Financial year ahead: Stocks and sectors to watch

Stock Watch

by Jessica Amir

Transcription of Finance News Network Special Edition of Stockwatch Interview with Bell Direct Equity Strategist, Julia Lee and Fairmont Equities Managing Director, Michael Gable

Jessica Amir:
Hello I’m Jessica Amir for the Finance News Network. Joining me for this special edition of Stockwatch is Equity Strategist, Julia Lee from Bell Direct and from Fairmont Equities, Managing Director, Michael Gable. Julia, Michael, welcome back.

Michael Gable: Thank you.

Julia Lee: Thanks Jess.

Jessica Amir: First up, this financial year we’ve already hit three new 10-year highs. So how would you sum up what’s been taking place?

Julia Lee: I guess firstly when we see the market hitting these fresh highs, it’s a sign of strength and we often forget that. For example, if we have a look at the MSCI global index last year, it returned 20 per cent. And when we’ve seen these double-digit gains in the past, it has been a sign of strength. So since 1970, we’ve seen 25 times where we’ve seen double-digit growth. And amazingly in 19 out of those 25 times, it’s been followed up by another positive year of growth. So at the moment, global growth had a 7-year high, earnings growth in the US quite strong. And the market hitting these fresh multiyear highs is a sign of strength for investors.

Jessica Amir: Of course it all comes despite trade war fears as well?

Julia Lee: Absolutely, look the fear is at the moment from an economic perspective, or a macro economic perspective. And we go from this beautiful scenario of rising inflation and rising growth, which is fantastic for equities, into the next phase. And the next phase is where inflation is still rising, we’re still seeing growth, but we’re still seeing slowing growth. And of course, this scenario isn’t as good for equities as the last phase. So everyone’s trying to pick that inflection point at the moment and that’s causing quite a bit of volatility, in terms of the market. So at the moment, I’d still be focused on growth, probably about 70 to 80 per cent, but look to a rotation into some of the more value defensive areas. And slowly move my portfolio towards that value defensive space, in the next 18 months.

Jessica Amir: And Julia, we’ve seen equity markets in the US, the three major indices hit all-time highs. When do you think our local market will see the same thing?

Julia Lee: I guess our markets firstly are different, especially from a taxation sense. In the US, the capital gains tax and the dividend imputation laws are quite different from here in Australia. So here in Australia, we do tend to pay higher dividend deals with those franking credits, because of our taxation laws. If you have a look at the all ordinaries or the S&P ASX 200 accumulation index, we actually reached fresh highs for the Aussie market in 2013. In terms of excluding that dividend out, we’re only 10 per cent away from record all-time highs. So look, if global growth remains on this trajectory and we are likely to hit that over the next 12 to 18 months.

Jessica Amir: At a macroeconomic level, what can we expect for the rest of the financial year?

Julia Lee: I guess the whole fear is that we move from that phase of rising inflation and rising growth, which is fantastic for equities and not good for bonds. Into the next phase, which is rising inflation and slowing growth. And some of the signs that we look for the market to be topping out, is an inverted yield curve. We are seeing a bit of a flattening out of that yield curve, but it is a very blunt signal. For example before the Global Financial Crisis, we first saw that flattening of the yield curve in 2004. So it would have been too early a signal for investors to act on.

But other things we watch is the breadth of the rise, how many stocks are participating in these all-time highs in the US. Are we seeing a narrowing of those companies participating in that? And are we starting to see some of those value players or defensive areas, starting to outperform the momentum and the growth areas? For example, the MSCI’s up around about five per cent for the global share market this year, and the consumer stables area is up 13 per cent. So signals like that are a signal that perhaps you should start tilting your portfolio, and slowly moving it more into those defensive areas; still growth focus but a slow shift and a slow rotation.

Jessica Amir: Thanks Julia, so now over to you Michael. Amid the trade war, what sectors and stocks do you think we should be eyeing for this financial year and beyond?

Michael Gable: One of the obvious sectors is the steel sector. So of course when it comes to Trump’s tariffs, Australia has an exemption for the steel sector. So investors at the moment are looking at BlueScope (ASX:BSL) as one potential play. But the other thing to bear in mind is Chinese demand. So Chinese demand for US goods might change due to the tariff war. So that might mean that Chinese demand will shift over to Australia. So we’re looking at education, LNG Limited (ASX:LNG), even agriculture. So they’re sectors that are worth keeping an eye on.

But just one point I’d make is I think a lot of investors need to bear in mind that with Donald Trump, part of his tactics is to go in hard when it comes to negotiation. So even though he’s saying one thing now, we don’t necessarily believe that that will be the case in a year from now. So investors shouldn’t get too, I guess, overweight these sectors in belief that there will be this huge tariff war, because it might not eventuate.

Jessica Amir: Changing pace now to resources, which have been exploding, tech has also been boding really well. But what other sectors do you think we should be looking at?

Michael Gable: Resources definitely I think still has further upside. So there’s been a lot of momentum there, we’ve seen some great price increases for commodities. And in an environment where inflation does kick up as Julia alluded to, resources is a good place to be, energy stocks as well. So I believe there is still further to run there, your stocks like BHP Billiton (ASX:BHP), Woodside Petroleum Limited (ASX:WPL) etc, very happy with where they are going.

And in terms of the tech sector, at the moment it does look like there is further upside. But we did have those initial warning signs in the US, where Facebook and Twitter dropped 20 per cent. The problem with the tech sector of course is that because those companies are so large, they have a large weighting within a lot of passive ETFs. So the next time we get a sell-off in those stocks, the concern is that the ETFs start redeeming as well and that could lead to a massive fall. So for the moment I think they’re okay, but I think the next time we see a big sell-off in the tech stocks, we do need to be concerned.

Jessica Amir: So what other sectors should we be looking at Michael?

Michael Gable: One of the things, which I think had an affect on the dynamics of the market this year, could be unexpected inflation. So resources of course do well when you have high inflation, other sectors are utilities and consumer staples. And just one other thing to bear in mind is I’m getting a lot of questions from investors about, if Bill Shorten becomes Prime Minister and what he can do to franking credits. So if that’s the case, apart from US stocks, investors should also start to look at stocks, which have a high yield and not necessarily any franking. So that case again, you’ve got utilities and potentially property stocks, listed real estate trusts. They could probably do fairly well, if we get a change of Government and we start to get some interest in these other sectors.

Jessica Amir: Thanks Michael and lastly guys before we let you go. What stocks do you think are attractive at the moment, or for the rest of the financial year and why?

Julia Lee: I think a key thing is going to be those corporate tax cuts over in the US, and the weakening Aussie dollar against the US currency. So given that backdrop, we’ve already seen a move by Amcor Limited (ASX:AMC) to increase those US dollar earnings. And I think that’s going to be a key factor when it comes to investing this year. That we will see some of these companies moving to the US, for the lower tax rate and it makes sense.

So if you’re looking at expansion, there are already companies expanding over in the US. These include stocks like BlueScope Steel, Afterpay Touch Group Limited (ASX:APT) as well. So these types of companies that are going to be able to take advantage of that lower corporate tax rate, which will naturally give them an advantage. And then also the currency rate working in their favour as well.

Jessica Amir: What about you Michael?

Michael Gable: I think in addition to that theme, again the inflation theme, resource stocks. So I like BHP (ASX:BHP), I’m still happy to buy any energy stocks on any dip. Apart from that, I like companies such as Cimic Group (ASX:CIM), Seven Group Holdings (ASX:SVW), Costa Group Holdings (ASX:CGC). So there are a few companies out there, which I think are looking good right now. But again, as we get into next year and if inflation does start to pick up, we do need to change the strategy and be fairly nimble.

Jessica Amir: Thank you so much for your insights. Julia Lee, Michael Gable thank you.

Julia Lee: Thanks Jess.

Michael Gable: Thank you.