Market Matters Report / Market Matters Weekend Report Sunday 10th June 2018

By Market Matters 10 June 18

Market Matters Weekend Report Sunday 10th June 2018

Market Matters Weekend Report Sunday 10th June 2018

As we head into the long weekend courtesy of the queen’s birthday the ASX200 managed a small gain of +0.9%, leaving it just 1.7% below a fresh decade high – it doesn’t necessarily feel that strong but it all depends on where you look! It was noticeably a quieter week on the stock level with only 7 stocks in the ASX200 ending the week +/- more than 5%, it was satisfying to see MM hold the largest winner while avoiding being amongst the losers list.

Winners – Origin Energy (ORG) +5.2%, A2 Milk (A2M) +9.9%, OZ Minerals (OZL) +6.2%, Xero Ltd (XRO) +7.6%.

Losers – AMP Ltd (AMP -5.5%, Ramsay Healthcare (RHC) -7.5% and Atlas Arteria (ALX) -5.3%.

With EOFY only a few weeks away one of the main questions we’ve been asking ourselves at MM is “if we were handed say $100k today what stocks would we buy and how much cash would we hold waiting for opportunities down the track”. This is a far simpler exercise from a psychological perspective than say considering what should we do with our position in Commonwealth Bank (CBA) which is sitting  -8% in the red.

While this a slightly tougher exercise than at similar times post the GFC simply because at MM we are short-term positive, but medium-term we anticipate a meaningful correction in 2018/9 it does help us sharpen the pencil on our holdings / plans moving forward. The clear objective is to identify how we should be looking to structure our portfolio today but with one eye firmly on our view for the future. Below are a few initial thoughts on some topical sectors / stocks from which to build a platform:

  1. Cash 50%.
  2. Banks 20% - looking to double position size into further weakness.
  3. Diversified Financials 0%, wait for further weakness to accumulate this out of favour “cheap” sector.
  4. Consumer Services – nothing just here.
  5. Energy 0% at current levels.
  6. A2 Milk 3% - as a start with the view of  doubling this .
  7. Healthcare 0% just here but we like Ramsay Healthcare (RHC) another ~5% lower. Plus a number of other names but all lower for now.
  8. Suncorp (SUN) 8% plus 5% QBE Insurance below $9 as an aggressive play for next financial year – we remain overweight insurance.
  9. Resources, nothing here but buyers into weakness – coincides with our plan to sell IGO, FMG and ORE into reasonable strength.
  10. Retail, Utilities, “yield play” and Real Estate no interest.
  11. Telco’s – Telstra 3% here and accumulate into further weakness – we can potentially average TLS below $2.70.
  12. IT / Software – nothing at current levels.

The clear takeout -  our cash level of 17% is lower than we would like here, we’ve fired too early in picking a low for the banks and Telstra plus our 10% exposure to the embattled financial services sector is too high at this moment in time.

However this reiterates our current “sell mode” message of recent weeks and subscribers should be prepared for a number of alerts as we look to increase our cash levels, but also rejig our portfolios over the coming weeks to better position for our future views. We did this to a degree in the income portfolio last week with the removal of Vicinity Centres (VCX) above $2.70 and the addition of Eclipx (ECX) and the proposed addition of IGL.

  • At MM we remain mildly bullish the ASX200 in the short-term, ideally targeting the 6250-area / around 3% higher.

I know a number of you may regard 50% of a portfolio in cash as excessive but just consider the following long list of Australian “blue chip / household names” who have already experienced~20% corrections at some point in 2018 alone i.e. just over 5-months:

  • A2 Milk (A2M) -33%, IOOF Holdings (IFL) -24%, CBA Bank (CBA) -17%, Challenger (CGF) -27%, Fortescue (FMG) -23%, Woodside (WPL) -18%, JB HIFI (JBH) -25%, Harvey Norman (HVN) -28%, Telstra (TLS) -28%, Ramsay Healthcare (RHC) -20%, Start Entertainment (SGR) -25% and Webjet (WEB) -19%.

These pullbacks have occurred in a steady market which is essentially unchanged for the calendar year and is only ~2% from a fresh decade high. Unlike a more traditional fund manager, we are not as concerned about underperformance, instead we have a higher focus on total return i.e not losing money. The important take out is don’t get caught up in “fear of missing out” as opportunities always come along and in all likelihood when we do have a decent correction they will be even more plentiful than over the last 5-months. Even the fabled FANG stocks have already endured major corrections in 2018 and they are now all challenging fresh all-time highs:

  • Facebook -23%, APPLE -17%, Google -18%, Amazon -16% and Netflix -19% - patience can clearly be a virtue.

NB The last time MM moved so aggressively into cash was in 2015, just prior to the 21% correction by the ASX200.

ASX200 Index Chart

In terms of the local index we maintain  to our view that the local market is looking for an important top in the coming months but ideally we will rally ~4% first – the only question we believe is how big a correction will markets experience.

Interestingly while lots of newsletters and pundits have been quoting the “May – June” negative seasonality statistics what is largely being ignored, it is what usually comes next that really counts i.e. over the last 10-years the local market has averaged a rally of 3.3% in July, by far the strongest month of the year, which usually wipes out a significant portion of any May-June decline, illustrating how selling weakness can often prove dangerous for investors – just ask those who moved to cash in 2016 or where stopped out of a lot of position in early February of this year.

ASX200 Accumulation Index Chart

1 The 2 potential degrees of correction MM is anticipating in 2018/9.

We’ve been talking about a +20% correction in global stocks for a decent period of time while remaining long equities but preparing for / trying to identify the “big turn”. However markets are constantly evolving and moving, just like an amoeba, hence if as investors we don’t remain flexible / open-minded to change, our performance will more than likely suffer accordingly.

Over the last few weeks a second option has emerged in our minds which we will outline today, the good news is that our initial strategy will be largely unchanged whichever proves accurate. We’ve deliberately used 3 charts to illustrate both scenarios, it will be fascinating to see which proves correct and as long as its profitable for MM and our subscribers!

1 A global correction of over 20%

Markets repeat themselves which makes total sense since they follow cyclical factors such as economics and “fear & greed”. Hence at MM we believe investors are naïve to ignore either fundamentals or technical indicators, they both exist & work so why ignore either? The following 3 charts tell a similar tale:

  1. The Russell 3000 – ideally will make fresh highs towards 1750 before correcting 500-points, or 28%.
  2. The US S&P500 – ideally will make fresh highs up towards 2900  before correcting 900-points, or 30%.
  3. The MSCI Global World Index - ideally will make fresh highs up towards 2300 before correcting ~600-points, or 26%.

These are almost doomsday numbers although they do only represent a pullback towards the lows of 2016, or a 0.382% correction of the whole advance from the post-GFC lows – a very standard correction for all markets, not just equities – Google the Fibonacci sequence for those who are interested.

US Russell 3000 Chart

US S&P500 Chart

MSCI Global World Index Chart

2 A global correction of ~15%

The second interpretation is primarily created by the more bullish NASDAQ and Russell 2000 indices but it does fit with the ASX200 over the last few years.

  1. The tech based NASDAQ – the market made fresh all-time highs last week but we can now see a period of consolidation similar to 2015-6, and another correction of 12-15% as we saw in January / February but longer in duration.
  2. The  small cap Russell 2000 – this has been a hot index in 2018 and we are now 50-50 whether the potential correction will be ~350 or 500-points in size – one close to 20% and one over 25%.
  3. The ASX200 – a rally towards 6200 followed by a correction back to major 5600 support area would be similar in magnitude to the pullback experienced in 2016.

US NASDAQ Chart

US Russell 2000 Chart

ASX200 Chart

Most importantly we don’t really mind how much markets do correct when it occurs as long as we are positioned correctly but all of the 6 long-term patterns evaluated above see little attraction for the bulls on a risk / reward basis at current levels.

For the record we know people will be asking where our “gut feel” sits and the answer is the deeper correction scenario – number 1.

2 Global banks look so different

As we all know Australian banks have endured a torrid few years with the recent Hayne royal commission arguably just another nail in the already sealed coffin e.g. Commonwealth Bank (CBA) fell 28% in 2015 / 16, the decline from the highs of 2017 is actually far less.

Global banks formed a decent bottom, like our own in 2016, however they have rallied almost unabated since with only the recent volatility hiccup in January / February slowing them down.

Fund managers have avoided local banks citing the lack of growth and potential bad debts from a property fall as prime reasons. The question is have they gone too far, we think probably yes but the downside momentum is strong and until confidence returns to our housing market they are unlikely to perform particularly well. However for investors holding the banks their dividends will compound over time.

Patience is required for now with Australian banks but we believe it will eventually be rewarded – sentiment feels as negative today as it was bullish in 2015.

Comparing global bank indices Chart

Technically CBA is threatening to decline another 10% over 2018/9 but we regard this as an opportunity, not reason to panic. CBA is currently trading on a Est valuation of 12.8x 2018 earnings while yielding 6.2% fully franked. Hence if the share price is 10% lower in ~14-months’ time the decline will basically be offset by dividends, while this is not exciting its not too scary either, especially as we are negative global equity markets over this time frame.

Commonwealth Bank (CBA) Chart

3 Will Europe eventually become the catalyst?

Europe feels like a basket case that’s being ignored, when BREXIT shocked the world global stocks fell hard but ironically as often is the case with news it basically became a low for the UK FTSE. The FTSE is now less than 3% below last month’s all-time high, while impressively sitting over 30% above its BREXIT low – another example of being in a position to buy panic usually pays dividends.

Conversely the German DAX is still ~8% below our ideal upside target, probably struggling as investors build in potential risks to the EU’s actual existence in years to come.

UK FTSE Chart

Remarkably the Italian 2-year bond yields were turned on the head recently surging the most in their history as political uncertainly escalated, but now they have a new Prime Minister whose promising to gradually reduce the country huge debt burden – good luck!

Although we believe that the EU is living on borrowed time it currently feels unlikely to be the catalyst that will undo the second longest equity bull market in history.

Italian 2-year bond yields Chart

4 Old v new age stocks.

New age stocks have dominated stock markets over the last 3-years, just look at our portfolio – the best position we currently hold is on-line business Webjet (WEB) which is showing a paper profit of over 30%. Over the last year we all know the performance of our Banks, Telcos and Financials has been poor but its not just the likes of Seek, REA Group and Carsales that have shot the lights out, the resources have soared and they certainly are “old fashioned” style stocks - BHP has outperformed all of the 3 mentioned IT names this financial year.

This brings us back to our favourite “remain open-minded” message when we consider the 2018/9 financial year – history tells us that Telstra (TLS) or QBE Insurance (QBE) might confound many and have a great year i.e. it’s not uncommon for a stock  that’s had an amazing year to struggle as the share price has got ahead of earnings, and of course vice versa.

At MM we acknowledge the FANG stocks are undoubtedly soaring but we can easily see at least one of them struggling significantly over the coming years – if they all arrive so quickly one can certainly be vanquished as fast when the next Mark Zuckerberg arrives in town.

As investors we must remain nimble and prepared to cut losses, probably quicker than we jump onboard winners – remember Nokia, Kodak, Blackberry and Blockbuster before you say it cannot happen. Individual stocks / sectors should all be judged on their own merits and investing in just new age tech may just be taking the easy psychological option as opposed to the best risk / reward opportunity.

NYSE FANG Index Chart

5 Energy stocks are out of sync with oil.

The energy sector has become extremely optimistic about its prospects and we still believe it’s a dangerous place to be invested at current prices.

The below chart illustrates how closely Origin Energy (ORG) has tracked the oil price over recent years, but not over the last few weeks – crude oil is sitting almost -10% below last month’s high but ORG is only -2.4% below its 2018 high.

  • We remain bearish the sector and believe the energy stocks will not be able to break away from the usual correlation with crude oil.

Origin Energy (ORG) v Crude Oil Chart

6 What’s tracking the $US now?

The $US has followed exactly what we expected from its February low but its dumped the usual correlation with commodities, resources or even gold.

Hence while we sit here watching the $US follow the MM roadmap, we ask ourselves can we use it to add value (alpha) in 2018.

The $US Index Chart

Interestingly in 2018 the ASX200 has loved a strong $US Index – we have an increasing number of stocks who have offshore earnings so it makes sense.

We believe the $US is fairly close to completing its current pullback before continuing its advance to fresh 2018 highs – a positive indicator for the ASX200.

The $US Index v ASX200 Chart

7 Lithium stocks volatility increases.

Lithium stocks have experienced a wild / uncomfortable ride recently with Orocobre (ORE) and Kidman Resources (KDR), our 2 sector picks, both tumbling last week.

News was a bit thin on the ground but we had Tesla saying they won’t need cobalt moving forward which may have scarred investors about the future risks to lithium plus Fortescue (FMG) made a play on Atlas Iron (AGO) which has lithium exposure - both are speculative thoughts however the market reactions in various stocks did seem to support the view.

At this stage we believe investors are simply taking some $$ off the table after the great gains this financial year but we are watching carefully.

Orocobre (ORE) Chart

Kidman Resources (KDR) Chart

Conclusion

Again no major changes following last week’s small rebound by stocks:

  • We remain net positive equities for the coming weeks (just) with a preference for one final high to complete the post GFC bull market advance.
  • We will continue to slowly increase our cash position and remain firmly wearing our “sellers hat”. 

“Shopping List”

  • None medium-term, we are wearing our sellers hat.

“Selling List”

  • General selling is / when the ASX200 challenges the 6250 area.
  • Webjet (WEB) above $13.
  • Independence Group (IGO), Fortescue Metals (FMG) and Orocobre (ORE), ideally into any reasonable strength.

Standout technical chart (s) of the week

CSL has been one of the standout stories of the ASX since the GFC and it still going! We took profit in this beauty too early but its does not mean we will be afraid to buy back in at higher levels – we’ve done it before and will do it again!

We believe CSL probably trades higher but the risk / reward has gone for now.

  • At this stage we are buyers of CSL into the next ~$25 correction – we had one in 2016 & 2017, why not 2018?

CSL Ltd (CSL) Chart

Trading Opportunities on our radar

Nanosonics (NAN) has not been one of our best stocks over recent years but we must not be scarred of history. It feels like a EOFY short squeezing is evolving before our eyes.

  • Buy Nanosonics below $3.10, targeting ~$3.75 with stops below $2.80 – ok risk / reward – but hard to get too excited.

Nanosonics (NAN) Chart

Our Holdings

Our positions as of Friday. All past activity can also be viewed on the website through this link

Weekend Chart Pack

The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking . Positions are updated each Friday.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 9/6/2018. 4.00PM.

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