Morning Report / The IT sector led us up but its having a mixed time at present (CBA, WBC, AAPL US, XRO, ALU, APX)

The ASX200 enjoyed another strong day rallying almost +0.5% with heavyweight Commonwealth Bank (CBA) contributing over 60% of the days 33-point gain, CBA’s rally was not surprising following an excellent result which allowed MM to follow our previously well flagged plan to take profits in Australis largest bank while reducing our market exposure in the process – more on this later. With only 53% of the ASX200 closing up on the day it was an interesting session which reminded me of a line in yesterday’s note with regard to US stocks:

“These marginal new highs in the indices like the S&P500 and NASDAQ are selective and mega cap driven, whereas the overall market momentum is waning which is not a good sign for the bulls from a risk / reward perspective.” – Wednesdays MM Am Report.

No change to the MM viewpoint: we believe that 2020 will continue to be a choppy year as waves of optimism and pessimism wash through stocks, our view is still that the ASX200 will make fresh all-time highs up towards 7200 before enduring another ~5% correction i.e. only another 1.5% upside if we re correct before the market will feel like a sell from a risk / reward basis.

At MM we attempt to add value (alpha) to portfolios through both stock / sector selection and overall market weighting, remember when global equities panicked on Monday 3rd February because of the coronavirus MM went limit long stocks, reducing our cash levels down to only 1%. Our target has always been to sell into strength up towards 7200 and yesterday’s sale was the first step in this plan – as we often quote “plan your trade & trade your plan”.

MM is looking to increase cash levels into current strength putting us in “sell mode”.

Overnight US stocks rallied to fresh all-time highs with the Dow up 275-points, sentiment was buoyed by the reduced rate of growth in the coronavirus and China making noises about getting many regions back to work, plus saying they’ll meet their economic targets (implies decent stimulus on the way). The SPI futures are pointing an open up around +0.5%, within a few points of last month’s all-time high.

Today we’ve again looked at the IT Sector which has been a major outperformer since Q4 of 2018 but whose momentum feels like it might be waning.

ASX200 Chart

US equities continue to trade around their all-time highs with the S&P500 closing up by 0.65%,  our preferred scenario is the S&P500 will now rotate between 3200 and 3400, or in simple terms it’s time for a rest following great gains since mid-2019 – in terms of adding alpha / value we feel investors should continue to focus on selling strength and buying weakness when they tweak portfolios, a classic saying but not always an easy one to execute.

MM is now neutral US stocks while they make fresh all-time highs.

US S&P500 Index Chart

Yesterday MM did the unthinkable to many Australian investors and took profit on our CBA position, my guess is one of our less popular MM alerts although I would remind subscribers that our purchase back in August received a reasonable amount of derision at the time. Our thought process is as below:

1 – While we firmly believe CBA is the best bank, a fact that was further shown at 8am this morning when we had the CFO Alan Docherty in to discuss yesterday’s results, our view in the shorter term is that CBA has now rallied too hard  compared to the likes of Westpac and NAB e.g. over the last 3-months CBA is up over +10% while Westpac (WBC) has fallen almost -10%. CBA is now trading on an Est P/E for 2020 of 18.1x while it yields 4.9% conversely WBC is trading on a P/E of 14.6x and its yield is a whopping 6.3% i.e. there’s now a huge amount of outperformance already  baked into the CBA cake.

2 – MM is looking for a decent swing high by stocks in the next 1-2% hence an ideal time to take our  $$ from CBA with a view to increasing our exposure to the Banking Sector probably via other members of the  “Big 4” into a pullback.

MM feels the CBA – Westpac elastic band has stretched too far.

Commonwealth Bank (CBA) v Westpac (WBC) Chart

At MM we’ve been using Apple Inc. to fine tune our target for US stocks, our forecasted area where we feel Apple will become in danger of  another correction from a risk / reward basis is now only 2% away,  interestingly is very similar to how much fuel we see left in the ASX’s tank. We are a fan of the company and  hold it in our Overseas Portfolio, a position we have  no intention of selling, but over the last 18-months APPL’s corrected 32%, 21%, 13% and 7.8% respectively illustrating perfectly that optimum entry can add significant value to a portfolio – MM believes on balance investors will get a better opportunity to enter / increase exposure to this quality company.

MM’s will become short-term neutral Apple ~2% higher.

Apple Inc. is now the world’s largest listed company with a market cap. of over $US1.4 trillion making it an obvious candidate to use as a roadmap indicator for indexes. 

Apple Inc (AAPL US) Chart

Is the IT sector raising a red warning flag?

On Tuesday’s report in the opening paragraph I wrote: “Elsewhere we saw gold stocks rally strongly while the IT sector was the worst on ground, I cannot remember many days like that over recent years”. Admittedly on Wednesday we saw the IT stocks again return to the outperformance corner but yesterday, on a strong day for the index, we saw these previous market leaders again one of the weakest on ground when noticeably more sectors were actually down than up.

As subscribers know MM is looking for a potential “swing high” in the coming days / weeks and a sector which has previously led the advance over recent months stalling / underperforming would support this view. However it’s also important that we don’t find ourselves guilty of forcing or curve fitting our opinion onto markets and the underlying Australian IT Sector has generated zero sell signals. 

The ASX200 Software & Services Index is giving away no clues, it remains in a clear bullish uptrend.

Today we will look at 3 influential stocks in the sector for further clues and ideas while also considering a global perspective on the same theme.

ASX200 Software & Services Index Chart

The chart below illustrates the explosive US Tech Sector which like our own has outperformed admirably since its panic sell-off in late 2018 on valuation concerns. While bond yields remain low the factors which worried investors just over a year ago have become dormant for now and we believe they will remain so until interest rates start to nudge higher – something we see in 2020 / 2021 but it’s not happening yet i.e. investors can justify ever increasing valuations for risk assets when $$ in the bank basically generates zero return but when the safe alternative becomes more attractive the dynamic changes very fast.

In line with our “choppy 2020” outlook and technical picture for Apple we see the NASDAQ rotating between 9000 and 9750 over coming weeks making the risk / reward fairly unattractive at current levels.

US NASDAQ Index Chart

It’s been a while since we considered if the Value Sector was poised to take over the mantle from Growth as best performer in the US and global market – it’s fairly clear whose been winning in 2020. Below are our updated thoughts around these indices and their relationship:

1 – We remain bullish growth stocks but like our view on the underlying market we feel it’s also an index to sell strength and buy weakness in 2020, current target is ~3% higher.

2 – We feel the value Index will catch up on the relative performance through 2020 and especially when / if bond yields edge higher.

US S&P500 Value and Growth Indices Chart

Lastly I have looked at 3 prominent players in the sector for potential clues and opportunities moving forward.

1 Xero (XRO) $87.40

Markets have a habit of reminding us that all great companies have a fair value and if / when they run too far quality will be forgotten for at least a while. On-line accounting business XRO has more than doubled since late 2018 and although it’s a great company we aren’t keen around $90 especially from a risk / reward perspective, at least a 10% correction is needed before we would consider it.

MM would be keen on XRO around $80.

Xero (XRO) Chart

2 Altium (ALU) $41.21

The ALU picture is very similar to MM, the picture is clearly bullish but a little stretched. This is another business we like which has run harder than we anticipated but again from a risk / reward perspective we cannot be buyers – a 5% correction is our initial preferred scenario.

MM is neutral ALU at current levels.

Altium (ALU) Chart

3 Appen Ltd  (APX) $27.05

This machine learning and artificial intelligence (AI) business is our favourite out of todays 3 at current prices. We like this company on a number of levels including they have cash on hand  to fund anticipated 30% pa growth, its exposure to China where  it generates  ~5% of revenue is probably surpressing its share price but as worries around the coronavirus dissipate this is becoming one stock in our buy headlights.

MM is neutral / bullish APX.

Appen Ltd (APX) Chart

Conclusion (s)

On balance MM feels the Australian IT stocks are positioned for a likely pullback after recent strong gains i.e. buy weakness not strength! However of the 3 stocks looked at today Appen (AX) is our favourite at current prices.

Overnight Market Matters Wrap 

  • The US equity markets reached fresh record highs as investors concerns of the coronavirus dissipated further and focus turned back on strong US earnings season.
  • 70% of US companies have reported, with over 71% beating expectations in their latest quarterly earnings results, according to FactSet.
  • BHP is expected to join the fun today after ending its US session up an equivalent of 1.20% from Australia’s previous close.
  • The March SPI Futures is indicating the ASX 200 will open 42 points higher, towards the 7130 level this morning. 

Have a great day!

James & the Market Matters Team


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