Income Report / Income Note: Taking the opportunity to ‘tweak’ the Income Portfolio into current volatility (GMA, MTS, SGP, WBC, SIQ, WPL)

The ASX is trading higher leading into lunch time recouping around 50% of yesterday’s decline with technology stocks seeing most of the buying, the sector strongly outperforming, trading up 1.75%. Healthcare and the broader financials are also doing well today. On the flipside, a big downgrade from Treasury Wine Estates (TWE) sees that stock off more than 20% on the session  – we’ll provide an overview in this afternoons note.  

Overall, the ASX 200 is currently trading up +43 points / 0.62% at 7037.

ASX 200 Chart

The Income Portfolio saw negative performance during the week, falling -0.85% although almost all of the hit was taken from yesterday’s market sell off. The portfolio outperformed a weak ASX200 Accumulation index which traded down around 1% in the shortened trading week. The bulk of the weakness came from our commodity exposure with Rio Tinto the most punished stock, off 6.07%.  No distributions were paid in the week. Despite the pullback, the portfolio continues to track above the benchmarks, currently up +4.29% financial year to date, versus its absolute return benchmark of +2.81%. Since inception the portfolio is up +21.70% vs the benchmark of +13.73%.

Taking the opportunity to ‘tweak’ the Income Portfolio into current volatility

As we discussed in the morning note today, our shorter term preference for stocks is another leg lower which will provide the main catalyst for movement across our portfolios, however we’ve actioned one amendment today in the Income Portfolio ahead of the expected move. Today’s note will set out our current plans for this portfolio as the market evolves into February.

From an overall portfolio perspective, the income portfolio remains fairly defensively set weighted 48% towards equities & 52% towards more defensive Hybrids, Listed Income Securities & Cash. If the market follows our anticipated path into an early February trading low, we are likely to tweak this skew back in favour of equities. The natural position of the portfolio is a 60/40 split in favour of equities.  

Overall market valuations remain a point of contention. Expensive on historical metrics however the chart worth monitoring most closely details the equity risk premium, or in other words, the return being paid over above cash to hold equities. This has proven to be a better metric over time and highlights relationship between equities and interest rates / bond yields.  

Right now, an equity risk premium just below 5% is around about average. Prior to the GFC, equities were offering just a 2% premium over bonds while at the depth of the GFC, this metric was 10%.

Equity Risk Premium

Source: Shaw and Partners Research

1 Genworth (GMA) into Metcash (MTS)

Mortgage insurance business Genworth (GMA) has been a strong performer in the portfolio, although that wasn’t always the case. Our thesis around excess capital on their balance sheet leading to big dividends was tested a number of times however ultimately our thesis proved correct. We are sellers of GMA now for two key reasons. GMA is now trading above NTA when it traditionally trades at a discount to NTA, somewhere in the range of 60-80%. It’s also trading at its highest premium to the ASX in the past two years and often has hiccups during reporting. GMA reports FY19 results on the 5th February.

Technically the stock is neutral / bearish at current levels.

Genworth (GMA) Chart

As discussed last week, Metcash is the ugly duckling of the supermarket group, although it is a different sort of proposition to Woollies and Coles. Metcash services around 1600 independently owned supermarkets dominated by the IGA and Foodland brands. They also service liquor along with hardware through Mitre 10 and Home Timber & Hardware.

Trading on an Est P/E of just 11.8x although earnings are under pressure and expected to decline by low single digits out to FY22. The yield is more attractive at an estimated 5.22% fully franked with the obvious questions being, has the current valuation now priced in the projected earnings decline?

Technically, MTS looks good with decent risk / reward running stops below this month’s low of $2.46.  

We have added Metcash to the Income Portfolio with a 4% weighting

Metcash (MTS) Chart

2 Stockland (SGP) into Westpac (WBC)

Diversified property company Stockland (SGP) has been a reasonable addition to the income portfolio back in July of 19, however given our view around markets in the coming weeks, we are likely to sell the position into further strength. US and domestic bond yields look perfectly positioned to break lower which implies a flight to the safety of bonds, a phenomenon which a worsening of the China situation is likely to cause i.e. Short-term sell stocks and buy bonds. 

The real-estate sector is heavily exposed to interest rates, lower rates = positive, higher rates = negative. If bond yields test their lows, SGP should test its highs and at this point we would be a seller of the stock. NB Stockland do report on the 19th February.

MM will likely sell SGP into news highs

Stockland (SGP) Chart

On a sale of SGP, we’re likely to increase our equity weighting to Westpac, a position we already hold in the Income Portfolio. History tells us that buying back into headline induced weakness often yield s results.

Westpac (WBC) Chart

3 Other stocks on our radar

Embattled salary packing business Smartgroup (SIQ) has been on our radar for some time, however the stock is having some difficulty finding a point of support. We like the stock into current weakness and it remains on our radar.

Smartgroup Chart (SIQ)

Woodside (WPL) has a greater capex pipeline over the coming years and as a consequence, the dividend could be at risk. We are considering cutting Woodside into the next bounce.

Woodside (WPL) Chart

Conclusion (s)

We have switched from Genworth (GMA) into Metcash (MTS) today

We are looking to sell Stockland (SGP) into strength at the same time increasing Westpac

If the market does pullback back again, we will likely increase our equity weighting towards 60%

Have a great day!

James & the Market Matters Team


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