3 Aussie sectors set for an outstanding year

James Gerrish

Market Matters

To earn an income of $100,000 per annum before tax in 2012, a conservative investor needed $2 million in a 12-month term deposit. Today that number sits at an incredible $14 million. On the flip side, those borrowing $1 million in 2012  were paying $3,300 per month on interest repayments; today that number sits around half that. If you take one thing away from this note, it’s that the cost plus the availability of capital has a huge impact on the price of things.

Sure, other factors come into play and there are times when external shocks will skew this relationship in the short term given swings in market sentiment – market noise we call it – but the cost of money should not be underestimated. As we enter 2021, cheap money combined with a number of other supportive factors could create a rare and very profitable sweet spot for equities.

By now we all know that official interest rates are at record lows and central banks have their foot on short-term bond yields which are pinned effectively at zero. They’re also saying (collectively) they’ll provide whatever liquidity is necessary to underpin the economic recovery as the world lifts itself out of the COVID-19 haze, obviously with the help of a vaccine in 2021. Australia is ahead of the curve by a long way, initially from a health perspective and that’s now filtered into a better economic outcome, helped by an unprecedented level of monetary and fiscal stimulus that has now become misaligned with reality i.e. an economy being overstimulated.

One measure that warms my heart has been the Australian labour market, which has bounced back strongly. A resurgence here is key and recent signs are extremely positive. That trend will keep a fire under implied inflation expectations and markets are now pricing negative real rates (inflation ahead of interest rates) for the next 10-years. In that environment, most stocks do well.

Australian RBA Official Cash Rate Chart

While at MM we always keep an open mind, we’re very bullish equities into 2021

What sectors to own given this backdrop: We like banks, resources, energy and building. This bodes very well for the Australian market overall, with the first two sectors accounting for more than 40% of the ASX 200, while the same two sectors in the US make up less than 15%. The composition of the Australian market implies local outperformance is coming, for the first time in over a decade.

ASX 200 Chart

Below we outline our top picks across our preferred sectors, 1 = low risk, 2 = moderate risk and 3 = high risk.

Top picks – Banks

  1. Commonwealth Bank (CBA) $79.07: Not an earth-shattering pick, but we’ve bought banks well when they were on the nose during the pandemic and see prices continuing to rally for the next 6-12 months at least. CBA back to the mid-$90s remains our view. Banks borrow short and lend long, benefitting from a steepening yield curve at a time when loan growth is likely to surge. We are bullish banks.
  2. Wells Fargo (WFC US) $28.46: A diversified financial services operation in the US which has almost halved over the past 12-months now looks set for some ‘mean reversion’. We are bullish targeting ~$40
  3. Virgin UK (VUK) $2.35: The UK remains in the gips of COVID and Virgin has suffered as a consequence. While a low-quality operator, it’s priced accordingly and has significant upside potential on an economic recovery in the UK. We are bullish VUK targeting $4.

Virgin UK (VUK) Chart

Top picks – Building

  1. Lend Lease (LLC) $14.35: Is in the sweet spot as property values rebound strongly and governments focus on infrastructure development, we are targeting ~$17
  2. Monadelphous (MND) $12.86: Skewed more towards engineering and construction in mining, our initial $13 target has been reached however a strong pipeline of work brings the $18 region into play.
  3. NRW Holdings (NWH) $2.65: The mining and civil construction services provider has enjoyed a strong recovery since March, however, this is a stock that is likely to benefit from a strong top line, magnified by a multiple re-rate. We have an eventual target of ~$4

Monadelphous (MND) Chart

Top picks - Energy

  1. Exxon Mobil (XOM US) $US40.19: A tough five years for the global energy giant, we now expect a period of outperformance as Oil prices permeate back to $US60, our upside target is close to $US50
  2. Beach Energy (BPT) $1.78: We believe the company may be able to capitalise on distressed asset sales over the coming period as well as gas growth opportunities in Western Australia, we remain bullish targeting $2.20
  3. Paladin Energy (PDN) 14.5c: Lack of investment in the Uranium sector for around 10-years could see a price inflexion in 2021. This is a high-risk call option on a beaten-down sector. If it runs, it will run hard.

Beach Energy (BPT) Chart

Top picks - Resources

  1. BHP Billiton (BHP) $38.25: The old “Big Australian” is exposed to the right commodities at the right point in the cycle, and looks poised to make fresh multi-year highs. We are bullish targeting ~$45
  2. South32 (S32) $2.41: One of our more recent purchases, S32 houses an eclectic suite of resources, the bulk of which have been under pressure, but they’re turning. We remain bullish, initially targeting $2.80
  3. Orocobre Ltd (ORE) $4.15: Lithium stocks have now worked through the hype created in 2017/18 and are finally looking good, ORE is our preferred exposure. We are bullish targeting $5.50

South32 (S32) Chart

Adding an ‘X factor’ around the edges

We’re always looking to add some ‘X factor’ to our portfolios, whether that be in terms of sector tilts or specific stock calls. Stocks we have on our ‘X Factor’ screen for 2021 include Fineos (FCL), Dubber (DUB), Adore Beauty (ABY), Money 3 (MNY), Zip Co (Z1P), Matador (MZZ), Strandline (STA) and of course our best performer in 2020, The Trade Desk (TTD US) which remains a core holding.

While we remain bullish into 2021, we are likely to see bouts of volatility that present opportunity for 5-10% corrections, these are regular events even in bull markets. Given our bullish bias towards stocks, we prefer to hedge broader market exposures via ETFs rather than risk losing our core equity positions.

The bottom line

The one thing investors can’t ignore in 2021 is the cost of capital, while it remains cheap stocks will remain supported, however, there will be an inflection point. While we are bullish for 2021, we can see next year being one where investors become complacently long stocks and when interest rates do start to rise, this will present a clear and present danger. Above all, remain open-minded and willing the take action when market dynamics change.

One thing investors can't ignore in 2021

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James Gerrish
Portfolio Manager
Market Matters

James is Portfolio Manager & Primary Author at Market Matters, a daily investment report with over 2500 subscribers that offers real market insight. He is also Senior Portfolio Manager within Shaw and Partners heading up a team that manages...

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