Good morning,

ASX200 up over 2% for the week and now 7.77% for the month rolling (which was much needed after a pretty horrible past quarter.)

Consumer discretionary names were the leaders, adding 3.9% as a sector with Navitas (NVT) receiving a takeover bid from private equity consortium BGH Capital and driving their share price up 15%. Automotive Holdings (AHG) bounced back despite weakening new car sales data and IDP Education (IEL) continues to impress, with Macquarie raising it’s price target to $11.50 a share which drove the stock up 8.8%.

What happened?

Stocks both locally and overseas were hammered in the last quarter of calendar year 2018, both down c.15 and 30% respectively between 1 September and the end of the year.

Why the sudden retreat? There was undoubtedly a strong and sudden desire from investors globally to reduce exposures to high growth cyclicals in favour of more defensive sectors and securities which was probably driven by the fear of the Fed raising interest rates too quickly, earnings growth slowing markedly and the rising (but still relatively unlikely) probability of a recession in the US. Locally, this was exaccerbated by the housing market that contines to go backwards.

Since then, we saw the market dead-cat bounce and then be bouyed by on the back of 2 important data points:

1. 4 January 2019 – Jerome Powell declared the Fed on hold. With the messaging being the Fed were going to take a ‘wait and see’ approach for 6 months. Importantly he compared 2019 to 2016, when the Fed stopped hiking as financial conditions tightened.

2. 4 January 2019 – US job market delivered a huge December performance with the most workers added to the labour force in 10 months, wage growth accelerating and participation jumping. Non-farm payrolls came in at 312,000 beating all forecasts.

Since 3 January, the S&P500 has rallied 7.77% and the NASDAQ has rallied 9.36%, both are now fractionally under where we started 2018.

Where to from here?

I’m a simple guy.

We buy companies to get exposure to earnings. Earnings growth equals higher retained earnings which increasing the value of our investments. This might be through dividends, buybacks or capital returns as well as through eventual/potential sale.

ASX listed companies are forecast to grow profits by 4.5% over the next 12 months, but that’s down from the 6%+ highs of October 2018.

And this decline in earnings growth forecasts has correlated with decline in our market. The question is are we to expect earnings to continue to decline (following the red arrow lower) or has the market ‘overshot’ and reacted too heavily to the moderation in growth expectations? Total 12m returns in green, 12m expected change in earnings in blue (yep, I know I did this chart last week as well, but I needed the context.)

I think it depends on where you are looking to invest. I figure you want to find companies that can grow their profits over the next 2 years by at least 5% organically, pay you a dividend and do all that off an expanding business (i.e. revenue growth > inflation, say 2%) and have historically been able to meet the same criteria, but are trading only at market multiples or less (I’ve used 16x here as my cutoff.)

Here’s the list of companies that meet that criteria, and who’s earnings estimates for next year haven’t changed for the worse on average over the last 3 months (give or take 1%).

Magellan (MFG) and Qantas (QAN) look like they’ve bounced, whilst Ansell (ANN) and Amcor (AMC) are both exposed globally exposed, defensive, high quality businesses that appear to be offering some relative value given the forecast growth outlook, dividend yields and relative performance.

Outside those names, I don’t have much confidence in the rest of the list to be able to meet the criteria in the forward period.

Beyond that criteria, there’s some potential value in Ausdrill (ASL), Ooh Media (OML) given recent price performances and estimates. Return to consensus price target is 50%+ for both.

Looking beyond Australia

Removing our domestic bias for a sec, my view is that the S&P 500 has priced in an earnings recession, and whilst the revisions might still ‘spread’ a little bit more, I think some stocks, particularly across technology have the chance to surprise to the upside with unexpectedly strong top line growth. Whilst it might be a touch early, I’m looking for a few more quality cyclicals for portfolios.

Source: Morgan Stanley Research

Why US tech/cyclicals?

Because they’ve been hardest hit and normally in that kind of pull back, that extreme negativity, opportunities emerge. Citi does a nice earnings revisions index showing how hard the US has been hit relative to other global markets and how IT and Energy (on the back of the oil price) have been most heavily revised down.

Which stocks look interesting?

Using a similar quantitative process (back-tested factors that make sense for the different investment styles/objectives) – in this case I’ve run with the quality + growth playbook (figure that’s what most people want from their international direct equity alloactions.)

Here’s a few names for you to take a harder look at and for the less well known ones, I’ve written up what they do to give you some context.

  • Visa (V-US)
  • Boeing (BA-US)
  • McDonalds (MCD-US)
  • L’Oreal (OR-FR)
  • Keysight (KEYS-US) – eletronic design and test solutions. exposure to a bunch of industrial end markets (particularly automotiev, energy, semis) with diversified revenue (36% US, 18% China, 8.8% Japan), recently beat the street with Q4 EPS of $1.01 vs consensus $0.90.
  • Ingersoll-Rand Plc (IR-US) – they produce heating/ventilation/air con systems, compressed air and gas systems, power tools, fluid management… again, general industrial-type exposure. 14% under consensus price target, 15x CY19 earnings, 16% ROE going to 21% by CY20. Free cash flow yield above 5%

And looking specifically at Technology, it’s just more of the same from the past few years. I’m focussed on who I see (read: what the data says is) as the monopolies/clear leaders in their relevant segment:

  • Amazon (AMZN) – owns ECommerce, did $258.2bn in US retail salees of 49.1% of ALL online retail spend in the US.
  • Google (GOOG) – owns Search, 90.28% of all searches on the internet happen on Google.
  • Spotify (SPOT) – owns Music – 36% of music streaming market, with Apple, the only current relevant competitor at 19%. Anyone use Apple Music lately? It’s rubbish.
  • Netflix (NFLX) – runs Entertainment – surprised at recently quarterly with International subscribers. Will win big in India in my view. Netflix has transended being a “company”, it’s now apart of “the culture”. It’s like Nike (NKE).
  • Adobe (ADBE) – owns Graphic Design/Creator software – find me one graphic designer who would give up Creative Suite tomorrow in favour of something else. It’s the equivalent of a surfer changing stance, a poet changing writing hands or a finance nerd changing from Excel to Google Sheet.

Back in December UBS issued a report on the Internet and Interactive Entertainment Sector. I won’t bore you with all the details but here’s a few snippets:

  • “We see NFLX and GOOG (YouTube) as best positioned to benefit from a continued shift of media consumption from traditional to digital given the breadth/depth of their user & content ecosystems…
  • “We also see AMZN (Prime Video) and SPOT as LT secular winners as their respective digital media platforms continue to gain scale. TWTR continues to develop new video ad formats and has gained recent momentum capturing incremental video ad spend.”
  • UBS Evidence Lab survey shows Spotify leading subscriber market share in key markets and high % of ad supported users: Our survey of ~6k global streaming music consumers in May ’18 shows Spotify has leading market share in terms of number of subscribers in the US, Sweden, UK and Germany. Additionally, the percentage of respondents who were ad supported users vs. paid subscribers was relatively high for Spotify compared to Apple Music & Amazon. This highlights the potential for Spotify to further monetize their existing user base by upgrading them to premium subscribers.”

Source: UBS Evidence Lab

Further, I just think there’s a few trends emerging that benefit these names:

2. ECommerce = Search = Social Media – buying and direct shipping with 1 click direct from Instagram. Buying direct from Google’s showcase ads in search.

3. AMZN continues to eat everyone’s lunch in media. Amazon Media is now the 3rd biggest ad business on plannet earth, behind Google and Facebook.

4. Being liked/trusted matters – FB needs a PR makeover if its stock is going to outperform.

Source: UBS Evidence Lab

Oh and one more thing, just because I’m a bit obsessed with it, Nike (NKE). Nike has generated a compound annual growth rate of 22% per annum for the past 10 years. Why? Because it’s the best brand on planet earth. It owns the idea of sporting elite and greatness, it’s part of the culture.

What’s it worth? We paid 30x earnings (10y average 21x, 5y average 24x) not that long ago and it looks like it’s cycling for another 2 years of pretty solid above median EPS growth.

Movers & Shakers

Right, as usual it’s getting late as I type this and I’m getting hungry/hangry.

Afterpay (APT) bounced this week on an update on their US business which is going pretty well by all accounts. I still don’t think they have a handle on how to manage bad debts at scale and their business model lacks ‘robustness’ – everyone disagrees with me (for now.)

We’ve talked Navitas and elsewhere a few of my languishing stocks started to recover. TPM, APX, ASL, CYB, CSR all had nice weeks at the office. For the old faithful clients of yester-year, SYR had a real run lately as well. Some big positive moves across the board which is great.

Not much to report beyond Sims Metal (SGM) issuing a weak trading update, defensives generally underperforming, Sydney Airport (SYD) traffic numbers underwhelmed marginally… not a lot to whinge about really here.

Have a good week,