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Morgans Chief Economist Michael Knox explains how the different dates of international financial years generate seasonal variation in the Australian and US stock markets.

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Our best ideas are those that we think offer the highest risk-adjusted returns over a 12-month timeframe supported by a higher-than-average level of confidence. They are our most preferred sector exposures.

Additions: This month we add Woodside Energy Group (WDS) and Camplify Holdings (CHL).

Removals: This month we remove Westpac Banking Corp (ASX:WBC), Wesfarmers Ltd (ASX:WES), Goodman group (ASX:GMG), Santos Ltd (ASX:STO) and Super Retail Group Ltd (ASX:SUL).

Large cap best ideas

Treasury Wine Estates (ASX:TWE)

It may take some time for the market to digest TWE’s acquisition of Paso Robles luxury wine business, DAOU Vineyards (DAOU) for US$900m (A$1.4bn) given it required a large capital raising. The acquisition is in line with TWE’s premiumisation and growth strategy and will strengthen a key gap in Treasury Americas (TA) portfolio. Importantly, DAOU has generated solid earnings growth and is a high margin business. It consequently allowed TWE to upgrade its margins targets. While not without risk given the size of this transaction, if TWE delivers on its investment case, there is material upside to our valuation. The key near term share price catalyst is if China removes the tariffs on Australian wine imports.

Macquarie Group (ASX:MQG)

We continue to like MQG’s exposure to long-term structural growth areas such as infrastructure and renewables. The company also stands to benefit from recent market volatility through its trading businesses, while it continues to gain market share in Australian mortgages.

CSL Limited (ASX:CSL)

While shares have struggled of late, we continue to view CSL as a key portfolio holding and sector pick, offering double-digit recovery in earnings growth as plasma collections increase, new products get approved and influenza vaccine uptake increases around ongoing concerns about respiratory viruses, with shares trading at 25x, a substantial discount (20%) to its long-term average.

ResMed Inc (ASX:RMD)

While weight loss drugs have grabbed headlines and investor attention, we see these products having little impact on the large, underserved sleep disorder breathing market, and do not view them as category killers. Although quarters are likely to remain volatile, nothing changes our view that the company remains well placed and uniquely positioned as it builds a patient-centric, connected-care digital platform that addresses the main pinch points across the healthcare value chain.

Transurban (ASX:TCL)

TCL owns a pure play portfolio of toll road concession assets located in Melbourne, Sydney, Brisbane, and North America. This provides exposure to regional population and employment growth and urbanisation. Given very high EBITDA margins, earnings are driven by traffic growth (with recovery from COVID) and toll escalation (roughly 70% by at least CPI and approximately one-quarter at a fixed c.4.25% pa). We think TCL will continue to be attractive to investors given its market cap weighting (important for passive index tracking flows), the high quality of its assets, management team, balance sheet, and growth prospects.

QBE Insurance Group (ASX:QBE)

With strong rate increases still flowing through QBE's insurance book, and further cost-out benefits to come, we expect QBE's earnings profile to improve strongly over the next few years. The stock also has a robust balance sheet and remains relatively inexpensive overall trading on 8x FY24F PE.

Aristocrat Leisure (ASX:ALL)

They are: (1) Long-term organic growth potential in the US. ALL is better capitalised than many of its competitors and has what we regard as a strong platform to continue investment in design and development in both its land-based gaming and digital businesses. (2) Strong cash conversion and ROCE. ALL is a capital-light business, despite its ongoing investment in Gaming Operations capex and working capital. It has a high level of cash conversion and ROCE. (3) Strong platform for continued investment following its acquisition of NeoGames.

Mineral Resources (ASX:MIN)

MIN is a founder-led business and top tier miner and crusher that has grown consistently despite barely issuing a share over the last decade. Also helping our investment view is that MIN’s diversification leaves it far more capable of tolerating volatility in lithium markets than its peers in the sector. We see MIN’s lithium / iron ore market exposures as an ideal combination to benefit from the China gradual recover. We also see MIN as well placed to grow into its valuation, even if we see unexpected metal price volatility, given the magnitude of organic growth in the pipeline.

South32 (ASX:S32)

S32 has transformed its portfolio by divesting South African thermal coal and acquiring an interest in Chile copper, substantially boosting group earnings quality, as well as S32's risk and ESG profile. Unlike its peers amongst ASX-listed large-cap miners, S32 is not exposed to iron ore. Instead offering a highly diversified portfolio of base metals and metallurgical coal (with most of these metals enjoying solid price strength). We see attractive long-term value potential in S32 from de-risking of its growth portfolio, the potential for further portfolio changes, and an earnings-linked dividend policy.

Woodside Energy (WDS) - New addition

A tier 1 upstream oil and gas operator with high-quality earnings that we see as likely to continue pursuing an opportunistic acquisition strategy. WDS’s share price has been under pressure in recent months from a combination of oil price volatility and approval issues at Scarborough, its key offshore growth project. With both of those factors now having moderated, with the pullback in oil prices moderating and work at Scarborough back underway, we see now as a good time to add to positions. Increasing our conviction in our call is the progress WDS is making through the current capex phase, while maintaining a healthy balance sheet and healthy dividend profile. WDS still has to address long-term issues in its fundamentals (such as declining production from key projects NWS/Pluto), but will still generate substantial high-quality earnings for years to come.

Qantas Airways (ASX:QAN)

QAN is trading at a material discount compared to pre-COVID multiples, despite having structurally higher earnings, a much stronger balance sheet, a better domestic market position, a higher returning International business and more diversification (stronger Loyalty/Freight earnings). The strong pent-up demand to travel post-COVID should result in a healthy demand environment for some time, underpinning further earnings growth over FY24/25. QAN’s balance sheet strength positions it extremely well for its upcoming EBIT-accretive fleet reinvestment and further capital management initiatives (recently announced another A$500m on-market share buyback at its FY23 result).

Morgans clients can download our full list of Best Ideas, including our mid-cap and small-cap key stock picks.

February marks a pivotal time for investors as ASX-listed companies unveil their half-yearly results. At Morgans, we're thrilled to present our comprehensive Reporting Season Playbook in this edition of The Month Ahead. Bursting with forecasts, company previews, and expert investment insights, our playbook equips you with the tools needed to navigate the upcoming weeks with confidence. Delve into our series of insightful videos where our analysts uncover the stocks poised to surprise investors, both positively and negatively, along with the key emerging themes shaping the market landscape. Stay informed as the results unfold and make informed investment decisions with Morgans by your side.

Technology, Media and Telecommunications Preview

With Nick Harris, Steven Sassine, James Filius and Leo Partridge.

Financials Preview

With Nathan Lead, Richard Coles and Scott Murdoch.

Healthcare Preview

With Scott Power, Iain Wilkie and Emily Porter.

Resources Preview

With Adrian Prendergast, Tom Sartor and Chris Brown.

Consumer Discretionary Preview

With Alexander Mees, Head of Research.

Travel & Tourism Preview

With Belinda Moore and Billy Boulton.

Consumer Staples Preview

With Alex Lu and Belinda Moore.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.

Morgans Chief Economist Michael Knox says that Federal Reserve rate cuts later this year will be shaded by a major program of quantitative tightening.

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Morgans Chief Economist Michael Knox walks us through his model for the US Economy using the Chicago National Activity Indicator, which explains 78% of YoY growth in US GDP.

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• Earnings trends remain remarkably stable despite widespread expectations of an impending earnings slowdown. While the 9% rally in the ASX200 and subdued outlook statements might temper some good results, we still see potential upside surprises in February.
• Quantity and quality of earnings will come into focus as the macro takes a back seat to company fundamentals. Key themes to watch include: the risk of hiding in defensives, small-cap/cyclical rotation, focus on cashflow and operating leverage, short selling signals and revisiting REITs.
• Morgans analysts preview the results for 150 stocks under coverage that report in February and call out likely surprise and disappoint candidates from page 10.
• Key tactical trades (page 3) include CSL, ResMed, A2 Milk, Domino’s Pizza, Tyro and Megaport, among many others.

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We reset our strategy following the 9% run since November

We update our strategy heading into February. First on the back of the late surge in 2023, we advocate being opportunistic on pullbacks.

Second, given the ongoing macro concern, we do not think the “focus on fundamental” regime is over - anything other than a path back to historically low rates and plentiful liquidity is likely to keep investors on the hunt for near-term cash and earnings generation. And last, cyclicals typically find valuation support as interest rates come down, providing an attractive alternative to growth and defensives.

Rising rates, recessionary fears and weak investor sentiment provided plenty of reasons for investors to hide in defensives in 2023. However, as conviction around a cyclical peak in interest rates firmed, a rotation to growth and cyclicals ensued late in the year with defensives all underperforming the ASX200.

We continue to favour a rotation away from defensives (telco, staples) as earnings growth broadens across the market.

Look below the surface – solid earnings growth on offer

We see the S&P/ASX 200 index rangebound in 2024. FY24 EPS is forecast to decline 5% before rebounding 5% in FY25, leaving the heavy lifting down to P/E multiple expansion, but at 16x vs the 14.5x 20-year historical average, there is limited scope for further expansion barring a sharp retreat in interest rates.

While we do not expect the index to do much at the headline level, high-level numbers conceal significant variation across sectors. Cyclicals including consumer and commercial services, media, retail and capital goods offer mid-to-high EPS growth into FY24 at lower relative valuations.

Cyclical stocks that look interesting include Acrow, GQG Partners, Alliance Aviation, Baby Bunting and Santos.

Small-caps continue to look constructive

Small-caps have historically bounced hardest upon confirmation of a flattening-out in the rates cycle. Several ingredients remain in place supporting a rebound in this space (rates, trading/fundamentals, sentiment/positioning).

We think the tide is turning for small-caps, and now is an opportune time to build exposure to forgotten small-caps including Helloworld, Credit Corp, IPH Limited, Clinuvel, Veem, Vulcan Steel and DGL Group.

Time to rethink REITs

REITs was the best performing sub-sector of the ASX200 in late 2023 on broadening views that the rates cycle in major economies has likely peaked and that material rate cuts are possible in 2024.

While we still see some earnings risk in Retail and Office that could weigh on the sector and valuations on the balance sheets that could fall in 2024, the downside looks more than priced in when we look at discounts to NTA of 20-40%.

We also expect strong balance sheets to help buffer any falls in book values. Our preferred A-REITs are Goodman Group, Qualitas, HomeCo Daily Needs REIT and Dexus Industria REIT.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.