ASX Market Update 4th December 2020

ASX200 (XJO)

· The XJO started December with a gain of 0.50% or 33 points for the week. The high was 6,650.10 on Friday and our low was 6,511.40 on Tuesday.

· In November, the XJO was +9.96%, which is our best monthly performance since March 1988. It was the strongest November on record.

· On the back of the re-opening theme the Energy +28.4% & Financial +15.2% sectors were the best sectors for the month. (chart below)

· The AUDUSD was also strong +5.1% for the month.

Market Commentary

US

The DOW, S&P500 & NASDAQ all went to new all-time highs during November on the back of recovery hopes moving forward. We also had Biden win the US election, despite claims of a fraudulent voting process by Trump. Despite what the betting markets and poles suggested we didn’t have a ‘Blue Wave’ and a dominant democratic win. The Dems lost seats in the house whilst only gaining 1 or two in the senate. Thus, as it stands now, there will not be many changes except for the face in the white house as the Republicans still own the Senate. Why does this matter you ask? Well it means without bipartisan support Biden will be unable to get policy through, so this means it’s highly unlikely we see Trump’s tax cuts rolled back, massive renewable energy spending, attacks on big tech or harsher regulations on the oil sector. As well all know markets hate uncertainty so the fact the status quo remains is hugely beneficial for equity markets. What we do get from a Biden presidency is a much more stable Government with less volatility, more uniformity and better communication. We will also most likely see a better relationship with China, with a relaxing of trade sanctions but still a harsh stance on intellectual property violations.

It is my belief, as things stand now, the current scenario is the best outcome for equity markets over the longer term.

Despite the fact we will not get the instant sugar rush with a massive stimulus bill, but a more conservative one in the near year, we will see all the positives from above. Markets will love this and hence why we saw the rally we did in November.

Moving on the US is seeing a second wave in the virus really taking hold passing 200,000 cases diagnosed per day + an overwhelmed medical system. The death rate remains much lower than last time mainly due to a better understanding of the virus and better treatments. It is resulting in more partial lockdowns and fears of even higher case counts (300k+) as we experience family get togethers over Thanksgiving and Christmas. The good news is both Pfizer & Moderna announced highly effective and safe Covid vaccine results. It is thought these will be rolled out to high risk candidates and front-line workers as soon as the end of the year.

Economically the US is surprisingly robust with its housing market performing extremely well. We are seeing strength in manufacturing and services PMIs, albeit softer numbers this week. Retail spending also remains solid with massive growth in online spending being seen. The Fed is going to continue its QE program for some time, especially in the absence of stimulus from the Government. I can see some softness ahead as we enter the winter months, more lockdowns to curb the virus are pursued and there is less spending. This will be a mere momentary lapse as I would expect an extraordinarily strong 2021 for the US as the vaccine is rolled out, Fed support continues, and more stimulus is eventually dispersed. This is on top of already historically low rates, robust housing sector & large company cash holdings.

EU

I will be short and sharp with the EU. Like the US cases are on the rise again with Italy, Spain & the UK seeing exponential rise in figures. The stimulus package from the EU is yet to be dispersed and seems locked up in regulatory hurdles. Economic data is solid but again softening as the EU also experiencing lockdowns and just a general slowdown in activity. The good news is the vaccine is coming and the UK has announced it may start dispersing it as soon as next week. Again, I would expect further softness in economic data over the winter months but a solid recovery in 2021. A lower USD will help emerging markets in the EU like Turkey, Poland, Hungary and Russia keeping a cap on their debt repayments and volatility in their currency.

China/Asia

Much the same for China as it was when we last spoke. An extraordinarily strong V-shaped recovery with the Caixin PMI manufacturing index hitting decade highs only this week. The focus continues to be on infrastructure spending, whilst consumer spending recovers to levels seen before the pandemic. Import data further supports the strength of the Chinese recovery. We have seen analysts expect the Chinese economy to grow from 8-10% in 2021, with 2020 expected to be in the vicinity of +2%. This obviously bodes well for us and our recovery.

Australia

Our local recovery seems to be very solid as well. We have the virus under control despite a couple of small flare ups. Borders are opening and should all be fully open by Christmas. Economic activity is tracking well as best shown by our Q3 GDP figures released this week. Our economy grew by 3.3% in Q3, well ahead of the +2.5% forecasts, but is still -2.8% for the year and 4.2% below pre-pandemic levels. 2021/22 are supposed to be strong, forecast to grow at +5% & +4% respectively. Retail spending remains robust and above pre-pandemic levels. The September quarter saw +6% growth despite Victoria being in harsh lockdowns. The housing sector is picking up strongly with prices surging again, but more importantly are lead indicators for construction. Building approvals printed a 20 year seasonally adjusted high this week suggesting a robust pipeline of housing construction to come in 2021/22. Loan growth is also seeing solid numbers as regulations are relaxed and incentives rolled out.

The RBA cut rates to an all-time low of 0.10% whilst also rolling out $100bill of QE over the next 6 months targeting 5-10yr Government bonds. So why is this QE important? In quite simple terms the way it works is the Government will issue a set of bonds, which a group of large financial institutions will buy from them (big 4 banks, JP Morgan etc.). The RBA will then buy those bonds from the financial institutions in the secondary market. The RBA arent allowed to buy them directly from the Government as they must maintain their level of independence from them. So, the money the financial institutions receive for the bonds, at extremely low rates, are then used to put back into the economy as loans to business or people or invested into assets for a return. This is how it helps the economy grow as cheap debt is more freely accessible to the population, which helps stimulate spending etc.

Finally, the Federal and state Governments have disclosed their budgets, which have a slew of incentives in there to help stimulate the economy over the next 12 months.

Australia is an envious situation moving forward and we look like we will recovery well from this pandemic. This should lead to better earnings and thus higher share prices moving forward. Obviously, risks are still present (i.e. China trade relations) but remain on the lower end of the spectrum at this point. I would back the XJO to outperform global developed market peers over the next couple of years because of this.

Company News

Bluescope Steel (BSL)- Upgraded FY21 guidance for the second time within a few weeks now citing EBIT for 1H 21 to come in at $475mill, which is 25% higher than their last update. BSL are seeing above trend growth in most company sectors. It says it is being driven by housing renovations & construction in Australia, US housing construction & renovations and e-commerce warehouse growth. BSL is sitting on a forecast PE of 11 & 12x for FY 21 & 22 respectively which makes them look extremely cheap. I really like them as exposure to a robust housing sector both locally and in the US. BSL should add a solid growth component to your portfolio of the next couple of years.

Harvey Norman (HVN)- HVN updated the market with their Q1 results FY21. NPBT was +160% on the back of a 28% rise in total sales. Comparable sales also saw a 30% rise in the Q1 period. HVN has a strong correlation to the housing sector as when people construct or buy a new home, they want to also fill it with new furniture, white goods, and appliances. Again, this should benefit HVN over the next couple of years. HVN trades on a forward PE of just 10x FY21 and 13x FY22. I feel analysts are being too conservative with forecasts here and we will see a series of upgrades over the next 6-12 months. HVN also comes with an incredibly attractive forecast yield of 6.5%. HVN also has the benefit of owning most of the property its stores reside in thus has around $2.40 of property value built in. HVN should provide both capital growth and income over the next couple of years for investor. I like it at current levels.

Aristocrat Leisure (ALL)- ALL FY20 results were poor as expected suffering from falling revenue in their gaming machine division as casino’s closed during lockdowns. Its online division saw +29% growth vs the -32% for gaming. Revenue split is now roughly 50/50 between the two, but ALL has commented that 92% of all US casinos are now open again. Overall revenue was -5.9% and profit was -46.7% for the year. Looking forward the company gave no specific guidance but said it expected growth in 2021. Looking at consensus forecast FY21 should see EPS return to pre-covid levels. However, FY22 looks the most positive as it sees EPS growth of 44% and a forecast PE of 20x. Now that forward PE may not seem cheap but for a company like ALL, but it is. Management have been able to maintain a ROE of 30%+ over the last 5 years pre-covid. Also, over the last 10 years its only dropped below 20% once. The shift towards online gaming has been greatly beneficial with wider margins and faster growth. I like ALL as a longer-term growth stock as management has proven in the past it can get the job done and as they expand more into online services.

Technology One (TNE)- One of the most mature tech companies on the ASX announced their FY20 results last week as well. As expected, it was extremely positive as their business management & HR software remains extremely popular both here and overseas. Top line numbers saw a 13% lift in NPAT and revenue +12%. Their SaaS ARR saw 32% and they are aiming for it to be $200mill by 2026 (currently around $100mill). 86% of revenue remains recurring, which is a big shift from its model a few years ago which saw a lot more upfront fees charged over the current subscription model. Some of you own TNE and have done so for an awfully long time. Whilst the share price has been bullish, I feel it still undervalues the quality of this company by a big margin. I cannot iterate enough how highly I respect this company. They have seen 11 years straight of record profits with it doubling every 5 years. They carry no debt and $125mill of cash. Margins are around 29% but they aim to grow them to 35% over the next few years. Whilst a 35x forward PE does seem expensive it has been trading around that or higher for several years. I suppose you must pay premiums for high growth/quality stocks.

Commodities

Iron Ore

Iron Ore is about as hot as it gets now. The spot price has surged to 7-year highs due to a few factors. The first being that steel prices in China are surging again and hence so are margins. It seems steel mills are now passing on those input cost hikes to customers and they are happy to pay. Eventually this will come through as some sort of inflation in China. Keep an eye on PPI levels in the coming months. Port inventories are on the rise and above average, however they are still well below their peaks. It is not uncommon for inventories to spike in Q4 as China prepares for weather disruptions in Australia in Q1. An interesting fact I heard the other day regarding China’s steel production. China has produced 3mt of steel every day for the last 6 months. It took 52,000 ton of steel to build the Sydney Harbor Bridge. That’s on average 58 Sydney Harbor Bridges every day. Just an amazing stat. Steel production did slow slightly in October in nominal terms but was at record highs seasonally adjusted.

We saw iron ore prices spike overnight on the back of Vale investor day which showed lower than expected production numbers for 2020 and 21. Guidance has been lowered to 300-305mt FY20 (from 310-330mt) and 315-335mt in 2021. This is still 20% lower than their peak in 2018. Vale still have not recovered from the tailings dam disasters of 2019 and now has covid to deal with as well. Their aims for 400mt of production by the start of 2023 looks unlikely as well. This benefits us greatly of course.

Looking forward this insatiable demand for iron ore from China wont last forever but it looks good for the next 6-12 months. Most analysts are now lifting 12-month price forecasts to above $US100t. BHP RIO FMG will all benefit from this greatly in the short term and we may see record dividends being paid out in February. Looking at the smaller caps I still really like CIA despite their recent price appreciation. Will produce very high-grade iron ore in Canada and set to double production in the coming years. Trading at a mere 4x FY22 earnings at current prices. In the high-risk micro-cap space FEX & TI1 who are both near term producers will also benefit from the bullish sentiment in the sector. Also, you need to remember DRRthe iron ore royalties’ company who will benefit from higher prices and increased production from BHP’s south flank projects. They also don’t have to worry about the costs it takes to run a mine as they simply take royalties from out of the gate sales.

Having said this risks remain elevated whilst spot prices are so high. If inventories continue to rise, steel production slows in the winter months and margins start to fall again then we will see spot prices come off. It won’t be disastrous but a price around d $100t would be expected. Still massive margins for the producers. The sentiment is what will change and hence share prices will see declines. Enjoy the ride and be prepared to take some off the table if indicators turn. However, if China is to achieve 8-10% GDP growth in 2021 then infrastructure/construction will be a huge part of it, which means lots more steel is needed.

Gold

For much of 2020 Gold was the poster child and loved by all. Since its highs in August it’s been a tough slog for the precious metal. It bottomed a few days ago around the $1,770 level and has since seen a solid bounce back to $1,820. The reason Gold lost its allure is risk events significantly reduced, thus its status as a safe haven was lost. We have also seen some strength in the USD and long dated yields, plus no stimulus package, which really are a negative for Gold. However, I believe we may have seen the bottom for Gold and good times ahead again. Longer term we should see the USD fall hard due to the Fed’s continued QE and eventual stimulus in the new year. This means Gold again becomes attractive as the USD devalues and shorter-term yields remain close to zero. In 2021 we should also see real demand for gold reappear. Jewelry demand fell significantly during 2020 for obvious reasons, but this should return in 2021 as economies open again and recover.

My favourite exposure to gold remains physically backed ETFs, and the best, in my view, in that space is QAU. This is a Betashares physically back Gold ETF that is currency hedged, this is the important part. As the AUD is forecasted to go up in 2021 having exposure to the USD would eat into some of our returns. Hence if we invest into something that is currency hedged then it protects us against a falling USD and rising AUD. Of course, a rising AUD is not a forgone conclusion and it could fall, but at this stage it looks the most likely event.

Outside of QAU there are a couple of producers which seem good value at current prices and they are NST & EVN. Both local producers on relatively cheap forward PEs, low debt, high free cash flow with potential for production growth. Outside of those two PRU looks cheap based on forward production guidance but does carry the risk of being an overseas producer.

Oil

The best example of optimism surrounding a re-opening of economies and vaccine can be seen in the oil price. The chart above is Brent oil which I feel is a better example of global demand/supply as it represents where most oil is traded. We saw oil dip to around $37bl a few weeks ago but has since bounced sharply on the Biden win + vaccine news. Its currently sitting around recent highs of $48bl. The theory is as economies open again, more people will be using transport etc. and hence the demand for oil will rise. My thoughts are this conclusion is a little premature as we see the US/EU enter in lockdowns again. Only yesterday we saw the Mayor of Los Angeles issue a stay at home order and for any business that couldn’t have workers, work from home they needed to shut. Thus, for me we will enter another soft spot in oil demand as movement is restricted again and we also enter colder months in the northern hemisphere. Hence, I expect the price of oil to drop back into the low 40s in the coming months.

We also had a significant event overnight where OPEC+ finally came to an agreement regarding its production. They decided to lift production by 500,000lb per day starting in January. This was not expected as investors had thought they would delay any lift in production until March. I must admit technically the chart looks bullish for oil but would need to break above $50 to continue this run. Until then it remains in a holding pattern.

Over the medium term I am bullish oil and the energy sector on the ASX. It has been beaten down more than any other sector and not seen much recovery. Not to mention many of the listed energy plays on the ASX have large exposure to LNG and most people don’t realise the price of LNG in Asia has bounced back to 12 months highs. Thus, my favourite exposures to energy locally are BPT & STO. Both have large exposure to the domestic gas markets with large reserves, increasing production and low valuations. BPT especially is trading a mere 8-10x forward earnings here with a fantastic growth outlook. The other major I am happy with, but on a longer-term basis, is WPL. The have massive exposure to the Asian LNG market, but face shorter term issues selling off exposure to some projects plus delayed production increases etc. Over the longer term I would expect WPL to outperform though.

I wouldn’t be rushing into the energy market either. I would be looking at a small entry here just in case there is some upside to come in the short term, but looking late this year and early 2021 I feel thats when we see another pull back in oil and a chance to grab a larger stake.

Market Outlook

At this point of the year investors usually talk about a ‘Santa Rally’ as a wave of optimism washes over the market. Seven of the last ten Decembers have had a positive return with an average appreciation of 2.50%. However, the last two have been negative and I feel this December will be flat to negative as well. The main reason is our performance in November. We saw a 10% lift for November, our best month in 30+ years. I just feel the market is a bit toppy here and exhausted. Its struggling to find reasons to lift in the current environment. It will also be a case for major fund managers to close off books early due to the great performance they would have experienced in November. The books should be looking good at this stage.

Technically after our breakout from 6,200 its been a strong rise fueled by a Biden win and positive vaccine news. A lot of upside has been factored into the short term and I can see exhaustion in the charts plus highs in the Relative Strength Index we havent seen since February this year. A retest of 6,200 could be on the cards over the next couple of months as we drift into Christmas and then low liquidity over the holiday period.

Moving further forward there is a lot of talk about the Value over growth play being back in vogue and over the last few weeks it has. I feel these commentators are slightly premature and I’ll tell you why. I feel over the next few years the market will still favour growth over value and the reason being is low yields. Shorter term yields will be kept low for 2-3 years on a global basis. This favours a Growth strategy as Value requires rising yields to prosper. We will see some longer dated yields rise, as they have been, and as long that’s merited and based on improving economic conditions central banks won’t have a problem with it. However, most earnings forecasting is done on a 2-year basis and at this stage those yields remain close to zero. It won’t be until those yields can rise again that we start to see the reverse. Having said that I expect a very bullish period for equity markets over the next two years and as we all know a rising tide lifts all boats. Thus, whilst value stocks will underperform it won’t be terrible and they are still likely to do very well. This means I still favor Tech, Health Care, Retail, Gold, Emerging Markets, Resources & Energy over all other sectors for the next two years.

Just to summarise I feel we are in for a very bullish period in equities for the next couple of years at least. Accelerated earnings fueled by cheap debt, fiscal/monetary stimulus, better than expected recovery from the virus in Australia and a cash build up in Australian households. We will particularly benefit via a commodities super cycle, hence why I spent a big period of this newsletter on the space. I’m not going to make any bold predictions about index levels except to say Morgan Stanley expects FY21 earnings to rise by 25% here in Australia.

It was a mammoth newsletter this week but well worth it I feel. In 2021 I think I will tackle market updates on two fronts. On a weekly basis I will do short live streams (30mins), via my website, discussing the weekly events and taking your questions. These will be available for you to watch at any time afterwards. Then once a month I will do a larger newsletter, like today, with a more in-depth coverage. I just need to upgrade my website and buy a new webcam and lighting to make the experience more professional.

We are currently entering my favourite time of the year. I look forward to Christmas more with every year, especially having young kids to share it with. Some may have already seen, via my Ausbiz interviews, I have had the Christmas tree up for some time. The Christmas Elf has also made appearance this week as he arrived on December 1st. I now get woken up at 6am by the boys running in to tell me where they have found the Elf and what he has been doing. My wife and I always set him up the night before in different scenarios. For instance last night we built a Christmas tree out of some of their toys (connetix blocks) and sat him under it and the night before we staged a heap of their toys around him with an artic theme, like he had been playing with them. They get so excited by it and I love the joy something so simple brings them. For them, this time of year is all about the magic and wonder and I want to foster that and encourage it as much as I can whilst they are young.

Macro and company news dries up at this time of the year so I feel there wont be much to chat about in the weeks ahead. There will be at least one more market update though before Christmas where I might cover some of my favourite stocks for 2021. A quick note about my interviews on Ausbiz. I have been moved to their feature timeslot every second Tuesday at 10:10am EST (9:40am ACST). I will be back on next Tuesday 8th December. I hope you all have a wonderful weekend and week ahead. Please stay safe and look forward to talking with you all next time. 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.