From Jonathan Bayes, Investment Consultant, Bentleys Wealth Advisors.
The selling across Asia continued this week, placing further doubts over the global economic outlook.
The US has been closed for most of this week and hence been untroubled by the weakness. Australia too has similarly displayed little concern from the deteriorating environment across north Asian share-markets, and again remains at ‘decade-plus’ highs.
As I mentioned last week, Australia has been a net beneficiary of foreign buying in recent weeks on the basis it is considered a ‘safe haven’ within the region.
This buying will soon pass however, and the opportunity to take our advice and trim equity portfolios should be followed.
REITERATE A DEFENSIVE PORTFOLIO POSITION – HOLD MORE CASH
We made a very clear decision in March 2018 to up sticks and REDUCE our global and local equity portfolio weights and to raise cash and defensive holdings. Whilst US share-markets are largely flat in that time, the weaker Australian dollar has helped international holdings rise by around +4%, in line with the rise in Australian shares since then too.
We have no concerns whatsoever in leaving these modest gains on the table, since our concerns relate to the potential for greater loss in the months to come.
At the time, we wrote in our note that we weren’t yet ready to call time on the economic cycle, but that issues relating to uncertain Chinese economic growth, trade wars, possible inflation surprises and the ever-diminishing pool of global liquidity were beginning to escalate and that the risk adjusted returns of being fully-invested in growth assets were beginning to deteriorate.
We feel more convinced of this view than ever, and would strongly encourage investors to hold just a little more cash through the Australian winter than they otherwise might have.
To repeat, our recommended asset allocations are to be OVERWEIGHT CASH and UNDERWEIGHT GROWTH ASSETS.
AUSTRALIAN EQUITY VALUATIONS LOOK VERY FULL
Risk-adjusted Australian equity returns are becoming harder to justify en masse, and this point was articulated well by Credit Suisse research this week, in which the broker highlighted that Industrial company valuations excluding the Bank sector had risen to be almost 3 standard deviations above the mean. To put this in laymen’s terms, the research suggests that current valuations have only occurred on less than <2% of all occasions in the past two decades.
This would be ok if their observations suggested the rate of earnings growth was at similarly pacey levels, but it isn’t. It’s around the average, and this simply means Industrial shares look very, very fully-valued in an historical context and within the scope of some pretty pedestrian growth.
The forward earnings multiple for Industrials ex-Banks of 20.6x is the highest in two decades.
This analysis can’t be overplayed, and it demonstrates that Australian equity markets have indeed had an incredibly strong bull-market in recent years, but that headline ASX200 returns have been maligned or overshadowed by the obvious weakness in major banks and Telstra (TLS).
Also notable in the analysis were Australian healthcare stocks, one of the best performing sectors over the past 2 years. The sector now has valuations some 3 standard deviations above the 20-year average, meaning valuations are at levels seen less than 1 in 100 times over the past 20 years.
Popular stocks such as CSL, Cochlear (COH) and RESMED (RMD) are all at risk of profit-taking, and could easily fall -20% each without the need for negative news-flow. The stocks are extremely fully valued.
EQUITY PORTFOLIO CHANGES
In keeping with our comments above, we continue to take partial profits on core positions as markets grind higher.
We have trimmed Oil Search (OSH) and Origin (ORG), but retain core holdings. We did the same with Afterpay (APT) recently, but still hold a core position.
Whilst we exited our Woolworths (WOW) position several months ago near $28, the stock has powered on through $30 and this week reached a 3-year high after it announced a new deal to consolidate its petrol stations/convenience store business with Caltex (CTX). The news is actually neither here nor there, but I raise the share price because for those of you still holding on, this move through $30 is an incredibly opportune time to be REDUCING/SELLING/TAKING PROFIT in Woolworths (WOW).
The stock now trades over 21x 2019 earnings which is a 10-year high, and hardly justifiable to my mind.
We recently initiated a BUY on Magellan Financial (MFG) and think the remaining WOW shareholders should SELL their positions here and use the funds for MFG.
MFG is on 14.5x 2019 earnings, but excluding cash and investments, the core earnings multiple is actually nearer to 13.5x, which would be a record low valuation point. More importantly for income-focused investors, MFG offers a 5.4% fully-franked dividend yield, well in advance of WOW at 3.1% now and Wesfarmers (WES) at 4.5%.
Both WOW and WES are unattractive investments at current levels, and MFG, alongside past recommendation Pendal Group (PDL), look far more interesting as an equity holding looking forward.
PDL, like MFG, has encouragingly seen an uptick in the performance of its key funds, and is now shaping as a company on the cusp of performance fee upgrades. It too has an attractive 5%+ dividend yield and a comparably cheap valuation of 15x.
Lastly, Vocus (VOC).
We initiated it with a BUY several months ago.
For those of you looking for real potential capital growth, and a defensive, cheaply-valued earnings stream, VOC is well worth your consideration. It won’t pay a dividend for several years, but I think there is +30% capital upside in the coming year, and arguably a lot more as the group begins to reduce excess overhead accumulated through numerous acquisitions in recent years.
In an increasingly expensive and unattractively priced Australian equity market, VOC stands out as an excellent opportunity for upside.
Local economic data this week pointed to continued local service and industrial sector strength in June, but interestingly construction is starting to roll over. Construction sector activity dropped to its lowest level in a year, and a precursor of future construction activity, building approvals, saw a significant drop in this week’s May release.
Where residential building approvals had defied the slowdown seen in apartment construction, the May approvals saw a substantial -9% fall month on month, and almost back to its lowest point in 5 years. It is impossible to hang one’s hat on only one month of data, but it does seem to indicate the impact of tightening bank credit is perhaps beginning to be felt across new home buyers.
That’s the lot. Hope this is helpful. Don’t be shy to hold some extra cash!
Friday 10am values
|S&P / ASX 200||6216||+!||–|
|Property Trust Index||1424||+12||+0.8%|
Thursday Closing Values
|U.S. S&P 500||2737||+21||+0.8%|
Key Dates: Australian Companies
|Mon 9th July||Div Pay Date – NABPD
|Tue 10th July||N/A
|Wed 11th July||N/A
|Thu 12th July||N/A
|Fri 13th July||N/A
6th July 2018, 1230pm
For more information on the above please contact, Robert Flynn, Senior Financial Advisor, Bentleys Wealth Advisors directly or on 02 9220 0700.
This information is general in nature and is provided by Bentleys Wealth Advisors. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.