Making smart traders smarter

Navigating uncharted waters

3rd April 2020
Navigating uncharted waters
Jessica Amir
Market Analyst
Bell Direct

Making sense of recent market events

In the space of just a few months, the state of the Australian and global economy has shifted greatly. We are living in unprecedented times and the world is trying to make sense of this strange new reality.

The rapid development of the COVID-19 outbreak has held the spotlight for the last few weeks, following a series of unexpected local and global events in 2020. In the midst of recovering from the catastrophic Australian bushfires, the February reporting season fell below expectations as companies in the resource sector failed to deliver.

This was followed by global markets moving in rollercoaster-like patterns, predominantly driven by the oil price war between Russia and Saudi Arabia. With these historic events almost overlapping each other and taking place within such a short time frame, it’s no wonder markets have been acting in disarray.

Even prior to the COVID-19 crisis, market indicators were all pointing to a “late cycle” stage of the economy. With the recent outbreak impacting every global economy, growth has slowed significantly and reignited fears of a global recession. In a move to ward off a recession locally, the Reserve Bank of Australia (RBA) has made an emergency cut to interest rates to a historic low of 0.25 per cent, moving the country closer towards a quantitative easing program to offset a drop in employment and gradually lift inflation to that 2-3 per cent target band.

Fiscal stimulus has also been implemented by the Australian government, specifically targeted at supporting households and SMEs that are most likely to be affected by the economic repercussions from COVID-19. As the crisis worsens, it is expected stimulus will continue to come – and with it, the government’s hopes of delivering a budget surplus long gone.

In this current environment, it’s no wonder sentiment across the board is pessimistic. With the outlook for the coming months remaining uncertain, it’s important for investors to remember that Australia has had 27 years of consecutive economic growth. Although the long-term trend for markets is positive, market declines throughout the year are not unusual and after historical declines, markets have always recovered and posted gains. With this in mind, investors should consider taking this as an opportunity to go back to basics, with the knowledge this downturn won’t last forever.

Reacting during times of uncertainty and unrest

With constant 24/7 headlines, it can be tempting to reposition your portfolio in response to every announcement. In such times, it’s crucial for investors to remain steadfast and stick with long-term investment goals to avoid incurring unnecessary realised losses.

Tuning out market noise is a skill and investors who review their portfolio and rebalance in line with their overarching goal are often rewarded when the market corrects.

In order to stay on track, investors should avoid common mistakes during times of market volatility by sticking to the foundations of any solid investment strategy:

  1. Focus on an investment goal: Recall why you started investing in the first place and what your goal is. This purpose should be unwavering, regardless of market conditions. If you don’t have a solid goal, now is the time to create one. 
  2. Consider your timeframe: With your ultimate investment goal in mind, consider the timeframe needed to achieve it – short-term, medium-term or long-term.
  3. Keep costs low: With so many investment options now available, it can pay to shop around. If you value professional management, it can be worth paying more but it’s important to understand the fees you are paying and the reasons you are paying them. Be mindful of switching between investments too much while markets are volatile, given the likelihood of capital losses and ETF spreads have widened. Remember, there is no yearly management fee on stocks directly purchased for your portfolio. 
  4. Diversify: With market volatility at its highest point since the GFC, having a well-diversified portfolio is more prudent than ever before. It’s important to note the biggest impact on your overall portfolio return is your asset allocation. Most investors have a mix of growth assets such as shares and property in their portfolio, along with more defensive assets like fixed income and cash, and have exposure to both the domestic and global markets. Research shows that those with a balanced portfolio, across such asset classes have outperformed just an Australian share portfolio over the last 10 years, whilst also reducing portfolio volatility. 

Remember it’s time in the market, not timing the market that is key. Reviewing your portfolio and deciding not to make changes is still a decision!

Finding opportunities during volatility

Market volatility and downturns often present buying opportunities for investors, with quality companies trading at significant discounts. Seismic market activity can make increasing exposure to equities daunting – however, with major sporting events put on hold, gambling services on lockdown and the majority of drinking and dining options closed, what better way to use that discretionary income than by focusing on your investment portfolio and long-term financial goals.

With volatility set to continue for the foreseeable future (until travel bans are lifted and business returns to normal), picking the bottom of the market is difficult and even professional fund managers get it wrong. To mitigate the risk of incorrectly picking the bottom, investors can consider ‘averaging in’ over a period of a few months.

When exploring the market for opportunities in line with a long-term focus, investors should consider screening for quality defensive stocks. While it’s difficult to know how the next three-to-six months will play out, it’s important to focus on what we do know.

Quality companies with surplus cash, strong and predictable earning streams and solid governance are most equipped to ride out market volatility, particularly as the RBA’s rate cuts will force investors back into the market to search for yield.

Consider the ‘defensive’ companies that fit in these categories within the non-discretionary sectors such as healthcare, utilities and consumer staples. These sectors continue to outperform even in periods of low economic growth, uncertainty and volatility, as demand for their services is likely to grow. On the flip side, discretionary retail, travel, gaming, along with the mining and energy sectors face headwinds, grappling with constrained demand, with many companies forced to abandon earnings forecasts and cut dividends. Although they look cheap on a valuation perspective, the current environment points to quality, defensive stocks being more resilient.

From a healthcare perspective, investors could look at blood therapy and vaccine maker CSL (ASX:CSL), pathology, laboratory and radiological services company Sonic Health Care (ASX:SHL) and private hospital operator Ramsay Health Care (ASX:RHC). All have had a consistent rise in sales, earnings and core profit as they provide critical healthcare services to the economy.

Sonic Health Care (ASX:SHL) is the third largest pathology provider, owning brands such as Douglass Hanly Moir, Melbourne Pathology, Sullivan Nicolaides, Capital Pathology or Clinical Pathology depending on the state you live. The company has high free cash flows and low debt to equity, and is well managed. Its pathology services could be deemed as critical, with 85% of revenue is sourced from these operations.

In Australia, 50% of surgery is conducted at private hospitals and Ramsay Health Care (ASX:RHC) has 30% of the private hospital market share. From an ageing population to demand for surgery growing at 4% per annum, Ramsay Health Care is positioned well. Notwithstanding that, mental health services and rehabilitation demand continues to grow.   

For CSL (ASX:CSL), many of their products are essential in nature and without treatment, patients could be at risk of life-threatening complications. As a snapshot, almost 50% of sales are in the immunoglobulin market to restore patients’ immune systems and its flu vaccine business, Seqirus, contributes 14% of revenue.

Looking at consumer staples, unsurprisingly many consumer staples stand to benefit as people stock up on everyday items, shifting to working and cooking more at home. This is something we see as a behavioural shift in the market, not just for the near term. Companies to watch include A2Milk (ASX:A2M)Coles (ASX:COL)Elders (ASX:ELD)Woolworths (ASX:WOW) and Metcash (ASX:MTS), with many already seeing a share price boost in the last week.

Outside of these quality defensive stocks, other companies to consider include Brambles (ASX:BXB). It’s considered a ‘defensive’ stock as 80% of its revenue is derived from supplying food and beverage customers with reusable pallets, crates and containers for dry food, groceries, fresh produce, health and personal care products.  Another company to look at is Cleanaway Waste Management (ASX:CWY) which earns 75% of earnings from collecting, processing and disposing of household and commercial waste. Around 10-15% of its revenue is sourced from local council, multinational, large Aussie businesses and SMEs. Both companies have modest debt and low debt/earnings ratios compared to their peers.

In the utility sectorSpark Infrastructure (ASX:SPK) is a solid energy provider which pays regular dividends. It owns 49% of electricity distributing networks Victoria Power Networks and SA Power Networks, 15% of Transgrid and 100% of the Bomen Solar Farm in NSW.  Another stock to consider is AGL (ASX:AGL), one of the most synonymous energy providers in Australia. The company has low costs via its coal-fired power plants and is a steady and consistent dividend payer.  Both are examples of providers of essential infrastructure services with predictable earnings, regardless of the economic cycle. Both are positioned to benefit from increased demand as people spend more time at home, however it is important to watch if the government intervenes to reduce the cost of utility bills.

Remaining positive in times of uncertainty

In times of uncertainty, remember to stay positive, make measured decisions and focus on the tried-and-tested factors that make businesses worth investing in.

Investors who stick with a solid investment strategy and tune out market noise are often rewarded after a period of volatility. Remember, that history shows that markets are resilient and do bounce back. Most importantly during this time, stay safe!

 

This article was first published on the ASX.