About a month ago, we highlighted here an opportunity that was emerging in the healthcare sector, which had been going in the opposite direction (down) to the general market since the big reflation pivot in November 2020. At the time, the chart seemed to be suggesting that it had bottomed, and buyers had moved in to snap up some of these high quality businesses which according to our ASX200 research table, were showing some value compared to Lonsec’s assessment of fair value.
In terms of how that’s going, so far so good, with the sector continuing to move higher since then. Looking at the ASX200 research table and screening for Healthcare, we see that a number of names are still trading under their fair value (i.e. the price to value ratio is less than 1). That’s not entirely surprising, because when reflation is the dominant regime that the market is trading with, healthcare is not historically an outperformer but can provide some entry opportunities for investors thinking longer term.
This time around, we are going to use the same process steps to look at one of the main beneficiaries of the reflation trade – specifically the banks and financials. We’ll look at the macro view, then the sector analysis including trends and our fundamental view, then the company specifics including price vs fair values and recent company updates, plus an added bonus of a forward looking model for financials to help add to the decision making framework.
The starting point when looking at sector analysis is always looking at what is going on at a macro level, and understanding the ‘macro regime’ we are in. Macro factors play a HUGE role in sector outperformance, and is one of the most misunderstood and under-appreciated aspects of the investment process.
For many months now, we have been re-iterating in the member’s weekly Portfolio Strategy Update that the data confirmed in early November 2020 that reflation (rising growth + rising inflation) was the dominant economic regime for both Australia and the US (and most of the world for that matter). Markets started trading strongly in that manner as a confirmation signal, and cyclical exposures started to outperform for the first time in a long time. In particular, this is the regime where upward pressure starts to build on bond yields (specifically the closely watched benchmark 10 year Government bond yields). And what are one of the biggest beneficiaries of rising bond yields? Banks and financials.
Note for the future: whenever the aggregate data flips in to the ‘reflation’ regime and global markets start to trade this way as confirmation, banks and financials should be on every investors radar.
Once we have a handle on what is going on at a macro level, we can then turn to the sector level. In our weekly ASX Sector Updates, we show 1 year charts and multi time frame performance tables that enable investors to clearly see which sectors are trending (or breaking trend) and in what direction, plus a Fundamental View, explaining our thoughts on the sector.
Here is what currently appears for Banks in the ASX Sector Update in the members section:
PRICE PERFORMANCE: (as at 21/05/2021)
|Sector||1 week||1 Month||3 Months||6 Months||1 year|
TREND: medium term uptrend intact
FUNDAMENTAL VIEW: banks (and financials generally) have historically been a sector that likes the “reflation” economic regime that we are currently in, and this has once again proved to be the case this time around. Banks have been moving higher since October 2020 in a consistent fashion as 10yr bond rates have moved up (higher rates are good for banks) and as global markets really started to price in the reflation regime into global asset markets. The banks have reported a number of positive factors recently, and are benefitting from moving to dividend renormalisation, the continued rotation trade out of Growth and COVID beneficiaries and into cyclical stocks, loosening lending standards with a boom in housing and the resultant loan growth, the Treasurer asking regulators to ease off on the sector, bank CEOs talking about improving conditions, the rise in bond yields, and the big Government stimulus in the Federal budget. These have all conspired to the upside for a boost in investor sentiment in the banks, which can be seen in the clear medium term uptrend of the sector.
As you can see from the chart above, from November 2020 its been bottom left to top right. Just a constant grind higher with little volatility. An absolute classic reflation trade. The question now is – is there any value left in it ?
There is no doubt that the ‘easy money’ has been made. Long term holders of banks will certainly be pleased, as the recent strong performance helps offset the ordinary performance banks have had to endure for a few years now (even prior to COVID).
Lets have a look at the ASX 200 research tables. Screening for Financials provides a longer list, but if we also screen for market cap greater than $50 billion, then we get the following table which just includes the big 4 banks plus Macquarie. We then rank them by value, by clicking on the ‘Price to value Ratio’ column. The lower number means better value.
As we can see, CBA is currently trading at a bit of a premium (as it normally does), while the others are still trading below Lonsec’s fair value with forecasted fully franked gross yields of over 6% for ANZ, NAB, & WBC, suggesting the market has not gone overboard just yet with this re-rating of banks and that prices are still sensible versus valuations.
When a sector is highly sensitive to macro factors (such as interest rates etc), then macro modelling can help us to identity times of opportunity and of higher risk. The following chart shows the ASX 200 Financials sector vs a multi-factor model that includes macro factors that act on a lag to the real economy, and are quite specific to the financials sector.
The orange line is the Financials sector. The blue line is the model. As you can see, its done a pretty good job over the past 8 years of identifying probable future directional trends and points of inflection. Note that its NOT meant to mirror it tick for tick, but rather just identify periods of time where macro forces are working for or against the sector. The current setup is suggesting that the probability favours that this run has still got some legs as previous stimulus in the pipeline continues to work in the favour of financials, but starts to run into some chop around August this year, and ultimately peaking early next year.
As with everything, no one model is fool proof, and should not be relied upon in isolation. It is simply a further piece of evidence to be weighed up in the overall decision making process. The rate of change of the high frequency data will give us the earliest read on any change at the margins in the economic regime, and the market will start to price that in when it sees fit (sometimes it front-runs it). Our job as investors is firstly to be aware of it, and secondly to be alert to the changes as they happen. Our weekly Portfolio Strategy Update and ASX Sector Updates will alert members to these changes.
Having looked at the macro and the sector analysis, the next step is to look at company specifics. Here are the extracts of ‘last major event’ taken from the Viewpoint Reports (which are found in the ASX200 Research table) for ANZ, MQG, and WBC, all of who have recently reported results this month.
ANZ: In May’21 ANZ reported a solid 1H21 result underpinned by a higher than expected NIM and dividend along with a net credit provision release of $491m. Cash earnings were $2.99bn up 28% on the half with EPS up a similar amount to 105.3cps, whilst ROE improved 2.1% to 9.7%. ANZ’s NIM benefited from lower funding costs due to increased deposits and term deposit rolls offs, increasing 3bps to 1.6%. Expenses were also well managed falling 1% on 2H20 with a further $900m in costs to fall over the next two years. ANZ noted that 42% of retail sales were completed digitally compared to 30% in FY19, with this expected to be closer to 70% in FY24. A dividend of 70cps was declared and ANZ’s strong CET1 position of 12.4% provides them with potential capital return opportunities. Valuation upgraded.
MQG: MQG reported solid FY21 results in May’21 with net profit up 10% to $3,015m vs pcp. The result was driven by a 56% net profit increase for CGM as MQG’s Commodities platform benefited from trading across Resources, Nth American Gas & Power, EMEA Gas & Power and Agriculture. BFS’s performance as solid and inline with FY20, reflecting growth in deposits, loan portfolio and funds on platform, but offset by margin compression and vehicle finance. MAM NPAT fell 5% on lower performance fees, AirFinance income and commission. We have increased our valuation as MQG’s revenue streams become more annuity based benefiting from ultra low interest rates.
WBC: In May’21 WBC reported a stronger than expected 1H21 result with core earnings improvement and a better than expected NIM. Cash earnings were up 119% to $3.5bn on the half with EPS more than doubling to 97cps. NIM improved 6bps to 2.09%, benefiting from lower deposit rates and term deposit run offs and ROE improved 5.5% to 10.2%. Notable was a plan to reduce their costs base by ~20% to $8bn by FY24, via branch reduction, lower compliance costs and non-core divestments. In light of this costs were up during the half and WBC is lagging the market in loan growth, with investor and business & institutional lending contracting in the half. We have raised our valuation taking into account economic tailwinds, but wary of cost expectations and lending growth.
Just like we did with Healthcare, the above work flow is a classic way to use the research that The SMSF Investor provides to find opportunities:
There is no fail safe, perfect set up, however a step-by-step process like this (which marries the top down macro with the bottom up micro in a linear way) greatly assists investors to reduce the risk of being in the ‘wrong place at the wrong time’, and to find the opportunities when they appear.
Author: Graham Parkes
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