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Is it time to go all in, buying shares aggressively and minimising portfolio cash? Not yet, although the case to increase equities exposure is strengthening.
For several weeks in this Report, I have argued it is too soon to call a share market bottom. My general advice has been to put a small amount of available cash (if possible) to work in the market and “average in”. It’s time to put more of that cash, cautiously, to work.
Every investor is different, so do further research of your own or talk to your adviser about what’s right for you. My strategy: at least half of available portfolio cash should be put to work in equities now with a view to adding more share exposure during big down-days in the market.
Expect elevated market volatility to persist for some time as COVID-19 uncertainty remains high. Don’t fall for commentary that the market has formed a base and is about to race back towards its previous high. It won’t take much bad news to spark another massive sell-off.
Experienced investors will recall the pattern after the 2008-09 Global Financial Crisis: some big gains after the plunge that turned out to be bear-market rallies. Investors buying now must be able to tolerate potential falls of 10-20 per cent and have at least a three-year view.
The carnage from highly discounted equity capital raisings, as companies repair strained balance sheets, is yet to come. That’s an opportunity to buy companies at even bigger discounts in coming weeks and a reason why I suggest still keeping half of portfolio cash on the sidelines and am avoiding calls to “go all-in” now from broking analysts and fund managers.
To my thinking, worrying COVID-19 trends in the United States are the biggest risk to markets and potentially the trigger for new lows. Australian equities fell just over 50% peak to trough during the GFC and were down 38% from their high at one point during this crisis.
The COVID-19 crisis is larger than the GFC and it is impossible to know the medium-term impact on banks, listed property trusts and sectors that have had their business models turned upside down. As bad as it was, the GFC did not shut down tens of thousands of businesses overnight.
Caveats aside, three factors this week underpin my view to put more cash to work in the share market. The first is what I call the easing of “peak panic”. As difficult as it is, people are adjusting to social distancing, self-isolation and a new way of life for the next few months.
The Federal Government’s wage subsidy will boost confidence among workers stood down, those fearful of losing their jobs and small businesses. The money is no panacea, but markets at least know most Australians will have enough money to buy essentials.
The second factor is small signs emerging overseas of virus containment. Denmark, for example, this week set out a path to lifting coronavirus restrictions. China is easing restrictions and Japan, South Korea and Singapore have made progress.
Sadly, many countries face rapid escalation of COVID-19 and the outbreak will get a lot worse before it slows. But some countries are showing signs of slowing growth in cases or talking about easing restrictions, reinforcing that the disease can be overcome.
Innovation is the third factor. The Mercedes Formula One team’s new breathing-aid design, now being trialled, is one of several innovations to treat the disease. To use a war analogy, reinforcements are on the way, giving hope that far fewer will die from COVID-19.
These and other factors have for now lessened peak uncertainty for the equities market, for now. That’s not to say the wild swings are over; rather that the big shock – and uncertainty about how the Federal Government would respond and when – is partly behind us.
Three weeks ago I suggested readers turn their attention to high-quality tech stocks here and overseas. Their crazy valuations had tumbled during the crisis, despite the best tech companies having recurring high income, high profit margins and “sticky products” that are hard to drop. Also, because tech was the best-performing sector a year after the 2003 SARS crisis.
WiseTech is up from $13.17 when I nominated it three weeks ago to $15.90. Altium is just below the $31 mark when I wrote about it in early March (currently $28.68).
Xero is down from $74 to $69.50, and JB Hi-Fi – a company that could do exceptionally well when this crisis eventually abates and consumers and small businesses buy gadgets – is down from $31.88 when I wrote about it to $31.
Last week, I added high-quality defensive yield stocks to the ideas list: Telstra Corporation, Australian Securities Exchange, APA Group, Woolworths Group and ANZ Banking Group. Each is in line with broader market strength, but these are long-term ideas.
This week, I add three more ideas to the list: Fortescue Metals Group, BHP Group and Woodside Petroleum. Investors need care with smaller mining companies – particularly those that have to raise equity capital this year to survive. Stick with the market’s highest-quality miners.
The big miners came into this crisis in a strong position. The GFC shocked mining companies into strengthening their balance sheets and the commodity-price rally over 2016-19 boosted their cash flow. Federal and State Governments will surely do everything they can to support mining production now that they need mining royalties more than ever.
Spot iron prices have been relatively resilient during this crisis, surprising market watchers who expected bulk commodity prices to tumble. With China slowly getting back on its feet, Australia’s big miners are better positioned than most ASX-listed companies.
However, COVID-19 could weaken demand for steel through lower manufacturing activity or a potential closure of offshore smelters due to quarantine. Business forecaster IBISWorld says both factors could significantly reduce the demand for iron ore and black coal, presenting a major threat to Australian miners.
A sharp fall in the share-prices of Australian big miners is already pricing a significant global slowdown in and further falls in commodity prices, including iron ore, in my view.
Consider Fortescue, a stock I badly underestimated last year. It has fallen from a 52-week high of $12.87 to $10.10 during this crisis. Fortescue this week confirmed its production guidance and emphasised its balance-sheet strength. The company sensibly suspended local and international exploration, but that’s less of a problem than cutting production.
Chart 1: Fortescue (FMG)
BHP has fallen from a 52-week high of $42.33 to $30. The world’s largest listed mining conglomerate has exposure to weak oil and copper markets, but has an exceptional balance sheet and about half of its total sales are tied to China’s economic growth. China is starting to recover earlier from COVID-19 than other nations – if you believe its data and that a second wave of infections there will not occur.
BHP’s tier-one mines and lower cost base boost its capacity to withstand larger commodity price falls, relative to most mining companies. The balance sheet provides ample firepower for BHP to buy assets from weakened competitors after COVID-19 at lower prices.
Chart 2: BHP (BHP)
Woodside Group has had the additional problem of fallout from the Saudi Arabia/Russia oil price war – the last thing the world needed during COVID-19.
In December, I nominated Woodside in this report as one my preferred stocks for 2020 – a view that remains unchanged. After falling from a 52-week high of $37,55 to $17.97, the market is factoring in a huge amount of bad news into Woodside.
Woodside announced it is cutting expenditure and maintained production guidance. That will push back some big projects in the pipeline, but the market suspected delays were likely well before the oil-price war and COVID-19. Also, it’s hard to see oil prices go much lower from here.
At $17.97, Woodside’s forecast grossed-up dividend yield is about 7%, on Morningstar numbers. The company’s gearing is conservative at less than 15%. Woodside is well-positioned financially to weather current threats and suits investors with a 3-5 year view.
Chart 3: Woodside (WPL)