Morning Report / Market Matters 2021 Outlook Report including our major forecasts for the year ahead (BHP, OZL, CBA, XRO, RIO, MND, VUK)

Happy 2021 to all of our subscribers, we really appreciate the support through what’s obviously been an extremely tough year for so many on both the humanitarian and financial perspective. At MM we are incredibly excited for the new year with 2 major factors putting a distinct spring in our step, after of course the prospect of the COVID-19 vaccine being rolled out over the coming months.

1 – As we will outline shortly bar the extreme volatility caused by the global pandemic early in 2020, MM was on point this time last year and we feel that our market finger remains firmly on the pulse in what looks set to be a great year ahead for active investors like ourselves.

2 – Also MM will be launching our significantly upgraded website in the coming month or so after what feels like an eternity of planning & development.  One of our driving goals is to continually improve the MM offering and we believe this will be a huge step forward providing a platform that will allow our subscribers to easily track our calls, understand our views, monitor our performance and follow stocks that interest them.

Since our last note on the 22nd December the ASX has been firm rallying 158pts/2.4% to again be testing recent highs, although while many other markets make new all-time highs, the ASX 200 remains 440pts/6% below our equivalent milestone. As we set below, we believe it’s only a matter of time before that milestone is breached.

S&P/ASX 200 Chart

Zip Co (Z1P) $5.54

Before getting onto today’s note, we’ve had a number of questions about the Z1P Share Purchase Plan (SPP) over the break which closes on Wednesday 13th January. This is a stock held in our Growth Portfolio with a 3% weighting. Shares are being offered at $5.34 and MM will participate in the SPP, although it is fairly marginal given the stock is only trading at a 3.6% premium to the raise price – we’d usually want something north of 5%.

Reviewing MM’s calls for 2020

While most investors know that the global pandemic produced the fastest market decline in history what’s being discussed with much less gusto is how global stocks are now enjoying their fastest rally in history. Through February / March global equities panicked down a scary 35% in aggressive fashion however in less than a year they’ve rallied almost 75% on a diet of unprecedented fiscal and monetary stimulus.

MSCI World Index Chart

There’s a trusted old saying that “if it not’s broken don’t fix it” and we will be applying this to the structure of today’s note which is very similar to our report penned this time last year. Let’s firstly review the calls we made at that time:

1 - Top 3 Macro Economic Drivers:

A – In currencies we called the $US to fall, the Pound as undervalued & the $A was set to rally: The year saw the $US fall -7% after spiking higher as the pandemic erupted, the Pound has rallied +4% after a choppy news driven year where politicians took longer than we anticipated to sort out BREXIT while the “Aussie” was the standout call rallying over +12% for the year and up an incredible +40% from its panic COVID low.

B – We called resources & inflation to rally: The virus and subsequent recession ensured our inflation call was off the mark as global inflation fell from +3.6% to 3% but the Resources Sector has soared. Local heavyweight, the old “Big Australian” BHP is up +20% even before we include some really healthy fully franked dividends – remember stocks usually lead and we believe inflation will pick up this year as the huge stimulus train drives economic recovery both locally and overseas.

BHP Group (BHP) Chart

C – We suggested bond yields were looking for a low: What a fascinating year with this call as the yield curve has steepened since March i.e. longer dated US 10-year bond yields have risen while the shorter dated 2-years remain suppressed as the Fed maintains the discount rate at an all-time low of 0.25% plus also adding unprecedented levels of economic stimulus / QE. We will look at the Australian equivalent later buts its even more pronounced.

Importantly a steepening yield curve historically implies a growing economy and potentially rising inflation looming on the horizon.

MM continues to believe that longer dated bond yields have found a very meaningful low.

US 2 & 10-year Bond Yield Chart

2 - Top 3 Sector Calls:

A – We called Materials / Resources Sector to make fresh multi-year highs: This one was right on the money with heavyweights BHP Group (BHP), RIO Tinto (RIO) and Fortescue Metals (FMG) all soaring to fresh all-time highs and significantly outperforming the market in the process.

B – US banks & yields to drag counterparts higher: This was off the money as the Bank Sector let us down thanks to recession fears however heavyweight Commonwealth Bank (CBA) has still outperformed the market by ~10% if we include attractive fully franked dividends. More recently (i.e. the last 3-months) the Australian banks have significantly outperformed as market participants embraced the economic / inflation recovery e.g. ANZ has rallied over 28%

C – We suggested to avoid yield sensitive sectors: Overall a mixed result but the classic “yield play” stocks such as the Transport & Utilities Sectors have struggled but in many cases, they are directly impacted by the COVID restrictions, so a bit too hard to call this one.

RBA Cash Rate Chart

3 - MM’s top 3 stock picks:

Over the last 12-months the MSCI World Index has rallied +14.5% while the local ASX200 has fallen over -2%, hence when you read the results below its easy to understand why we are extremely proud of last year’s 3 picks which has all stormed higher.

MM’s top 3 stock picks this time last year were:

A – OZ Minerals (OZL) was at $10.76, it closed on Friday at $21.02, a gain of more than +95%.

B – Sims Metal (SGM) was also at $11, it closed on Friday at $14.19, up almost +30%.

C - Tencent (700 HK) was at HKD390, it closed on Friday at HKD573, up +47%.

OZ Minerals (OZL) Chart

Moving into 2021 MM is assuming, which we all know is an extremely dangerous word, that the COVID vaccines will be rolled out in relatively orderly fashion and of course they work.

Our view remains that a number of major inflexion points ‘showed their hand’ in 2020 and will see the continuation of some of these significant trend changes, particularly in the 3 key areas of Currencies, Commodities & Interest Rates. Equities have powered their way higher since the COVID panic lows back in March and at MM we remain bullish equities through 2021 and probably into 2022 but volatility appears likely to remain elevated in both directions. Our core view towards stocks in general can be summed up below:

1 – We believe the bull market which began back in 2009 following the GFC has further to run and 2021 could well be one of those rare pockets where the stars align for equities, and we see an aggressive move on the upside, a typical phenonium in maturing bull markets.

2 – If we are correct and this is the last chapter for the bulls, which has seen the S&P500 rally almost 5-fold in 11-years, volatility should continue to increase as warning signs get erected but we remain buyers of descent pullbacks at this stage.

3 – Again if we are correct this last leg higher for stocks should be characterized by increasing stock, sector and index selectivity – an exciting time for active investors.

I sat down with Livewire Markets at the end of 2020 and discussed MM’s Outlook for the year ahead in a short video.

Today’s note will firstly look at the macroeconomic back drop which MM believes will drive financial markets and equities. Next, we will move onto the sectors which MM wants to be over / underweight during the year and lastly our 3 top stock calls for the next 12-months - I’m pretty apprehensive after enjoying an average 57% return on last Januarys picks!

US S&P500 Index Chart

1 MM’s Top 3 Macro Economic Drivers for 2021

The following 3 points should shed the most light / reasoning on what MM envisages unfolding through 2021 and into 2022.

1 – The “Free money” should remain for at least 2021.

The Reserve Bank of Australia (RBA) has pledged to keep interest rates lower for longer in an effort to aggressively kick start our economy post the virus, their rhetoric should leave investors with no doubt to their intentions, in essence it’s clear the RBA is committed to do whatever it can with the tools at its disposal to support the recovery of the Australian economy. Its our opinion that while the RBA / government focus on unemployment they will again let the inflation gene out of the bag but that’s probably not an issue until next year.

The chart below illustrates that investors indeed remain confident that the RBA will maintain interest rates around zero for the next few years i.e. the 3-year bond yield continues to hug the RBA’s 0.1% cash rate hence why hold cash!

Australian 3-year Bond Yield v RBA Rate Chart

Markets usually repeat themselves and history tells us that investors rarely learn their lesson. We only have to look at the performance of 3 hot stocks just 12-months ago to remind ourselves that the elastic band of both optimism and pessimism regularly stretches way too far i.e. a2 Milk (A2M) -24%, Cochlear (COH) -19% and Altium (ALU) -12%. As we constantly repeat at MM remain open-minded, even the best stocks only have a certain value and vice versa.

The market currently believes we will have free money for at least 3-years hence a blow-off in risk assets feels highly likely, looking at the chart of the NASDAQ below and considering that Bitcoin is up ~400% in less than 4-months its not unreasonable to assume it’s already well and truly underway. A couple of calls from the stalls – through 2021 pullbacks of both 10% and 20% by global equities feels a strong possibility, at this stage for the NASDAQ that’s only back to the levels of last July, hardly a dent in the vertical ascent shown below.

MM remains bullish equities but we believe the volatility is likely to increase as assets rally.

US NASDAQ 100 Index Chart

Historically inflation kills bull markets hence until we see any meaningful inflation and / or central banks turning hawkish, there is no reason to be worried about this bull market, hence any decent correction should still be a decent buying opportunity.  We think that future pullbacks are most likely to be caused by market concerns the Fed, RBA et al will be reassessing their stimulative stances as financial markets continue to enjoy the sugar hit of mass liquidity injections, simply whenever required – one day it won’t be forthcoming and some degree of 2nd guessing is likely to spook investors as it did back in late 2018.

We think there’s a high risk that central banks will start feeling uncomfortable about the momentum in asset prices, it felt like they largely pumped money into the financial system to stop assets like housing prices falling into the abyss during the early stages of the pandemic, but they may have gone too far and prices have actually rallied. A remote change in rhetoric could create a classic “Taper Tantrum”, guessing when such pullbacks is likely to unfold is akin to tossing a coin – we’ll wait an let the market guide us on this one.

Obviously apart from bond yields we will continue to have policy decisions out of the US & China impacting stock valuations but it’s the former MM believes will primarily drive prices through 2021/22.

US S&P500 Growth Index Chart

Any doubters that inflation is percolating below the surface of the global economy should simply look at the CRB Index’s rally in 2020, its poised to make fresh 5-year highs. The last time commodities were at these levels the RBA Cash Rate was at 2.5% significantly higher than today’s 0.1%.

CRB Index Chart

2 - The yield curve will continue to steepen – for now.

As we said previously the RBA has pledged to keep interest rates lower for longer in an effort to aggressively kick start our economy post the virus, their rhetoric should leave investors with no doubt to their intentions – like the government nobody wants to be caught on watch when Australia does eventually endure a meaningful and prolonged economic downturn.

Hence, we believe Australian 3-year bond yields will remain fixed down around 0.1% while we believe the 10-years are slowly but surely headed back towards 2.5%. At some stage when the market starts believing the local economic strength we will see rate hikes being priced into markets, we should always remember equities generally trade 6-12 months ahead of economic fundamentals.

Australian 3 & 10-year Bond Yields Chart

3 – The Australian Dollar $A to remain firm.

MM has been bullish the $A targeting ~80c for over a year, it’s basically arriving now and a period of consolidation would not surprise but on balance we remain positive feeling the surprises will remain to the upside although the “easy” money is probably behind us at least for a few months.

Hence through 2021 we will remain very cautious when investing in companies with a large percentage of their earnings from overseas.

The Australian Dollar Chart

2 - Top 3 Sector Calls for 2021

Following on from our macro views our sector preferences should contain no great surprises, through 2020 we’ve already started to skew our portfolios towards these themes. Until further notice we see no reason to change our adopted stance, while we remain bullish equities, from a risk / reward perspective as the yield curve steepens, we prefer to be overweight the previously out of favour Value Stocks.

US S&P500 Value v Growth Indices Chart

1 – The Materials / Resources Sector looks awesome.

There’s no need for any in depth explanations here we believe the Resources Sector will make fresh all-time highs in 2021 and our preference is the likes of BHP & RIO are already accelerating to the upside, we wouldn’t be vaguely surprised to see another 10% upside in the coming weeks i.e.be long and stay long until further notice.

MM remains bullish the Resources / Materials Index in 2021.

ASX200 Materials Index Chart

2 – Banks should maintain their recent strength.

Commonwealth Bank (CBA) led the Australian Banking sector in 2020 which included a 26% advance over the last 3-months as the “Value Trade” gathered momentum. We can envisage a test of $100 in 2021 but as the chart below illustrates pullbacks are commonplace, even since the sector / market bottomed in March. With Australia’s leading bank expected to trade ex-dividend $1.40 this time next month a squeeze higher feels likely, if you buy today the anticipated yield over the next 13-months is ~5% fully franked making it unlikely many investors who can utilise the franking credits will be sellers into February.

MM remains bullish banks from current levels

Commonwealth Bank (CBA) Chart

3 – Be selective with the Growth Sector.

At MM we remain bullish stocks but in 2020 57% of the IT Sector closed lower although of course stellar performances from the likes of Xero (XRO) and Afterpay (APT) enjoyed most of the headlines. Even during its ~50% rally in 2020 XRO has pulled back -13.5% and -11.3% illustrating perfectly the rising volatility across our market. If / when we see a sharp rally to fresh all-time highs MM will be watching XRO for signs of failure, it might give us a indicator for the first pullback for stocks in what we believe will be a volatile year.

In general MM is a seller of strength and buyer of weakness in the IT and Healthcare stocks as opposed to the Resources where we have no interest in losing our core long position. 

Xero Ltd (XRO) Chart

3 - MM’s top 3 stock picks for 2021

After last year’s success I am starting this weeks selection with a cautionary note that I doubt if we can average well over 50% from todays 3 but lets give it a go. We’ve pulled out three stocks from three sectors we are bullish on for the year ahead, however we must stress that actively managing a portfolio of stocks consistently over time is the real key to generating strong returns in the market, picking three stocks and betting the house on them is not the way to go. But alas, here goes!  

1 – RIO Tinto (RIO) $124.01

No surprise that one of our choices is a large, diversified miner which we hold in our Income Portfolio however there may easily be a place for it at some stage in our Growth Portfolio. RIO looks great benefitting from rising commodity prices as central banks stimulate their economies while it also yields 3.5% fully franked, a perfect candidate for a squeeze higher.

MM is bullish RIO initially looking for ~20% upside.

NB We could easily have had BHP Group (BHP) in this position, which is a large overweight position in our Growth, Income & International Equities Portfolios.

RIO Tinto (RIO) Chart

2 – Monadelphous (MND) $14.13

As commodity & energy prices rise, new mine development will be incentivised after a period of underdevelopment in many areas. Overlay that with the fast tracking of large-scale infrastructure projects to support the economic rebound post COVID and the service providers into these areas are in a sweet spot. While MND has rallied from recent lows, we expect further upside for this leading engineering & industrial services provider.  

MM is bullish MND initially looking for  ~25% upside.

NB The higher risk / reward alternative here is NRW Holdings (NWH).

Monadelphous (MND) Chart

3 – Virgin UK (VUK)

A steepening yield curve as discussed above is bullish for banks given they borrow short and lend long benefitting from the differential. As the UK remains in the gips of COVID, Virgin has suffered as a consequence and the share price has struggled.  While a low-quality operator, it’s priced accordingly and has significant upside potential on an economic recovery in the UK, a move into ‘perceived value’ stocks and a degree of catch up to other banks.

MM is bullish VUK targeting $4

Virgin UK (VUK) Chart

Conclusion

2021 is setting up to be a big year in markets providing the perfect backdrop for the Active Investor, 3 major takeout’s:

1 – MM remains very bullish equities through 2021 but we believe the 11-year old bull market is maturing fast hence volatility will be high through the year.

2 – Hence we still believe decent pullbacks can be bought but blowoffs in stocks / sectors should be considered as profit taking opportunities.

3 – Our favourite investment space for 2021 is the Resources Sector.

MM will continue to remain relatively active in our portfolios, increasing cash when prudent while we also expect to have some ‘short exposure’ at times throughout the year given the increasing maturity of this bull market.  We hope you found our thoughts and predictions thought provoking for the year ahead. As always, we’ll continue to pen our daily notes to subscribers, manage our portfolios of shares and importantly, present our views in the usual straight talking Market Matters way. 

Here's to a cracking 2021 for us all!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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