Under the Radar Report

Market Insight: Buy Big Resources, Buy Big Banks

20 May 2022
Richard Hemming

Stocks priced for blue sky growth prospects are vulnerable. Look at the tech sell off and …retail. The bigger they are, the harder they fall. In the past few weeks the biggest names in American retail, Walmart, Target and Amazon have all dropped 25% in short order on first quarter results. In the same breath, investors are hoovering up stocks where they see value, such as Westpac Bank (ASX:WBC), which has climbed 7% since we tipped it a Buy in February (11 Feb 2022, Issue 97).

More on that later, but back to the retailers. Inflation is eating away at profit margins and these retailers, A. over-estimated demand with fat inventories, B. face rising operating costs, and C. also serve a consumer who is spending more on mortgage rates and gas (petrol).

How does this impact the ASX?

Much of this is true in Australia. Wesfarmers (ASX:WES) is vulnerable through its Bunnings powerhouse. WES was down just under 7% yesterday and is down 11% so far this year, against the S&P/ASX All Ords fall of 7.7%. There is a rapid margin compression going on across retail and the market has been taken by surprise.

Elsewhere, tech stocks are getting hit as interest rates go up and investors sell in search of cash profits. The pandemic boosted the fortunes of retailers and of digital services as remote working gained a bigger foothold. Now we’re seeing that unwind

We’re also seeing China’s economic activity fall sharply due to a wave of lockdowns associated with President Xi’s policy of Zero Covid infections, also creating nervousness.

What to do? Hunt for value is the only solution. Buy small parcels of stock and back off. This is how you make money over time and minimise risk.

Which stocks? This week we cover stocks in two big sectors: resources and financials.

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Blue Chip Portfolio: Overweight Resources

Mining stocks are vulnerable to deteriorating global demand, but there is a long way to go before that happens. Read our report on iron ore on page 6, which highlights that Chinese steel production is showing signs of recovery as the global superpower uses its levers in property and infrastructure to support the economy.

Moreover, big mining companies were burned by the financial crisis and the punishment meted out by investors for unnecessary expansion. They are focussed on returning capital to shareholders.

Looking through the lockdowns and there remains upside to growth for years go come. GDP per capita in China (spending power of the average person) is considered to be middle income and is rising towards higher income. This was the case in Latin America, but they remain stuck in the middle income segment in part due to political instability.

China is not a democracy but it does not have political instability. Its leadership appreciates the shift from fossil fuel to renewables and the migration from country to city continues, which involves many more apartment complexes and infrastructure. You need steel for that.

Blue Chip Portfolio: Overweight Banks

We favour the banks and are buyers where there is greatest value.

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There is increasing competition, which impacts margins, but these banks have balance sheets that remain very strong. There are also positive signs on asset quality, which means that the risk of bad debts is still low. These are strong businesses that can weather shaky consumer sentiment.

Conclusion: Value is your Best Bet

Overall, we favour investing in stocks where there is demonstrable value, whether they be small or large. These are stocks that have forecast earnings growth but are not expensive. They are companies that have strong balance sheets, which act as a buffer, and are cash flow positive, or there is a line of site to this achievement without dilutive equity raisings. We are finding many of these stocks after recent selling.

ABOUT THE AUTHOR

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.