Why we definitely prefer the active over passive approach into 2020

James Gerrish

Market Matters

Bond yields continue to be the tail that wags the stock market dog whether it be the overall index, or the specific sectors that are swinging in / out of favour. When US 10-year bond yields have fallen below 1.5% on recession fears it’s been good news for the yield play stocks like Utilities and Real Estate, conversely when the Fed was hiking rates in 2017 /18 on concerns the US economy was growing too fast the resources enjoyed a stellar run.

We’ve already seen 3 inflection points for US 10-year yields in just 3-years which has given rise to huge divergence in sector performance over this period. We believe this will continue as central banks / governments fight to maintain post GFC global economic expansion, staving off a much discussed potential recession in the process. We believe it's time for fiscal stimulus from governments as central banks run out of monetary policy ammunition – there’s not many cuts left for the RBA from 0.75%, plus as CBA reported yesterday only 7% of its borrowers reduced mortgage payments as rates have fallen, this clearly doesn’t stimulate spending.

We can see US 10-years oscillating between 1.25% and 2% in the months ahead with both extremes likely to have significant impact on which sectors are in vogue.

US 10-year bond yield Chart

We're looking for some mean reversion from the growth vs value elastic band into 2020 and beyond, this by definition implies we believe the bear market for interest rates is reaching its conclusion but note that doesn’t mean we necessarily expect rates to rise just yet, but just stop falling.

If we actually get “close” to the very influential US 10-year yield chart, our preferred short-term scenario is one final dip down towards 1.25% before a more sustained rally - this would imply one last spike for sectors like Utilities, Real Estate and Gold but we remain very mindful that it feels like the end of the road is getting close, hence we are monitoring our gold exposure very closely.

This very same potential rotation of bond yields is why we expect the pronounced sector rotation theme of recent weeks to be ongoing, providing excellent opportunities for the active and nimble i.e. buy risk below 1.5% and buy defensives around 2% in the short-term but longer term we have no interest in the crowded defensive space.

We prefer the Value Index over Growth into 2020.

S&P500 Growth & Value Indices Chart

Due to our view that stock / sector rotation will dominate the market into 2020, readers should expect a lot of focus on individual sectors followed by the actual stocks under the hood.

Recently we bought Service Stream (SSM) and NRW Holdings (NWH) after turning bullish the Capital Goods Sector while we are now out of the Healthcare Sector because we feel it’s too owned and very rich from a valuation perspective. This “call” with regards to these 2 sectors is still in its infancy but as the chart below illustrates it’s a very stretched elastic band.

We will continue to look for areas were we think fund managers will almost be forced to invest as their cash levels continue to grow – when a stock / sector comes back onto investors radar the impact can be dramatic on the upside.

ASX200 Capital Goods & Healthcare Sectors Chart

It’s not just sectors that are experiencing some pick up in volatility, it's also happening on the stock level as fund managers look for places to put their burgeoning cash levels to work but they’re equally as prepared to jump off the train when things feel too hot, or in other words we currently have a very fascinating but fickle market on our hands.

Just consider the previously “hot” Australian WAAAX stocks – Wisetech (WTC), Appen (APX), Altium (ALU), Afterpay (APT) and Xero (XRO). They could do no wrong over the first 6-months of 2019 but in recent weeks there’s been some significant pullbacks across the names with APT and WTC both down well over 20% in the last month – our simple point is be prepared to take profits when stocks hit our / your targets as they might vanish as quickly as they materialised.

ASX200 Software & Services Index Chart

I have briefly looked at 2 stocks in the MM Platinum Portfolio that are threatening to hit our target area into Christmas and not surprisingly we will take the $$ if the opportunities do present themselves. 

It's always important to remember that there’s 2 components to buying shares – the quality of the business and the price of the stock, we see no reason to chase excellent companies at silly prices in today’s market – that almost has us in the minority!

1. Fortescue Metals (FMG) $9.01

Market Matters is enjoying a solid performance from Twiggy Forest’s iron ore producer FMG, we’re already up over 25% but another ~8% feels likely in the coming weeks. While we are keen to lock in profits when they present themselves in today’s volatile market its important not to get too itchy a “sell finger” while things are moving our way.

MM is bullish FMG targeting a break of the 2019.

Fortescue Metals (FMG) Chart

2. BlueScope Steel (BSL) $13.02

BSL is another stock who should benefit from positive noises from US – China trade talks, we remain bullish targeting the $14.50 area but again we will be sellers here.

MM is targeting the $14.50 area for BSL.

BlueScope Steel (BSL) Chart

Conclusion

We remain cautiously bullish the risk on sector but we will take our $$ if / when our respective target areas are reached.

Due to the likely oscillations of bond yields as markets rotate between optimism / pessimism around the global economy we prefer active investing at this stage of the post GFC bull market.

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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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