TOL - 14th Nov, 2022
Why the pros are still cautious (and whether you should be too)
A recent Bank of America survey found that professional investors are holding their highest levels of cash in 21 years, with the research house's Michael Hartnett declaring the latest survey of 371 global investors "screams macro capitulation, investor capitulation, [and the] start of policy capitulation."
Despite the negative connotation of the above, this could actually be good news for markets. After all, BofA found that the share of investors who believe rates will lower over the next 12 months doubled to 28% in October, while those who see rates going higher dropped from an early 2022 peak of 92% to just 59% during the month.
And with US CPI coming in lower than expected overnight, the bulls could just be right. But that doesn't mean you should throw all caution to the wind. Inflation is still running at an incredibly hot 7.7% (in the US, at least).
So has the bearishness of the market created some crowded trades? And should you be hiding within these stocks too?
To find out, Livewire's Ally Selby was joined by ClearLife Capital's David Moberley and QVG Capital's Josh Clark for their outlook on today's market.
Note: This episode was filmed on Wednesday, November 9th 2022. You can watch the video, listen to the podcast, or read an edited transcript below.
Edited Transcript
Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby. And since the beginning of the year, the VIX or the Volatility Index has risen around 54%. As a result, fund managers have bolstered their portfolios with cash, with the Bank of America recently finding that cash allocation levels are at a 21-year high. So to find out what that means for markets, we're joined by Josh Clark from QVG Capital, and David Moberley from Clear Life Capital.
First up, I want to know what indicators you've been watching to get a sense of market sentiment.
The indicators to watch
Josh Clark: I think there's almost an endless list of indicators that you can look at. You can make it as complicated or as simple as you like. Things like put/call ratios, yield curve inversion, or a bunch of other long complicated words. But I think the easiest and probably the best one to look at is just overall market valuation because what that does is incorporate everyone's views, and effectively the sentiment of the entire market.
The best way to look at market valuation, I think, is the equity risk premium. So that's just the investment return that investors demand over and above the risk-free rate. And just look at where that is relative to long-term levels. It actually looks like it's a bit lower than where long-term levels are. So investors are demanding a little bit less of a return than what they typically would or typically should. To me, it actually looks like on that indicator, investors should probably be a little bit more bearish than they currently are.
Ally Selby: Oh wow. Over to you, David. Which indicators have you been watching, and what are they saying about markets?
David Moberley: I agree with Josh. There are a million things we can look at and talk about. Some of the things we've been looking at, similar to what Josh was mentioning, suggest that maybe sentiment is not quite as bad as what people are thinking. And the VIX that you mentioned earlier has actually come back to about 25. So that doesn't suggest to us that there's a lot of concern in the market right at this point. And some of the more retail-focused indicators like the Greed and Fear Index on CNN have gone from max fear or max panic type levels a month ago, to actually back in greed territory right now. So we actually think that markets and indicators are not really too bad.
Is the downturn over or was that a dead cat bounce?
Ally Selby: We've rebounded off September's lows. Is the market downturn over or is that just a dead cat bounce?
David Moberley: That's the key question at the moment. And unfortunately, we're only going to know in hindsight whether or not that was the bottom. In our opinion though, we're still quite cautious. We've been having the debate around price versus earnings. And at the moment, as Josh alluded to before, equity risk premiums are still quite low. You've seen a derate in multiples in line with interest rates going higher, but the earnings levels in the market still look quite high to us.
Ally Selby: Okay. What do you think, Josh?
Josh Clark: I'd love to disagree and say it's very easy to pick the market direction, but I equally don't know. What I would say though is that a lot of people reference the pivot, or a V bottom, or a recovery, and I think that's because we look at the most recent drawdown, which was in March 2022. That's all pretty fresh in people's minds. It was only a couple of years ago. That was a really sharp drawdown and a really sharp recovery. And you remember what was happening at the time. It looked like the world was ending, we were moving into a zombie apocalypse. And then governments came to the rescue, both on the central bank side and the actual government in terms of fiscal and monetary stimulus, and really turned things around. You don't really have that this time around. Central banks are leaning in the opposite direction. They're really trying to kill the consumer and crush inflation by raising rates and really dampening activity. So I don't think you can really call for a pivot or a recovery in that same aggressive fashion.
And then if you look at the way the market's behaving on a day-to-day basis, the days that are quite strong up days, you're seeing really high beta stocks absolutely flying. So that's really reminiscent or potentially indicative of more of a bear market rally.
Cash levels at 21-year highs
Ally Selby: Well, I mentioned there in the intro that fund managers are holding a lot of cash at the moment. BofA found that cash levels are sitting at an average of 6.3%. It's the highest since April 2001. From comments I've seen on Livewire, it sounds like readers are holding a lot of cash too. What do you think that means for the market?
Josh Clark: Well, firstly, I think we are hearing the same kind of anecdote. So I'd agree with that. I'd probably just be a little bit cautious in terms of reading too much into it in terms of what it can do for markets because you end up almost a little bit at risk of falling into that fallacy of talking about cash "on the sidelines". For everyone who's been a seller and gone to cash, equally there's been a buyer and deployed capital on the other side. It's like a soccer team. You don't sub someone off and end up with a bunch of subs on the sideline. So I'd be a bit cautious about using that as your only indicator.
But what I would say is probably the more fundamental, more active, more market-timing type investors, are more the ones I think that have gone to cash. So they're probably going to be the more active ones should markets recover. So I think if you see a sharp up move in markets, you're going to see a lot of those same kinds of investors experiencing a bit of FOMO and looking to deploy that cash quickly. So I think it just talks to potentially the leverage around a potential price move in markets.
Ally Selby: What do you think it means to markets, and are you holding a lot of cash?
David Moberley: I agree with Josh. I mean, interestingly though, the data we're looking at suggests that retail investors have actually been a net-buyer in the market in the last six months. And while institutions, as a whole, the survey you mentioned earlier, are incredibly bearish, when we look at some of the monthly reports, a lot of these guys are still fully invested, despite maybe positioning a little bit more defensively. So I think what it means, from my perspective, is that we are quite susceptible to bear market bounces because a lot of the fund managers are relative performance benchmarked. And when they're defensive and the market rallies, they get a bit of FOMO, as Josh highlighted, and they want to chase it. So it means that sometimes those bounces can go on for a little bit longer than what we all think, and they can be quite painful.
A lot of the work we're doing is making sure that the companies we want to look at on the long side have a rock-solid earnings base and that the growth drivers they've got are independent of the cycle. And there are some companies out there I think that people are hiding in as a defensive balance in their portfolio that might have a bit more cyclicity than what they think.
Whether you should be hiding within crowded trades (or avoiding them)
Ally Selby: That's quite a great lead into my next question. I was going to ask you what you think the crowded trades are in the market, and whether you are hiding within them or whether you're avoiding them.
David Moberley: So I think the expensive defensives are definitely a hiding spot at the moment and pretty crowded. The other part of the market that has a lot of crowding I think is lithium, and the long-term outlook for lithium is incredibly strong, but I think some of the valuations are probably more than capturing that. So what does that mean? I guess if you're going to play in that space, make sure you've got a quality asset because some of the valuations and some of the more questionable assets are probably going to get found out in the next few years.
Ally Selby: Do you feel like there are some areas of the market that are really crowded right now?
Josh Clark: I'd certainly agree with both of David's comments. Expensive defensives are a pretty typical term to use for it. Anything with earnings certainty. So there's a fair amount of earnings uncertainty in the market, and investors are rightly moving away from that. So in the areas of the market that we spend a bit of time looking at, companies like IPH Group (ASX: IPH) - intellectual property services and a very defensive business, they also do insurance broking. Again, a very defensive and predictable business. So companies like AUB Group (ASX: AUB) or PSC Insurance (ASX: PSI) appear to be pretty well held for that same reason, as well as NIB Holdings (ASX: NHF). TechOne (ASX: TNE), a software business that sells to local governments and universities - again, a very defensive business with good visibility and defensive. So people are really taking on valuation risk to get rid of earnings risk.
Ally Selby: So do you feel like investors should be investing in those kinds of stocks, or going the opposite route?
Josh Clark: Well, certainly we've moved the portfolio towards earning certainty, but in terms of whether you want to be in a crowded trade or out of a crowded trade, I just don't think you can apply a blanket rule to it. I think what you've got to do is really look at it on a stock-by-stock basis. If a trade's really crowded, you don't necessarily want to avoid it completely because there's something that's happening positively within that company that's attracting investors, and there's a good chance that you want to be there. And the converse is true as well.
So what I would look at, or pay attention to, or the prism through which I'd think about it is just the leverage that it gives you to price moves. So if something's really well held or well looked at, typically there's a lot of positive expectation there. Positive news doesn't necessarily mean that the share price is going to respond to the same extent on the upside. And I guess the converse is true, something that's really well owned or well looked at, if that reports negative news, that can get absolutely punished because you've got a lot of people that you've just disappointed. So that's actually a good setup that we look for on the short side that can pay off handsomely in that scenario.
2 stocks that fundies don't own right now, but would at a better price
Ally Selby: Last question for today. I want to know, is there a stock that you don't own currently, that you've been looking at recently? And you want to have it in the portfolio?
Josh Clark: One that comes to mind would be ARB Corporation (ASX: ARB). So for anyone who knows anything about four-wheel drive accessories, they're the premium brand in the market. They've been a really great Australian success story in terms of growing their brand here, but they've also taken that international. So I think you've got almost half of the earnings of the business now overseas. They've won OEMs like Toyota and Ford, big names. So I think that's indicative of more OEM wins to come in the future. So there are a lot of positive things happening within that business.
I just don't know if you can hold it right now because they've really been the beneficiary of just the consumer spending frenzy in the last couple of years, and it took them less than two years to double their earnings throughout that period. So it looks like the business has maybe got a bit of over-earning in it at the moment. You'd be cautious that comes out of the business and what the share price does in response. And then their most recent trading update for the September quarter of this calendar year showed that revenues were down around 10%. There's a lot of operating leverage in the business, so earnings will be down more than that. So I think you really want to just sit on the sidelines while you watch those earnings normalise somewhat.
Ally Selby: Over to you David. Is there a stock that you don't currently own that you want in the portfolio eventually?
David Moberley: Yes, similar to Josh, it fits in that bucket of potentially over-earning through the COVID period. It's Fisher & Paykel Healthcare (ASX: FPH). It's one of the best businesses in the market. The balance sheet's rock solid, management is really strong, and it's a global leader in its space. Its Optiflow oxygen therapy is basically close to a monopoly position, and they're very underpenetrated. So we're talking single-digit type penetration and the opportunity is huge for them.
Unfortunately, similar to what Josh was saying, COVID was a huge beneficiary for them. A lot of their machines were put out into the market to support hospitals over that COVID treatment period. And the industry, at the moment, is trying to digest some of that inventory. So we've been doing a lot of work to firm up our view on what core underlying demand is, and having a look at that inventory and when it draws down. But the stock looks good on a medium-term view, we're just looking for a better entry point.
Ally Selby: Well, that's all we have time for today. I hope you enjoyed that special of Buy Hold Sell. If you did, why not give it a like. Remember to subscribe to our YouTube channel. We're adding so much great content every week.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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