global economy. Recently Evergrande was granted further funding and allowed to restart projects again.

4. Regulation of Big Tech to end soon- This was a big one as for the last 18 months China has been trying to clean up their tech industry and stop companies becoming behemoths like Google or Microsoft. They forced Ant financial group to break up and news recently suggests they will force Tencent to demerge their ‘WeChat’ division. They had also placed new regulations on how long children could play video games each week amongst other things. This coming to end will hopefully allow Chinese tech companies to operate freely again. Some Chinese techs like Alibaba are down as much as 60%-70% from their highs and have fallen from 40x forward earnings to 12x valuations.

Global equity markets reacted positively to this news and was the major reason we saw the strong rally we did last week. The Hang Seng Tech index jumped 22% on the back of the news but remains 60% off recent highs. Overall, all the above supports the notion that I was pressing on you all late last year and that was after the Winter Olympics China would drop most restrictive mandates and allow their economy to run at full capacity again with some fiscal stimulus to kick start it all. This all seems to be happening with recent data suggesting credit is flowing again and commentary turning much more supportive. In fact, this was my overarching theme for 2022 I wrote about to start the year- ‘Central Bank Headwinds vs Chinese Tailwinds’.

This obviously bodes well for the Australian economy as a strong property sector in China supports commodity prices that we benefit from.

Finally, we come to the Ukraine/Russia conflict that will seem like is front and centre of the market’s attention, but when in fact I feel it has moved past it in most ways & is content in where things sit over in the EU. Unless things dramatically escalate over there in the form of weaponry used (nuclear or bio) or it spills over into other countries in terms of actual war (Poland?) or economical via sanctions, then I feel the market will just keep it in the back of its mind.

Australia

*Chart: S&P/ASX 200 as of 21/03/22

The XJO has performed relatively well through all the turmoil and sits a mere 2% lower (as at 21/03/22) than it was to start the year. This was mainly due to our large exposure to commodities and mining companies that performed well when we saw the likes of energy, copper, nickel, coal & iron ore have had very strong rallies. Technically we have broken our downtrend we have been in since the start of year and tested the 200dma today (21/03/22). It seems to have rejected it, which usually happens first time around, and we could see some weakness in the XJO again. I would expect 7,180 to be tested again before we see some further strength in the index. Given the value nature of our index, and the fact value outperforms during times of rising rates/inflation, we will continue to outperform our global peers.

The Australian economy looks like we are in for a purple patch with +4.7% economic growth expected for 2022 before falling to 2.5% in 2023. Jobs growth remains strong, and we are at multi- decade lows in terms of our unemployment rate of 4%. Most economists are expecting an unemployment rate of 3.6% by the end of the year. We also have a record number of people employed in Australia with 300k more people employed than pre-covid. Leading indicators such as job ads, business conditions and overall economic strength suggest there is a lot of runway left in the jobs market. Of course, with buoyant economic conditions come strong earnings with 13% earnings growth expected in FY22 and 8% in FY23.

Now you may hear a dirty word thrown around, especially by the media, by the name of ‘stagflation’. Basically, it denotes a period of slowing growth, high inflation, and rising unemployment. Now I think this is a long way from the truth and just a buzz word being thrown around to get viewers and website traffic. What I think people are mistaking for stagflation is a just a normalization of economies and markets. We went through a period of very high economic growth that is not sustainable and would natural slow. The US is unable to keep its +5.7% GDP growth it saw in 2021 as it is a very mature and large ($22trillion) economy. It will naturally slow to its +2-3% norm. Similarly, here in Australia we will revert to our normal 2-3% growth. As for inflation I think we will see figures in the US come down to that 3-4% by the end of the year as new data draws on higher base levels in comparison from 2021. Here in Australia, we haven’t really experienced much inflation outside of some petrol and food. Inflation will also ease as supply chains open, and oil eventually settles back down. Finally rising unemployment is just not occurring. We are experiencing the complete opposite both here and in the US.

I do believe we are about to experience the same conditions we saw 3-4 years before the GFC whereby economic growth was strong, inflation was above trend, wages grew, and we saw a very healthy period globally. The catalyst for this remains the extra investment in infrastructure globally and decarbonization of the economy.

Opportunities Moving Forward

The theme of value over growth moving forward has been done to death but is the overarching theme for the foreseeable future. Not to say there can’t be some value in growth, but that is a story for another day. As I mentioned earlier the XJO is fundamentally a value-based index and thus we are spoilt for choice when seeking opportunities in this area. I feel the three sectors that portfolios should be tilted towards are Resource, Financials & Energy.

Resources

*Chart: BHP Group (BHP) as at 22/03/22

The obvious call here is BHP & RIO, which I feel are worth accumulating on any dips that present. They give us a wide variety of exposure to minerals such as iron ore, copper, energy, nickel. I don’t feel you need to rush in here as we will always get periods of weakness here that provide opportunity. Nickel, Copper & Lithium remain my favourite minerals to be exposed to within the resources space and companies such as Independence Group (IGO) & Panoramic Resources (PAN) will certainly give you that Nickel exposure, along with some lithium in IGO’s case. Both trading at cheap FY23 valuations with a lot of upside to come from increased production and resource expansion. PAN also is in play for mine with IGO taking over WSA, and also gaining a handy 20% stake in PAN as a result. I feel eventually they will use this to take control of them as well. Its not widely known but 50-70% of a lithium-ion battery is Nickel and hence my fondness for it.

Copper demand will outstrip supply for some time as electric vehicles consume 4-5x as much copper as traditional cars not to mention all the copper we need for infrastructure + the tools to build it. My favorites here are Sandfire Resources (SFR) & Copper Mountain (C6C). SFR has had a transformational period recently and will soon produce as much copper as an Oz Minerals which trades at a much higher valuation. C6C is a smaller producer but also trades at a fraction of its peers valuations.

Lithium is my final favourite commodity, being the foundation of the battery industry, that is about to explode. It seems that lithium supply will be in deficit until 2026 and may constrain our electric vehicle adoption. Lithium prices have gone crazy in China as the spot price hovers around $US70kt for hydroxide. The Chinese government has called meetings with the battery producers in China to advise them they do want prices to normalize, thus we could see some downward pressure there. However global spot prices are still materially higher historically around $US31kt which seems a much more sustainable level. In this space I have four companies that will give you great exposure to the industry. The first is Mineral Resources (MIN) which will eventually produce around 700kt of SC6 (hard rock) lithium and 80kt of hydroxide. Its recently been sold off due to struggles with its iron ore division, thus presenting another entry opportunity. They also have mining services & energy division.

The next is Allkem (AKE) which is the result of the merger of Orocobre & Galaxy Resources. They produce a mixture of lithium brine and hard rock with major expansions in production for both in the next 2-3 years. Pilbara Minerals (PLS) rounds out the producers with a target of 700-800kt of SC6 within the next few years. Again, have been sold off their $3.80 highs to be around $2.80 currently givens an opportunity to enter.

The final Lithium exposure I prefer is Liontown Resources (LTR) who are just an explorer at the moment but aiming to start producing 400ktpa of SC6 by 2024 and have recently signed offtake agreements with the likes of Tesla & LG Energy.

Financials

*Chart: Commonwealth Bank (CBA) as at 22/03/22

Much like resources our market is blessed with a large weighting, and variety of choice when it comes to financials. And when I’m talking about financials here, I am referring to the banks & investment companies as I have sectors such as insurance on AVOID. The banks do very well in times of rising yields and inflation as their margins start to expand. I saw an interview with the head of CBA recently that suggested that for every 0.25% increase by the RBA it adds 0.04% to their net interest margin (NIM). Furthermore, every additional 0.01% to their NIM adds $80mill in net income to their bottom line. Thus that means an extra $320mill for every 0.25% move and if they do that 10 times in the cycle that’s over $3bill added to their bottom line. Very impressive indeed. CBA is not alone here and whilst I don’t think the other banks have that sort of leverage they also benefit in a similar way.

Thus, one of my preferred exposures to financials moving forward is Commonwealth Bank (CBA). It’s the biggest and best here in Australia and as we saw above it has fantastic leverage to higher rates. Yes, you are paying a premium in terms of earnings multiples, but I think you pay that for quality. They have the best quality loan book, and they are the leader when it comes to banking tech offerings to their customers. I feel earnings will constantly beat forecast and this will help drive share price growth. Having said that I feel you will be able to get them for sub $100 again soon so just keep your powder dry for now.

Next in my financials playbook is Macquarie Group (MQG), Australia’s largest investment bank with huge exposure to commodities, mergers & acquisitions and the green assets/technology. They continually under promise and over deliver when it comes to earnings which the market loves. Trading 17/18x FY22/23 earnings and 3.5% makes them attractive in my book given management’s earnings history. One downside is their exposure to aircraft. They are one of the largest jumbo owners and leasers in the world and there are $10bill worth of these planes sitting in Russia at the moment that are likely never to be seen again. If they had a large exposure there, then this could hurt short term earnings with a write down but does not dampen the longer-term picture. Anything under $200 a share I feel worth accumulating on MQG especially since Morgan Stanley just whacked a $245 price target on them.

Final financials exposure I would suggest is via the VanEck Australian Banks ETF (MVB). This is for a more diversified, lower risk investment as it will give you exposure to 10 listed Australian banks including CBA & MQG above. It probably won’t give you the leverage to rate increases the other two will but saves you from being more selective with your investment. A yield of around 4% makes this ETF attractive as well.

Now I’m going to give you a cheeky small cap that will also benefit from this environment and that is Auswide Bank (ABA). Mainly servicing SE QLD and NSW, ABA only have a $300mill market cap but a very strong track record of increasing earnings. EPS was 30cps in 2016 and since they have been able to increase it to 57cps as of FY21. It trades a mere 12x FY21 earnings with a 6% yield. In its recent half year profit report it saw NPAT +14%, loan book growth of 8.7%-and-a-half-year EPS of 31.8cps. If they can replicate that in the second half, then it is trading a low 10.5x FY22 earnings. I can also see it being in play with a BEN or BOQ maybe looking to take it over and adding a cheap $3.5bill to their own loan books. Obviously a much riskier play with such a low market cap and being more susceptible to economic gyrations.

Energy

*Chart: Crude Oil (WTI)

My last sector I believe you need an overweight exposure to and possibly the most undervalued is the energy sector. Here I am mainly referring to oil, LNG/Gas & Uranium. I have no interest in the over regulated utility sector at this stage. My preferred exposure here is simple and its Woodside Petroleum (WPL) & Santos (STO). Both make most of their earnings by selling LNG into the Asian markets. Only the other week LNG was trading at the equivalent of $US300bl in Asia showing how it too has been swept up in this energy upswing. WPL has outperformed STO as it sells approx. 18% of its LNG into the spot market vs STO 14% which gives them more leverage to the upside. They also have a much higher yield of 6%+ vs STO 2%, which I feel makes them more attractive to investors. However, this means STO is trading at a cheaper valuation compared to WPL trading at 9x forward earnings vs 12x and thus why I am happy to include them.

My final major energy play on the ASX is the Betashares Global Energy Companies ETF (FUEL). This gives you exposure to a basket of the world’s top energy companies, ex-Australia, and thus names like BP, Shell, Chevron, Total etc. are all included. It will help diversify your exposure with a more global outlook. Global energy companies are currently swimming in cash with record profits, high free cash flow and lower debt. I can’t see a material downside in energy prices anytime soon as an underinvestment in production + rising post-pandemic demand is creating that perfect storm. In 2010-2014 oil traded in a $90-$120 band and stayed relatively high until more supply could come online and I feel we could see a similar situation here for the next few years.

Lastly, we have uranium, which is a very high-risk sector here in Australia dominated by small caps. For instance, when Russia was attacking the nuclear reactor in Ukraine the other week most of these companies lost 20%+ in value during a few short hours. However, if there is a push to use more nuclear power, especially in China & EU, then Uranium spot prices should continue climbing. The spot price has moved from about $US40lb to $60lb in the last 3 weeks, but probably still not high enough to get 50% of the globe’s production that is shut-in back online. Also, Russia controls about 35% of the globe’s uranium enrichment production, via decommissioned weapons, which its supply is currently under threat.

Thus, I am looking for companies that could bring production online quickly to take advantage of higher prices. Hence my picks in the sector are Paladin Energy (PDN), Boss Energy (BOE) & Lotus Resources (LOT). These are all miners who are sitting on existing mines which have gone into care & maintenance and can bring production on quickly within 6-12 months. Again, I want to reiterate these are very high-risk investments and thus should be treated accordingly.

Well, it’s been a monster update this time around and I’m sorry if I dragged it out too much. My main point I want you to take out of this is the markets are taking things in their stride and economies are normalizing, we are positioned well here in Australia both from an economic & market perspective + there are many investment opportunities out there. More than I can cover in my updates. Its time to ignore the noise and take hold of those opportunities when they present themselves.

Personally, it has been a very busy period in the Moss household. We welcomed a new puppy into the house, a Spoodle called Winnie. The kids are in love with her, and she is a beautiful little dog. After both kids starting school & kindy for the first time we are almost at the end of term 1 already. I have loved seeing their growth intellectually and personally. One of my favourite parts of the day is when they come home and tell us all about their day and what they have learnt. Sometimes it can be a bit like pulling teeth getting that info though. Also footy is back! It didn’t go the Crows way this week in a heartbreaking loss, but that’s footy and there is always next week. It’s just great to have footy back on our screens. I hope you are all keeping safe and well. I look forward to speaking with you all 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 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.