Charlie Jamieson, Chief Investment Officer at Jamieson Coote Bonds, discusses the market and performance of high grade bonds in January 2021.

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Chief Investment Officer, Steve Johnson, is joined by Alex Shevelev, Senior Analyst on the Australian Shares Fund, as they discuss the factors contributing to a strong start to the year for Australian retailers including JB Hi-Fi and Super Retail.

Forager Australian Shares Fund

Forager International Shares Fund

Transcript:

Steve

Hi everyone and welcome. It's Steve Johnson here, Chief Investment Officer at Forager Funds, bringing you our first video for 2021. I'm joined by Alex Shevelev, Senior Analyst on the Forager Australian Shares Fund. Hi Alex, how are you?

Alex

Hi Steve, hello everybody.

Steve

It's been a bumper start to the year for Australian retailers, lots of them out early in 2021 talking about some very buoyant Christmas trading. We saw JB Hi-Fi, Super Retail, a couple of stocks that we own small positions in our portfolios such as Shaver Shop and Michael Hill pretty consistent across the retail industry, making lots of money.

Alex

It's been a great time to be a retailer. All that money that we saw that's not going towards international travel and a lot of the money that's coming from government stimulus is ending up in the coffers of some of these businesses and the revenue growth has been absolutely staggering for what are already some pretty large businesses. Supercheap and JB Hi-Fi group grew 23% and 24% in total revenue and that's including the fact that some of these stores were shut down for a period during that half.

Steve

I remember doing an analysis of JB Hi-Fi probably 10 years ago, questioning whether it could ever get to $10 billion of sales given the amount they Australians spend on electronics. But we've seen through this past period, they just keep taking market share and also the market keeps growing. The big thing though, has been profit. You talk about sales up 20%, but profit numbers are up a lot more than that.

Alex

In some cases they're up 80% plus and the reason here is twofold. Firstly, we've got increasing gross margins. So the retailers have managed to tick up the sales prices of their products ever so slightly relative to their costs. That might only be a couple of percentage points and you may not see it necessarily in your purchases but for a retailer that makes maybe a high single digit margin that is a really big change.

Secondary to that, you've then got all those extra sales, all that extra gross margin coming through and the operating costs of these businesses have stayed largely similar. So you're getting a double benefit there.

Steve

I think as a well-run retailer, you might be talking sort of 6% to 8% margins at the bottom line. So as you can add 2% at the gross margin level, that's having a fairly dramatic impact on your profit. Maybe a bit counter-intuitively retailers are talking about it being difficult to get goods into the country, from China in particular, with lots of capacity constraints in shipping. It's probably been a good thing net for them because there's less competition and lots of demand and it's enabled them to put those gross margins up a little bit. Now the share price reactions have been muted using profit here up 80% and 90% on stocks that were not trading on crazy multiples to start with.

Yet we've seen share prices, maybe up 5% or a bit more on the day and retracting a bit over the days after that. What's going on with the bumper results coming out way above everyone's expectations and share prices not really moving?

Alex

These retailers had run up to some extent already. There was already an expectation that there was going to be more revenue flowing in. However, it is higher than people expected, but that increase is limited, or appears to be limited in investor's minds, to this first half of the year and potentially subsequent couple of months. These businesses are not necessarily getting credit for this level of profitability continuing.

We're going to really get to see that in the first half of next financial year, how these businesses end up relative to the half they've just had.

Steve

I'd probably say we agree with that. That's a sensible reaction from the market to say this is clearly unsustainable, both at a sales level, people are going to start spending money on travel and other things again, towards the back end of next year. Probably most importantly, you would assume these to come back to something more normal eventually.

Alex

That's right. There are some things that have changed though for some of these retailers and Shaver Shop is a good example of this. There has been a transition to online and the businesses that have really been able to seize the opportunity in online and transition some of their offline sales to online should be better positioned for that come next year.

Shaver Shop for example, has seen its online sales percentage tick up from 10%, two years ago, closer to 30%. Now that's a big change for a business like that.

Steve

Yeah and I think you've seen some of these businesses manage that transition well. Shaver Shop is up to more than a third of its sales through its own website online. They're delivering those through the store network. But it says to me that all of that brand awareness they have, when you think I want to buy a shaver, where do you go? The money that's been spent on that over all these years is worth something. As long as you can get your offering right online, you're not actually seeing the likes of Amazon kill these businesses. In fact, they're doing quite well online.

Alex

That's not the only thing that's happening though. There's a secondary aspect of it and that is that this period has really been a shake up for a lot of these industries.

So you've got, for example in the jewellery space, some competitors that might struggle more than the listed player Michael Hill. In that situation you might be taking sales off competitors. Eventually, like we had seen with someone like Baby Bunting, over a long period of time those competitors might fold and you might capture more of those sales.

In other situations that shake up has really been a COVID affected shakeup, but with implication over a long period. So personal travel on motorcycles for example, is likely to be a bigger feature going forward as people remain a little bit hesitant of public transport, and that's really feeding into a Motorcycle Holdings result, which probably is not going to be quite as good as our bumper first half of 2021, but has a good chance of being better than the prior years as that industry is really shaken up.

Steve

I think people are actually underestimating how difficult the environment was for the three years leading into this COVID meltdown. Retail in Australia has been really hard. You've had costs marching up slowly while revenue has not been growing at all across the whole sector and this leakage to online going on at the same time. I think you've seen some of those businesses do a great job of consolidating in their industries and I don't think we're going back to 2019 levels of profitability.

There's no doubt that this year is going to be an anomaly on the high side. But I think people are looking back and saying, well I'm going to apply a multiple of 2019 earnings. In my view, that might be a bit too conservative given where share prices are at the moment. So still some really interesting opportunities out there in the space and still a meaningful part of our portfolio.

We're looking forward to hearing those and other companies give us further updates through February as our Australian portfolio reports results. Thanks for tuning in, and we'll be back with some regular updates over the next month as we get all of those results.

ARE RISK MARKETS ENTERING A CORRECTION ZONE?

Chris Manuell, CMT, Jamieson Coote Bonds

5 February 2021

The market adage of January being the barometer for equity market performance for the year will always get tossed around as investors outline their roadmap for the year ahead particularly coming off the historic events of 2020. The RBA may also be paying particularly close attention to the performance of the US equity market given the strong marriage of the pair since the nadir in risk markets last March. The RBA governor could become a fan of seasonals, with strong statistical evidence that the S&P 500 Index performance for the start of the year drives returns for the remainder of the year. With this in mind, the S&P 500 Index fell -1.11% (for the first month of 2021) in price terms and Deutsche Bank has studied data going back to 1872 that shows negative first months of the year have a strong impact on the performance for the remainder of the year, with 58% resulting in down years.

The RBA will be very disappointed that after embarking on an aggressive QE campaign it has failed to generate the transmission mechanism into the exchange rate that it would of anticipated - an 8% rally since November 2020 would have figured deeply in the surprise move to extend QE by another 100 billion of bonds or 5 billion a week for a further six months. The currency has managed to continue on its ascent with the global liquidity pump switched on full power mode driving a strong performance in commodities markets - with iron ore 22% of our exports - and domestic data surprising to the upside as the fiscal cheque book keeps printing alongside a successful Covid-19 suppression strategy.

The weakness of the USD has also played its part in providing a tailwind for the AUD which will stymie any attempts for the RBA to achieve its overly optimistic target of getting inflation consistently in the 2-3% target band. The RBA is not alone in lamenting the weakness in the USD with the ECB continuing to talk down its currency as USD strength will continue to undermine global economies' attempts to escape a post-Covid world.

We monitor price action, sentiment and investor positioning as part of our rigorous investment framework and within that there are some subtle signs that indicate that risk markets may be entering a zone where they could pause or correct from their recent moves.

The record short positioning in the USD is a dangerous development with the market all on one side of the boat leaving it very unstable and vulnerable to any unexpected shocks which can generate aggressive unwinding. 

The below chart highlights the historically stretched positioning of USD bears which will make it difficult for another secular leg lower in the USD currency as sellers become exhausted.

Source: Bloomberg

The robust correlation between the AUD and risk markets is well documented and is interesting to note that the price action of late has showed some signs of that marriage starting to sour which provides investors with a salient reminder of the old risk-on/risk-off nature of financial markets and of the possibility that the text-book philosophy of interest-rate differentials may become in vogue again in 2021. The intention of the RBA to weaken the currency with its outsized bond buying program might finally gain some traction if the US/Australian yield differential reasserts its downward trend. Careful what you wish for, as a weaker Australian currency could also suggest trouble lies ahead for risk markets in general.  

Performance of Australian Dollar (RHS) and US Equities (LHS)

Source: Bloomberg. Past performance is not indicative of future performance.

CHINA IS NOT GOING TO SAVE THE WORLD THIS TIME

Marcel von Pfyffer, Arminius Capital

4 February 2021

In November 2008 a panicked Chinese government launched a stimulus package equivalent to 12% of then GDP. The package propelled China out of the GFC, but it created more problems than it solved, e.g.:

• A tenfold increase in corruption.
• Useless or non-economic projects: "bridges to nowhere".
• A surge in banks' bad loans.
• A sharp increase in the ratio of debt to GDP.
• Unsafe buildings, and highways that collapsed.

The current Chinese government is not about to repeat this mistake. Its response to the GFC has been modest, focusing on maintaining public sector investment and propping up the banking sector. Households have been left to fend for themselves, with no support payments like Jobkeeper or Jobsaver. Many small businesses have closed permanently, and many low-skilled workers and new graduates have been unable to find jobs. Households' need to draw down their savings means that, even for those who still have incomes, spending remains subdued and consumer sentiment remains cautious.

The IMF forecasts GDP growth of 1.9% in 2020 and 7.9% in 2021. Although this level of growth is better than most of the world, the Chinese economy is still operating well below potential, with more downside risk than upside:

• The central government may cut back spending too soon, before private sector capex has strengthened enough.
• Many small rural and regional banks still have weak balance sheets and rising bad debts (especially related to local governments), so that further runs and collapses are likely.
• Corporate bond defaults spiked in 2020, and 2021 will see even more defaults, particularly in the property sector.
• Decreasing credit quality may cause solvent banks to tighten loan criteria, reducing the availability of finance to the private sector.
• China's strong export performance was strong in 2020, but in order to continue it relies on sustained economic recovery in the rest of the world.
• The US trade war and "technological decoupling" may worsen profitability and employment in several Chinese sectors. So far, the Biden Administration seems to be continuing Trump's hard line on China.
• In the immediate future, Chinese authorities are hoping that the annual Spring Festival migration will not trigger more coronavirus outbreaks.

For Australia, a slowdown in the Chinese economy would be very negative. More than a third of our exports go to China, and another quarter go to China's Asian neighbours, whose economies are also linked to China.

South Korea is the country that China imports most from, at US$203 billion, with Japan second at $180 billion and Taiwan third at $177 billion (although China may not agree that these are cross border flows). Just off the podium stands the US in fourth place at $156 billion, with Australia coming in sixth place at $105 billion - remembering that America started a trade war based on these figures (a mere $51 billion difference between US and Australian numbers).

When viewing the trade balances (below) between China and the rest of the world we understand far better the precarious position Australia is in. Although, commodities are in finite supply around the world with only a few other countries physically able to step into the breach should China make the political decision that they would no long wish to purchase Australian commodities.

In light of current political tensions between China and Australia, and Australia's over-reliance upon China as its primary export market, policy makers and diplomats both need to ensure that their current strategies are robust enough to ensure that Australia does not also sneeze should China catch a cold.

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