The NotSo Daily Bulletin No. 337

Top Stories
Today, October 9 the ASX 200 was flat after four positive days moved the market to 6102 and closer to the top end of the four-month trading range 5750 to 6150. The “kitchen sink” budget and the RBA are providing the necessary financial support for the economy to get to the other side of this pandemic hopefully.

Global markets were buoyant for the last couple of days but are still showing signs of unease as COVID numbers hit a new daily high figure of 345,000 cases yesterday.

The list of uncertainties hasn’t reduced, and we are likely to see two steps forward and then two steps back as we bounce from one news story to the next in the US pre-election melodrama.

The betting odds and polls have Biden well in front. The main question now is, have markets factored in a “clean sweep” by the Democrats. If not, we may see some more volatility. 

The one thing markets WILL NOT LIKE an unresolved election (no result for a while).   
The search for income 

According to new Vanguard analysis, investor portfolios built on a dividend-focused strategy will need to be 100 per cent allocated to equities and greatly elevate their portfolio risk, to meet most income needs in the current low yield environment.

An enduring solution for low yields found that investors using the rule of thumb 4% withdrawal rate as a target for income from their investment returns could have relied on a diversified portfolio of 50% equities and 50% bonds back in 2013.

However, to obtain the same result today, investors will need to shift to 100% equities and almost double their risk. “Many retirees who have experienced the recent reduction in dividends across the Australian share market are understandably worried given their reliance on these payouts to fund their retirement,” said Inna Zorina, Senior Investment Strategist, Vanguard Australia.

“This scenario which requires a retired investor, arguably at the most conservative phase of their investment journey, to take on immense risk. It certainly presents a real challenge to the most impacted group in today’s low yield and high volatility investing environment, and is probably not in their longer-term best interest,” she said.

The research also debunked the popular rationale that investing in higher dividend-paying equities would generate greater overall returns relative to other equities. Data from the previous 25 years found that total returns are generally not affected by actual payout, as capital not used for dividends could be reinvested in projects that increased shareholder value instead.

The research further warned of the risk of tilting a portfolio towards value stocks, finding that the higher yield an equity portfolio delivers, the more substantial the amount of concentration risk the portfolio holds. “Previously proposed changes to dividend imputation rules highlighted the potential risks that a high yield, concentrated portfolio may be exposed to. The current high volatility, low yield environment further affirms these risks,” said Ms Zorina. “The alternative to an income-oriented strategy is the total returns approach, where a portfolio’s asset allocation is set at a level that can sustainably support the spending required to meet those goals and encourages the use of capital returns when necessary,” said Ms Zorina. The approach allows for the capital value of the portfolio to be spent during periods where the income yield of a portfolio falls below an investor’s spending needs. It utilises both income and capital growth elements of the portfolio during the volatile periods for markets which inevitably occur, as long as the total amount drawn from the portfolio doesn’t exceed the sustainable spending rate over the long term.

“While this approach requires the discipline to reinvest a portion of the income yield during periods where the income generated by the portfolio is higher than what is required for living expenses, it provides many advantages over the income-focused method,” said Ms Zorina. “In addition to helping address unintended factor and credit exposures, this approach also addresses the main concerns that many retirees have around portfolio longevity,” said Ms Zorina. “Ultimately ensuring your portfolio includes an appropriate level of diversification matters for all ages and stages, and certainly even more in retirement. The total returns approach aims to provide for income needs without the risk trade-off,” said Ms Zorina.
Bank rebound? 

An article from fund manager & journalist Christopher Joyce in today’s AFR suggested the banks may have turned the corner as some well-known “bank bears” are starting to change their tune. 

As noted in the “Banking Index section” below, the banks are still down 15%-20% for the year, however, the pessimistic view on the housing market may not be as gloomy as expected. Some of the banks own forecasts were suggesting housing prices were to fall 10% to15% and the unemployment rate to jump to 9%. However, so far the national average price is only down 2.8% and unemployment is 6.8%.  

After this week’s “kitchen sink” budget, the Government may have provided enough support for the economy to bottom. Joyce thinks property prices will actually rise from here which will reduce the bad debt provisions the banks have already made in the May profit results. 

He also notes in 2015, the banks were trading on a price to book value of 2 to 3 times and they should have been between 1 to 1.5 times.  ANZ is now at 0.86 times, NAB’s at 0.99 times, Westpac is at 0.97 times and CBA at 1.67 times.

We only have a few weeks (early November) to see ANZ NAB and WBC release their full-year results. Hopefully, they are a little less gloomy than they were in May. 
Why we still like Global Themes?

Macquarie provided an interesting piece on global investment themes (technology, health, AI, etc). These are the themes we have been investing in via the exchange-traded funds (ETF).  

Macquarie made the following observations. 

Whenever there are deep dislocations, caused by economic, technological, military or pandemic reasons, the balance of power changes and needs to be readjusted.

Over the past two centuries, the industrial revolutions have already spawned waves of communism, fascism, tyrannies and rules of the mob.

Today, the dawn of the Information Age is causing an even deeper disruption. Our modern age can be best described as one of declining returns on humans and conventional capital and rising returns on digital capital, with most commentators concluding that this disruption is hundreds of times greater than that caused by the industrial revolutions. It is both broader and much faster. Financialization and the pandemic are aggravating the deep fissures of slowing productivity, rising inequality and a growing irrelevancy of traditional inputs. Nations are also moving in different directions and at different speeds, amplifying geopolitical tensions. The announcement of Trump’s COVID infection added another layer of risk to an already highly fraught and partisan environment.

How should one protect one’s wealth or portfolio against such unquantifiable uncertainties? The best course is to join disruption rather than resist it. In different ages, such protection was offered by land, factories or gold. Today, it is Thematic Portfolios that we believe offer the best chance.

The chart below illustrates the outperformance of these themes compared to the world index. 

Other Stories 
Sports Bet – US Election Trump $2.80 ($2.75). Biden $1.40 ($1.40). Trump needs a hail mary from here based on these odds. 
Broker Target Price changes 

  Goldman Sachs
BHP increased from $40.70 to $42.10
Rio Tinto decreased from $99.70 (lowest broker) to $98.10 (still lowest broker)

Ord Minnett/JP Morgan 
BHP decreased from $45 (highest broker) to $44
Origin Energy (ORG) decreased from  $7.60 to $7.45
Sonic Health (SHL) decreased from $35.40 to $35
Woodside (WPL) decreased from $25 to $23.55

BHP increased from $37.60 (lowest broker) to $37.80 (still lowest broker)
Transurban (TCL) increased from $13.71 to $14.11

Morgan Stanley

BHP increased from $44 to $45 (highest broker)
Resmed (RMD) decreased from $24.67 to $20 (equal lowest broker)
TCL increased from $14.45 to $14.49
Wesfarmers (WES) increased from $49.10 (highest broker) to $51 (still highest broker)

Bell Potter/Citigroup

Today’s Sector Movements
Best –  Energy +0.7% 
Worst Healthcare -0.9%
Core Watchlist Index 

The CORE Watchlist is a collection of 30 Australian shares, predominantly “Blue Chip”. We obtain research from up to 6 brokers on each share. Each broker provides a Target Price (value in 12 months) which then provides us with an average for each stock. We then compare that average to the current price as a percentage. IE BHP price $38.56   Av. Target Price $39.73= 97.1% (meaning 2.9% upside over next 12 months) + income 7.11% (including franking).

To get the CORE Index we take the average across the 30 stocks. This provides us with a market average as there are up to 80 teams of analysts providing the research and target prices. The CORE Watchlist stocks represent more than 55% of the ASX 200 and so provide us with a good indicator of the market value. When it’s at 100% then the market is fully priced. We have seen that when the index is below 90%, then it’s good buying, but that doesn’t happen very often. 

Should you have any questions, please let me know.  
The new stocks include in the CORE WATCHLIST 
Amcor (AMC) Brambles (BXB) JB Hi-Fi (JBH) NextDC (NXT) ResMed (RMD) and Trasurban (TCL).  

The Core index increased from 91.95% to 93.1 which is just above the BUYING TERRITORY signal

Overall Earnings Per Share (EPS) (including new stocks) 
FY21 increased from 19.52% to 19.75% forecasts of some companies to have a large rebound after the 15% drop in FY20 profits.   

In the medium term, markets need profit growth to see the indices increase in value. 

Most expensive – (SEK) 118.7% (buoyed by jobs growth)  

Least expensive – Origin Energy (ORG) is the cheapest at 67.2%. 

Stocks trading below all broker forecasts are as follows; (it has been a handy indicator in the past). 

AMC current price $15.82   Broker range $17 to $18

BHP current price $36.58    Broker range $37.80 to $45
BXB current price $10.60    Broker range $12.05 to $13.67
COL current price $17.52    Broker range $18.90 to $21
LLC current price $11.98    Broker range $13.25 to $16.74
MQG current price $129.77 Broker range $130 to $135 
ORG current price $4.44      Broker range $5.35 to $7.80
RIO current price $97.50     Broker range $98.10 to $122
TLS current price $2.77       Broker range $3 to $3.60
WPL current price $18.38    Broker range $20.60 to $33.70

ANZ moved out due to rising price.  
Banking Index 

Like the CORE Watchlist index, the Banking index is the average target price of the four major Banks based on research from up to 6 brokers. The percentage below 100% is the potential upside over the next 12 months (not including income). If at or over 100%, then this is indicating the Banks are fully priced. 

The Banking Index increased from 94.3% to 97.2%.

The budget stimulus should provide the following benefits for the banks.

1. Employment increases which should lower bad debts and increase loan repayments.
2. Business investment should increase due to the tax credits and depreciation allowances which increases the need for credit.
3. Infrastructure spending will have a positive indirect benefit. 
4. Tax cuts should increase consumer spending which assists households and consumer business and inturn banks.
5. Housing market regains some confidence and easing of lending criteria (avoiding a credit squeeze).   

The banks are up 6% this month but still off 15% to 25% for the year. ANZ, NAB and WBC have their half-yearly results in early November. 

There are mixed views regarding the prospect of dividends. ANZ is mostly likely to increase theirs whereas NAB (capital raising) and WBC (Austrac fine) may pay a little or suspend their dividend.

The graph below shows the fall in banking dividends but we are likely to see an improvement next year, however not to the levels since before the Royal Commission.   

Other Indicators 

US VIX Index increased from 29.48 to  29.48. This is elevated above normal levels (10 to 17)  More volatility expected.
Iron Ore – closed for Chinese holiday $123.47. . A six year high was $130.17
Copper increased from $2.94 to $3.07. Recent high $3.10.  Gold increased from $1888 to $1915. Record high $2063. AUD/USD increased from 71.3c to 71.8c Fell to a low of 55c.  The future direction is more about the USD rather than the AUD.  USD/CNY decreased from $6.79 to $6.71 The lowest point in many months China becoming more comfortable with its recovery and controlling COVID.
Asian markets – UP  
US 10 year Bonds increased from 0.76% to 0.77% Hit a low of 0.31%. I’m adding the US 30 year Bond which increased from 1.56% to 1.57% (if this one start to rise, then it could provide inflation and volatility sign). Near the highest level for the year.  
German Bonds decreased from -0.51% to -0.53. Hit a low of -0.9% Japanese Bonds  increased from +0.022% to +0.029%  
Aussie Bonds 10 year Bonds increased from 0.85% to 0.85%  Lowest point 0.68%   
Other rates have slightly fallen 1 year 0.11% 2 year  0.16% 4 year 0.22% 5 year 0.33% . The market is starting to price in a November rate cut to 0.10% or 0.15%. However, we need to watch the long end of the yield curve. Aust 15 year Bonds 1.16%. 
Oil price increased from $39.95 to $41.13. 
Tungsten remained at $215-$220 mtu. 
This week & next week  Last “Not So” opened in 5 Aust states (missing SA NT & Tas) US 4 states (California, South Carolina Virginia & Georgia)   

This week – Finishing Investment process.  

Next week – Starting October reviews.

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