Volatility ahead, why these fundies aren't selling yet

Well, that's a wrap on reporting season, and what a boomer of a season it was. Data provided by FNArena shows that February 2021 had the lowest percentage of companies to miss expectations ever recorded. It comes after ABS data revealed that Australia experienced a second quarter of GDP growth of over 3% in Q4 2020. 

It's not all fun and games though. While the beats have been numerous, markets remain choppy.

Sharp movements in US and AU bond yields have markets up then down, and all the same all over again. Last week the NASDAQ lost over 6% and the ASX All Ords is down 2%. So what will this mean for markets?

To answer this, Matthew Kidman is joined by Aberdeen Standard's Michelle Lopez and Monash Investors' Simon Shields as the trio reflect on reporting season, rising bond yields and the rotation from COVID-winners to losers.

Note: You can watch, read or listen to the discussion below. This episode was filmed on 3 March 2021.

Edited transcript

Matthew Kidman: Welcome to our Thematic Discussion. I'm Matthew Kidman and thank goodness, the reporting season is done. The half year out of the way. What did it show? It was pretty strong. The recovery is on. Just like the economy companies reported, it was all pretty nice. It didn't guarantee you a share price movement though, because the only thing that grew quicker than the momentum in the economy was expectations. Let's have a chat about it. I've got Simon Shields from Monash Investors, welcome Simon and Michelle Lopez from Aberdeen Standard. Michelle, I'll start with you. Give us one line that wraps up the reporting season.

Michelle Lopez: Well, for me, it's the strongest I have seen perhaps in the last decade. And this is actually quite remarkable because when you think about the conditions that many of these corporates have had to operate in, with this stop start environment, it was remarkably strong.

Matthew Kidman: It was, wasn't it? Simon, cashflow was strong, balance sheets you can't jump out over. How would you sum up the reporting?

Simon Shields: Yeah, it was a good reporting season. We had more positive surprises than usual, and there was also at the same time, a rotation going on from COVID winners to COVID losers.

Matthew Kidman: Okay. Let's stay with that. It's a good segue. What have you done with your portfolio? You've had what, three or four days to change the whole thing? Since the reporting season? What have you done?

Simon Shields: Well, we were very focused on the actual price targets. Every time we make an investment decision and as those COVID winners were moving through most of last year, we were selling down and taking profits. So we're actually out of quite a lot of them. And we're positioned then for the COVID losers and the term, particularly the travel stocks and so forth. So, the portfolio is probably going to move a bit more in that direction.

The cash level now is a bit lower than it was, say six months ago. And, but it's probably stabilised as well. We think that we're going to be seeing a good growth recovery out of the COVID recession lows. So we want to be positive, but those over the top gains that were available six, eight, nine months ago, are no longer there.

Matthew Kidman: Yeah, it was, it was strong. And we talked about it a bit earlier. Michelle, big rotation going on at the same time, it was almost like some of the profit results come out and you think, 'better I'm selling it anyway, let's go to something else'. How did it affect what you did with the portfolio or what you're doing?

Michelle Lopez: So it's important, I guess, to understand when we're constructing portfolios, we do take a three to five year view. So there's no kind of whole sell changes that we put through after reporting season. But we can't deny that rotation that has played out over the last, I guess since November last year, when there was all that very strong news flow around vaccine efficacy and similar to what Simon was saying, over the last six months, we've been taking profits in some of these really strong COVID winners. Healthcare, as an example, a number of players there.

But what this reporting season did and sort of re-diverting, recycling that capital into ones that were leveraged more to the reopening of, and recovery of the economy, we thought that had already played out. But what we're seeing following this reporting season is that many of these COVID losers, if they haven't already factored in, there's still a bit more to go. So the likes of, the energy sector, we still think that there's quite a bit to go, so we're putting a little bit more into that. A number of, maybe travel, very selectively though. It's not across the board, we're also considering some of those. So it's at the edges. I think there's a bit more to go in this rotation.

Matthew Kidman: Yeah, So Simon, I think earnings across the market, there are about 10% below the peak. They were 30 at June. They're back to 10, they're on a run. So that's all good, but there's other things going on. There's a rotation generally in the market and interest rates or market rates are kicking up. What does that mean for you?

Simon Shields: Well, at this point in the cycle, seeing bond yields rise is not a concern to us, right? The rising in response to growth, or expected growth coming, when we get concerned about rising bond yields is in the latter part of the cycle, when growth is really flattening out or rolling over, yet bond yields are still going up because the central banks typically lag what the share markets do.

Matthew Kidman: Trying to catch up.

Simon Shields: Yeah, exactly. But in terms of the rotation going at the moment, absolutely. The WAAAX stocks have certainly lagged, classics. Whereas, the COVID losers, whether they'd be because they're bricks and mortars or travel stocks, which are classic COVID losers, but even some other stocks that we thought perhaps shouldn't have done so badly, they did do badly during COVID. They've really started to get to recover.

Matthew Kidman: Give us an example, come on.

Simon Shields: Okay. So, a stock like EOS, which is a defence based stock for the most part, laser targeting for satellites and so forth, should have been immune from COVID. But it turned out that one of its largest customers in the Middle East shut down its military bases. You wouldn't have expected that, but that's what happened. Therefore, there was a cashflow lag, therefore the stock got hammered.

Matthew Kidman: Yeah. So I feel a lot better now that Simon said that, because I was worried about bond yields. How about you, Michelle? There is a big rotation going on. We're in that next phase of the COVID recovery and there's a little bit of inflation scare out there. What are you thinking about that? And do you join in that rotation or you just stick to that long term view that you were signed up for?

Michelle Lopez: You can't dismiss the rotation that is playing out. As I mentioned, I think there is still a little bit further to play out. And why I say that if I can qualify it, is when you look at the factors again, that's driving it, and fiscal policy is one of the biggest ones in all of the stimulus. I mean, it's undeniable that that's supporting the recovery here. That's still yet to play out in big economies like the U.S.

Michelle Lopez: We're about to enter a period of three stimulus packages that could be up to three trillion dollars. So if you even put, multipliers on that, there's serious growth in the US that we're considering. And domestically, last year we saw the budget shift from consumer to business. And again, we're at the early stage of that coming through. Then if you look at macro factors, such as global PMI, commodity prices and what they've done, oil copper to a certain extent iron ore, they're very supportive of this rotation continuing somewhat, but you've got to be careful not to chase that. And that's the big part. And I think that's what Simon was saying. You don't get too worried about it.

Matthew Kidman: So, measured rotation, don't get to too excited.

Michelle Lopez: I think so. And, I think it was just last week when we saw that very rapid, sharp move. There was a bit of fear in the market. What does this mean? But stepping back, we don't expect that to carry on. And you need to be a little bit, sort of, patient and careful, that you don't just chuck out all the, a lot of these kinds of technology stocks, that are actually going to be the long-term winners, long-term winners of the structural shifts that we're seeing.

Matthew Kidman: Yes. Okay. Simon, you got something that really impressed you during reporting season? A name that we can just go and have a look at.

Simon Shields: Yeah. So we were really impressed by EML Payments. Now this is a company that's got quite a large exposure to gift cards. And if you think of any company that was going to get hurt, with all the shopping centres closing down, it was those gift card suppliers, in effect, and that's EML. Well, the result came out and while gift cards were weak, they weren't as weak as expected. Overall, the result was only 10% lower than last time. So, that was a magnificent result. And if that's the worst that the world economy can throw at EML Payments, the outlook's pretty bright.

Matthew Kidman: And the reopening will help them.

Simon Shields: Exactly.

Matthew Kidman: Yes. Okay. Michelle, you got something?

Michelle Lopez: Mine's a very different company and it's Cochlear. And again, if you think about the healthcare system entirely shut down, and access to hospitals and surgeries, and all of that. So, Cochlear was in an interesting situation, the last six months, they had that really big second wave flushing through the U.S. and Europe, which is two of their biggest markets. Yet, they had a very strong first half and they provided guidance for the full year that implied 50% growth at the mid point on what they did in FY20. And that's taking into account FX headwinds as well because they own a lot of their revenue offshore.

The second part of it is we were really quite surprised as to the return of Cochlear surgeries that were going on across different age groups in the developed markets. So, that gave us confidence that the recovery was well and truly underway. They gained market share over that period and coming from a 60% global market share, that's quite, it's not a small feat.

And really the other interesting thing with Cochlear, when they raised capital last year in the thick of COVID, they did so, so they could carry on investing, which was very different. They were one of the first to go, very different because it wasn't an emergency raising, like we saw a number of companies do. It wasn't very dilutive, the discount wasn't large. So they've come out of this in a much stronger position from a technological advantage point of view. They've got new products coming out to market. So they're about to enter a bit of a purple patch.

Matthew Kidman: Okay, let's get a bit bearish. Got something that disappointed you?

Michelle Lopez: Well, there's always the disappointing ones. There are. Look, I'm going to flip over to small caps now. And when we looked through kind of the performance of stocks on the day, the largest disappointment was Netwealth. And Netwealth, I believe was off 9% on the day. And that from a portfolio perspective was the largest move.

And what disappointed, I suppose, was the re-pricing that they were doing on their back book, and the impact that was going to have on margins for the full year. But, looking through that, we were really comforted by what they're able to deliver from a nifty way growth perspective. And this is a situation of a rising tide with themselves, and Hub24 in that camp as well. That there's this kind of structural tailwind, and they're taking share off the incumbents, and the majors. That's likely to continue, but the fundamentals of Netwealth are actually very strong. So when you think about the balance sheet, the management, these are owner operators, right? So, they're very good stewards of your capital and they're continuing to invest for future growth. So yes, it was the worst performer after the results came out, but it's still solid.

Matthew Kidman: Some of them are hard markers aren't they. Simon, what made you feel sick when you saw the result and went, 'Oh, no, that's going to be a hard day.'

Simon Shields: I felt sick for them, but luckily we didn't own any. Cimic Group. It's a company in a sector that I've covered for decades.

The cashflow has been a real problem for them for the last couple of years. And a disappointed again, in this result. The thing that was really disappointing about Cimic from a revenue and earnings point of view, was that, construction activity should have been sort of okay. The governments were paying to allow our construction workers to continue as much as possible. But when the result came out, we see that Cimic's down 59% in new jobs, in terms of bidding for new jobs and so forth. And so the stock got hammered. It was down 17% on the day.

Matthew Kidman: That's pretty healthy.

Simon Shields: Yes.

Matthew Kidman: Yes, the vaccine is rolling out, but luckily COVID has left us a few gems as the economy recovers. If you enjoyed that, as much as I did, tune in to the Livewire YouTube channel.

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