ASX Market Update 27th January 2021

ASX200 (XJO)

· The XJO has continued its solid start to 2021 with an 85 point or 1.32% gain for the week. Our high was 6,829.30 on Thursday and our low was 6,651.60 on Monday.

· To date January has seen the XJO climb 3.24%

· On Monday the XJO hit 11-month highs

· Below are the best performing sectors and stocks for the last week.

Market Commentary

Global equity markets seem to be driven by three main factors now 1.) Covid 2.) US Election & 3.) Reflation. I will break down the implications of all three as simply as possible below.

1. Covid: The virus continues to spread like wildfire in the US & the EU during their colder months. The EU have enforced harsh lockdowns that may last past Easter in April. The US are semi open with each state doing their own thing. Newly instated President Biden has announced extra measures to help curb the virus and hasten the roll out of the vaccine. I don’t feel the markets are all that concerned with the virus anymore. The vaccine is rolling out quickly in the USA & EU and seems effective and safe. There is light at the end of the tunnel. One would think the second half of 2021 would be back to some sort of normal if things continue to progress the way they are. Any lockdowns are brushed aside as it seems it will be met with more stimulus and just more pent-up demand.

2. US Election: President Biden has been sworn is and took control of the white house this week. Only a couple weeks before the Georgia run-off vote was held which did end up giving the Democrats control of the Senate. This gives the Dems an easier path to push legislation through now as they control both the house & senate. Biden has wasted no time in getting to work rolling back some of Trump’s executive orders and mandating a new covid action plan. Most notable of the roll backs was the Canada/US oil pipeline which he has revoked and no longer given permission. This sticks with their very green energy policy and promises they made in their campaign. This extra power the Biden administration now holds does represent a market risk moving forward which I will discuss later.

3. Reflation: With the Biden win in November + extra stimulus to flow through we have seen the re-emergence of the inflation trade. This is where yields on longer dated bonds have risen and money flow has been directed mainly into value-based stocks (utilities, energy, financials etc.) over growth (Tech, healthcare, retail, gold etc.) The simple basis of this is the recovery will be strong and thus bring about inflation and hence drive yields higher, which favor the fore mentioned value sectors over growth. This is as growth stocks tend to rely on debt to accelerate earnings and of course if yields are rising then debt is more expensive and hampers their growth. The consequence has been in the last few months have seen the outperformance of Value over Growth equities. I don’t believe this is a longer-term trend and more of a catch-up trade since value has lagged growth for so long.

Market Outlook

Rather than give you a technical breakdown of the XJO chart and my forecasts there, I thought I’d give you my top three market risks for 2021 along with my top 10 investment ideas as well. So, without further delay lets get stuck into it.

2021 Market Risks

Let me clarify in saying I don’t feel these risks necessarily will cause market crashes, but small possibility is still there. However, sizeable sell offs in the range of 20% are possible on the back of these.

1. Democratic Policy: I believe the Biden administration is the biggest threat we face this year, especially since they now have control of the house & senate. Biden has long been an advocate for higher corporate taxes and the redistribution of wealth. There is some talk they may in fact roll back the tax cuts Trump imposed. This of course is a negative for listed companies has it puts a drag on earnings as they are paying more tax. Of late Biden has only spoken of adjusting CGT taxation methods and has gone quiet on corporate tax rates, so hopefully this remains the status quo for a little while.

The next major policy risk is surrounding the tech sector. There is a big push by the Dems to start antitrust proceedings against some of the bigger tech companies (Google, Facebook, Amazon) and look to possibly break them up or at the very least force tougher regulations upon them. In March of 2000, the DOJ won an antitrust court case against Microsoft which was one of the catalysts for the Tech crash at the time. It saw the Nasdaq fall 8% on the day and eventually saw it bottom out with 76% of value lost in the index. Now I do not believe we will see a repeat of that but given the big tech’s concentration in the Nasdaq (around 50%) then it could cause a sizeable sell off in markets. I am talking around 20% or more. I think the actions of the big tech companies in the weeks leading up to Biden taking office was an indication that they are willing to play ball more. Their actions seemed to pander to the Dems a bit banning Trump off social media, Amazon offering its services to the Government to roll out the vaccine quicker etc. Thus, we could still see harsher regulations brought in, but no major breakup of companies is called for.

The above, and other democratic policy does represent the biggest risk to markets in 2021 in my view hence occupies the top spot.

2. Inflation/Rising Yields: This may give people a few chuckles and may give them concern to question my sanity, but I am of a belief that inflation & rising yields is a major risk for markets, especially in the second half of the year. We have lived for a decade or more in an environment with little to no inflation. It gave rise to negative rates and deflation in some industries. I feel in part tech disruption was a major player, but also over supplied and low-cost commodities caused the phenomena. However, I believe in 2021 this begins to change, and markets may start to factor this in.

We have seen since the start of the recovery commodity prices have surged rapidly with many hitting decade highs. From iron ore, copper, zinc, to now food prices are climbing fast. This means input prices for manufactured products will have to rise, which then must be passed onto the consumer. This is all before the EU/US and parts of Asia come out of lockdowns and place even more demand on the system. I liken it to the few years before the GFC whereby commodity prices rose substantially and forced prices up in most facets of our lives and our core inflation reached 4% (in Australia). This then forced central banks to lift cash rates, hitting 7%+ locally, before the ultimate bust and GFC event. Now I am a big believer of a commodity super cycle is just beginning thus to believe similar will happen again. Investment in extra capacity in commodity production has been low, due to low prices over the last 10 years, thus it will take some time before new supply comes online. This inflation will appear quicker then expected and test central banks resolve.

Central Banks have mandated they are happy for inflation to run hot for a while and keep rates at zero for the foreseeable future. Members of the Fed have stated they are happy to see inflation run over 2% for a year before they would consider lifting. Locally the RBA has stated they don’t see themselves lifting rates for 3 years. This is where I feel if they stick to their guns, they will see a disconnect between real yields and the official cash rate. We have already seen 10yr yields climb in the US from 0.50% to 1.15% in just a couple of months. Shorter term yields have not seen as steep a rise but are the place to watch. 10yr+ yield horizons are being shrugged off as they are too far out to factor into corporate earnings at this stage. However, if the 2/3yr yields start to move rapidly, or even 5 year, this may have to be factored into forecasts and thus impact earnings. As I said above this will lead to higher debt costs and a tougher environment to increase earnings. Don’t get me wrong, yields will remain exceptionally low when compared to history but if say the 3yr treasury yield were to move from 0.19% to 0.50% rapidly it could cause a sell off in equity markets. Don’t forget markets are being priced for growth with forward PEs around 25x on the S&P500 when their historical average is closer to 20 in the last 5 years. This could cause a downward revision here and hence a correction (approx. 20%).

3. China: This is a simple one and basically surrounds the same situation we have faced since 2018. Despite the Dems criticism of Trump and how he handled the China situation it seems nothing will change. Biden is set to be just as tough on China and there will be roll back on tariffs etc in the near term. Obviously if things were to boil over this could harm international trade and the global economy.

Closer to home tensions have escalated between Australia and China since Scott Morrison pointed fingers at China regarding their role in the pandemic and called for a full investigation. Since then, China have banned or limited imports of our coal, timber, lobster, wine etc. The impacts of these actions have been minimal, but if China were to start banning iron ore imports then it could have serious implications. Its very unlikely China would ever do this, but you can’t rule it out.

Given how much our economy relies on China than these heightened tensions between us will always remain a threat in the background. Even if the risk remains minimal.

2021 Top Investment Opportunities

Again, I want to set some parameters here. The below opportunities are in no particular order and do not mean they are to be entered straight away. As per usual the below should be considered General Advice only and does not take into consideration your personal financial circumstances, goals, or objectives. Please consult your financial advisor before making any decision regarding the below.

Harvey Norman (HVN $5.40): Australia’s largest furniture and homewares retailer has seen the benefits of the work from home era along with excess cash in households. It will also see the benefit of a housing construction boom that looks sets to take place as building & loan approvals soar to record levels. As people construct their new homes, they like to fill it with new furniture and historically HVN earnings have had a strong correlation with construction. Trading a lowly 12x forward earnings and 6.5% forecast yield I feel HVN is undervalued and will see the tailwinds from this construction boom + cashed up households for a couple of years.

Bluescope Steel (BSL $16.30): The constructor of steel and steel related productions have upgraded earnings three times in the last 6 months on the back of the US & Australian market surges. Locally they will obviously benefit from a housing construction boom as they are one of the largest suppliers of steel products such as roofing, fencing, water tanks etc. Their US division is also seeing earnings ramp up as they are experiencing similar conditions here. Again trading just a mere 11x forward earnings I believe we see their numbers outperform on the back of greater than expected demand.

Super Retail Group (SUL $11.84): These guys own Rebel Sport, BCF, Mac Pac and Super Cheap Auto. Similar to HVN will benefit from cashed up households + the re-opening of the economy. People have yet had the confidence to travel as at any time internal borders can shut leaving them out of pocket. With a vaccine comes no need to keep borders closed meaning Australian’s can travel domestically without fear again. Its also unlikely international borders will be open again in a meaningful way until 2022. Australians tend to spend a lot when travelling overseas so now that can be spent at home. This means more camping, outdoor trips, local tourism & maybe the 700k+ caravans and ‘Grey Nomads’ get on the move again. This means all brands under the SUL umbrella will benefit. Again trading cheaply at 12x forward earnings and a 5% forecast yield prices SUL cheaply compared to the market and peers.

Beach Petroleum (BPT $1.77): Australia’s cheapest oil & gas play versus peers trading at 10x forward earnings. Around half of their earnings come from domestic gas sales, which are in short supply and high demand. The rest is exported petroleum products, mainly into Asia. Again, as we open up more then there will be a increasing demand for oil & gas. BPT will benefit from this in a big way. Looks undervalued at current prices but we may see some initial weakness on the back of falling energy prices.

Appen (APX $23.02): Provider of artificial intelligence (AI) and machine learning (ML) services and products, mainly in the US. Companies provide them with data that they then annotate, catagorise, sort & improve so that they can be input back into machine learning models such as chat bots, virtual assistants, and e-commerce software. Have suffered in FY20, with a couple of earnings downgrades as tech companies in the US cut spending due to the pandemic and APX couldn’t get face-to-face meetings with customers to market their services/products. The stock has subsequently been sold off from $42 to just under $23. Consensus earnings are still expected to grow at 45% FY20 and 20% FY21. Trading at 33x FY21 forecast seems reasonably priced to me for a company in a niche sector, with a large moat around its business and little competition. APX also generate very high free cash flow with it being $50mill+ in 1H20 and no debt. APX remain my favourite tech stock on the ASX at this point.

Temple & Webster (TPW $11.96): Purely online furniture & homewares provider with a unique drop ship model. TPW hold no inventory themselves and instead all online orders go direct to the manufacturer to then ship out. This keeps operating costs flat and a unique difference to other online retailers such as Kogan (KGN). Like HVN, benefited from the work from home surge and should benefit from the housing construction boom. Saw a huge surge in sales in FY20 without a phone app for most of the year, thus most sales came straight from the website. Also have a unique AI function that will suggest products to buy when you go to check out. For example, you buy a lounge from them it may also suggest a rug, vase, side table etc. that suit the lounge and décor. This has seen customer spending increase since implementation. TPW also have no debt and high free cash flow generation. They also have a lot of cash on hand due to a raising completed earlier in the year.

Breville Group (BRG $30.18): The household appliances manufacturer is expanding globally at a rapid pace. It has about 25% penetration here in Australia and its aiming for the same in the US & EU. A brand that is highly regarded has a long runway with much growth to come. You pay a lofty price to enter these guys at 40x FY21 earnings forecasts, but you are also seeing approx. 30% growth in earnings. I feel in 5 years’ time these prices will seem real cheap based on the growth and penetration they can get in overseas markets.

Invocare Group (IVC $11.62): This is as much a re-opening play as an airline or travel group. IVC own the largest stake in the funeral homes market in Australia with close to 30%. The next biggest in the industry is less than 10%. It’s a highly fractured market, thus having such size is a real advantage. Funerals were restricted to 5-10 people throughout most of 2020 so large spending on funerals were well down. This will recover in 2021 and build into 2022. I feel by 2022 they can hit their FY19 EPS again of 55.8cps which puts them on a forward PE of 20x. Given the stability of their business and confidence in earnings pre-pandemic I feel this is a cheap price to pay. The death rate in Australia should climb back to normal levels this year + they are moving into pet funeral/cremation services. A sector that is growing at 8% pa itself.

Gold ($US1,851oz): This one is a general opportunity as there are many ways to gain exposure. It is also on the proviso that the USD continues to fall, and yields don’t get out of hand. If yield curves steepen too much, then I will be avoiding this space. My favorite exposure in the sector is a physically backed Gold ETF in QAU. The betashares ETF gets you exposure to the gold price, whilst hedging against the USD, which is important with a forecasted rising AUD. Major Gold producers I like in the space are EVN, NST & PRU. The first two are Australian based producers whilst the later is international. Low historical yields, increasing stimulus and a falling USD could produce the best environment for Gold to appreciate in 2021.

Resources: Again, this is a general one that comes with a caveat. I’m looking at exposure via the major miners so stocks like BHP RIO FMG OZL DRR MIN IGO ILU CIA LYC etc. However, since the sector has run really hot to end 2020 and start 2021, I am saying to hold off and wait for a decent 10-20% correction, which I think we will see in the coming weeks. Its no secret I am of the belief we are at the start of a major commodities super cycle which should last for years to come and the fore mentioned stocks will benefit from greatly. We still want to avoid paying too much for these stocks hence why I am suggesting waiting for a decent dip. I will make a special note about lithium and how it has been a hot sector again. I too believe this will correct in the near term and give us another opportunity to jump in. There is no need to rush as the market will give us another shot.

Finally, I just want to make a statement regarding the markets and the exuberance being shown. Many experts are saying the markets are in a bubble-like territory, whereby fundamentals have been too dislocated from price as many indexes hit fresh highs against current morbid economic backdrops. However, it all comes back to markets and how they price in earnings ahead of us rather than what we are being presented with today. I feel when we look back in 2 years’ time, we will discover markets were 100% right and that 2020/21 presented us with a massive investment opportunity. The recession we have just experienced is unlike any other and is not part of a normal economic cycle and thus we won’t see the same economic characteristics we did after the GFC.

This is not to say that some individual stocks or even sectors are not in bubbles, but overall, I feel we will find markets are in the right place moving forward. Looking at the XJO Morgan Stanley (MS) expect FY22 earnings to rise to 405 or 11% above consensus. This sits a mere 3% below the 410 FY22 forward estimates that were in place in Jan 20 before the pandemic. At current XJO index levels this means we are trading 16.5x FY22 earnings. This hardly looks expensive when you consider rates are at zero and we were trading close to 19x PE pre-pandemic. Its also remarkable that if earnings are to hit those 405-410 estimate in FY22, then it will be like there was no pandemic at all and it was more like an earnings pause.

It is my belief that the market is cum-upgrade and many forward-looking estimates for the XJO are lagging well behind, it is this catch up and upgrade cycle that will drive markets higher in 21/22. We have already started to see sectors such as retail & healthcare upgrade earnings well above consensus and expect many others to follow. MS have a forward target on the XJO of 7100 base case and 7700 bull case. I feel we will be closer to the 7700 target come the end of the year.

Will wrap up our first update for 2021 here as it is a lengthy one. Let’s hope 2021 brings some normalcy back to our lives as we finally push past this pandemic. I also hope you all enjoyed the festive period and any time you had off. Personally, I have a lot of mixed emotions now. Only this morning we dropped off our eldest son to Kindy for the first time. Whilst I am extremely excited for him to learn, make new friends and just have a wonderful time it also is sad seeing him grow up so fast and the fact he’s not the little boy he once was. It feels like only yesterday it was 2016 and I was writing to you all about his birth and holding this tiny baby in my arms. It also really tugged at the heart strings this morning when his younger brother exclaimed how much he was going to miss him a few minutes before we left to drop him off. I can’t wait until he gets home, and he can tell me all about his day.

I hope you all have wonderful week, whats left of it anyway, and keep safe. I will speak 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 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.