With the Australian Federal Election resolved and the coalition government surprising most pundits with a ‘come from behind’ victory, it seems very appropriate that we update investors with our current portfolio thoughts and any changes to long-standing views we have held.
In short, there is a lot to discuss and a lot to re-calibrate.
We were incredibly concerned that Australian retirement investors would be significantly impacted by the election of a Federal Labor Government and we have spent the better part of a year forewarning of the crowded exposures many investors had to domestic franked income.
Whilst we can undoubtedly breathe a sigh of relief now that threat has passed, our message remains the same – never be over-exposed to any one single event risk.
Diversity of portfolio risk and return is vital to ensure a healthy and functioning investment portfolio. This is why your portfolios were strategically positioned to reduce exposure to the impact of a change in government and the subsequent negative impact to certain assets.
The commentary below speaks to our willingness to consider a more positive view on Australian assets and an improving economic backdrop from 2020+.
There are a variety of potential portfolio implications to consider, however the timing of many of these potential changes is unresolved and hard to predict.
In the near-term we remain very concerned by the potential impact on global growth from the escalating tariffs, and for that reason, in spite of our willingness to look more favourably on the Australian investment opportunity-set, we retain a cautious ‘wait-and-see’ attitude to portfolios.
Liberal Coalition Government gives us reason to be more optimistic on Australian assets
For 5+ years we have held out concerns for the Australian domestic economy, the Australian Dollar and for the performance of Australian stock-market assets relative to those offshore.
In large part this has been the right call with the Australian Dollar having fallen from over 90c to be 70c currently, and US and global share-markets having materially outperformed the ASX200 in that time.
Where Australian shares have returned +7.70% per annum including dividends in the 5-years to the end of May, the U.S S&P500 has risen 13.9%% and the MSCI World Index +9.9% annually in Australian Dollars.
Whilst we certainly aren’t yet ready to turn more bullish on domestic Australian shares, we are of the view that the period of significant underperformance by Australian assets is largely done and we do see grounds for an improving local economy from early 2020.
Where we had thought the Australian Dollar might bottom out near 65c we now feel that it could be nearing a bottom now in the 68-70c level.
Whilst we see a pretty downbeat finish to 2019 courtesy of slowing construction work and regrettably, a softer employment outlook, the prospect of improving household incomes from tax cuts and the promise of more tax cuts in 2022 and 2024 leave Australia well placed for a stronger domestic economy in 2020 and beyond.
The RBA might cut rates again, but it would surprise me to see local cash rates below 1% given the improving outlook.
In fact, it is quite possible the RBA could be back raising local interest rates by Q3 2020.
Potential domestic portfolio implications from this shifting view are manifold
The portfolio implications from this shift in stance are many, but not all will be acted on immediately.
In fact, some might never be acted upon.
However, it is possible to begin contemplating the following in building portfolios:
- Out-performance of AUD exposed stocks such as those in the healthcare space might begin to end
- Out-performance of domestic infrastructure or hard asset stocks such as the REIT’s might also be nearing a peak
- Hedging AUD exposures to foreign equity fund exposures
- Reducing positions in Australian domestic government bonds as 10-year yields at 1.50% might prove to be cyclical low point
Let’s see where things land in the months ahead, but make no mistake, several long-standing themes surrounding the local economy and the Australian Dollar seem to be ending.
Potential Australian equity portfolio opportunities
For the first time since November 2018, when markets were under heavy pressure, we are feeling encouraged by the potential for opportunity in the Australian share-market.
We think much of the opportunity however lies in many of the unloved stocks, some of which we have already recommended and whose share price could well be under water.
On this front we say, ‘be patient’, and if appropriate, consider our view carefully if we suggest adding more.
If our view for the local currency and economy holds true in 2020, the best returns won’t be coming from highly valued healthcare and infrastructure names, but from cheap, heavily discounted future ‘growers’.
In the following few paragraphs, I would like to highlight a half dozen or more Australian equity scenarios that we are watching very closely in the weeks and months ahead – mostly positive, but one potential negative.
When the time is right we will notify clients directly of our thoughts and views in greater detail.
COSTA GROUP (CGC)
A fallen market darling, CGC has underperformed the ASX200 by ~55% year-to-date, however its long-term growth prospects are incredibly bright.
CGC have dramatically expanded their production capacity locally for avocado, blueberry, mushroom, tomato and citrus crop, and globally in China and Morocco in berries.
Buying this stock on near 15x 2020 earnings could prove a steal.
OIL SEARCH (OSH)
A long-standing portfolio holding, OSH has been buffeted by oil price volatility and worries over its involvement in the current PNG political scandal involving PNG government investment in the stock.
If the stock remains under $7 for long it will rapidly become an attractive takeover target for any number of oil majors seeking exposure to OSH’s suite of low-cost, long-life production.
MINERAL RESOURCES (MIN)
MIN are a diversified mining and contracting business who are currently developing the world’s largest hard-rock lithium deposit, Wodgina, and who will evolve over the coming 5 years as a world leader in the supply and processing of lithium for electric vehicles (EV).
The long-term story for lithium and MIN is a strong one and we think the opportunity is approaching during the 2H to gain deeply discounted exposure to a terrific secular theme.
BLD has been a recent recommendation and fortunately is +15% in the past 2 months since we flagged it.
However, for those of you yet to gain exposure, we think pullbacks under $5 could be interesting as the stock has heavily discounted the domestic construction slowdown and we think stands well placed to benefit from better demand in 2020 both here and in the U.S.
Regrettably, IFL is significantly underwater on our initial recommendation, having been one of several financial services firms taken to task by regulatory bodies during the recent Royal Commission.
In the coming 3-months we believe many uncertainties will resolve themselves for IFL, including the appointment of a new CEO, articulation of any exposure to remediation payments relating to so-called ‘fee for no service’ and resolution of the firms planned acquisition of ANZ’s wealth and advisory business.
Clear air on these issues should land by September, and assuming no great surprises, leaves the stock trading very cheaply and potentially with an under-geared balance sheet.
IFL could quickly become a target for takeover by private equity by Christmas depending on how the issues above are resolved.
DOW shares had been a standout performer up until last week, when news of a ‘potential’ and worst-case liability of<$100m was announced in relation to DOW’s development of a local wind-farm with German wind-turbine manufacturer Senvion.
The stock fell -15% and is now back near our original recommended entry price despite the potential risk being a mere 2% of the company’s value.
DOW remains a terrific portfolio holding and is again looking great value.
RELIANCE WORLDWIDE (RWC)
Like CGC above, RWC is a fallen market darling, but a company with an enviable track record of double-digit earnings growth over the past decade.
RWC manufacture various fittings for the plumbing industry globally and has had terrific success with its ‘push-to-connect’ Sharkbite fitting which allows connection of pipes without the need for soldering.
A recent profit warning from RWC now makes the stock look potentially attractive on a mid-teens type P/E valuation.
We are keeping a close eye on the shares.
This has undeniably been a near-term disappointment for us, with the shares down -40% since our initial recommendation in October last year.
Sadly, Australia’s east coast drought has lingered significantly longer than expected, leaving NUF’s indebted balance sheet under breaking pressure from unsold inventory.
It seems very apparent that NUF will indeed require a further equity injection, but we expect when it occurs it ought to prove a turning point for a stock we believe to be significantly under-earning against its mid-cycle potential.
NUF has issues, but there is material long-term value in the stock we think if they can resolve their ongoing balance sheet stress.
TLS shares are now at a 2-year high relative to the ASX200 and +40% above their lows seen around this time last year.
We think TLS shares are becoming more fully-valued and hence feel like the time is near to be reducing exposures to the stock.
At current levels, TLS is trading with a lowly 4%+ dividend yield and on around 16-17x core earnings in 2021, which is far less attractive than many other stocks in the market, and particularly those I have mentioned above.
This is a stock we could be reducing sooner than later.
Global tariff wars remain a headwind short-term
We have discussed our fears for the global economy over the impact of rising tariffs and this remains a very real, and significant, near-term risk.
One measure from the New York Federal Reserve now places the threat of U.S recession in the coming year at 30% and the highest possibility since the GFC.
The stakes are high and the outcome is incredibly difficult to predict.
For that reason, we retain our cautious outlook for risk assets in the near-term, but we are alive to the idea of ‘buying the dip’ on any prospective resolution to the current conflict.
We hope this provides you with some context on how we are thinking insofar as global investment markets, Australian equity portfolio’s and more broadly, our near-term desire for caution despite the potential for a more optimistic local viewpoint in 2020 and beyond.