Insights

• A new regime of heightened volatility is playing out. The impact of higher interest rates is starting to be felt and counting on broad market moves won’t do now, in our view. That shift comes as US and European economies enter a period of stagnant economic growth. But we don’t see central banks coming to the rescue with rate cuts.
• We see opportunities in relative pricing and structural trends. We maintain a slightly cautious tilt this quarter: overweight cash, underweight Developed Market (DM) stocks and neutral fixed interest/Australian equities. But we are ready to seize opportunities as macro damage gets priced in.

Patience required

The combination of faltering economic growth and central banks still focused on above-target inflation will remain a challenging backdrop for most risky assets.

The recession now taking hold across advanced economies means some short-term pain is in store: risk assets, such as equities, will not turn the corner decisively until the economic outlook in the US brightens, even if safe asset yields fall a bit further in the interim.

Poor investor sentiment and elevated cash levels will ensure a relatively short-lived pullback in asset prices, so it’s important to remain nimble. Our tactical position retains higher cash but remains near fully invested given our view that the inflection point for risk assets will be difficult to time.

China’s recovery stalls but stimulus will aid growth in 2H 2023

After a promising start to the year, China's economic growth has recently slowed down, falling short of expectations as shown by recent weakness in key economic data. The central government had anticipated a post-COVID recovery in consumer spending that could drive growth to the c5% GDP growth target. However, due to concerns about housing market stability, this recovery faltered.

To address the issue, key interest rates were reduced to encourage banks to lend and kick-start a recovery in the real estate sector, which accounts for more than a quarter of China's economy.

At this stage, stimulus looks set to be fairly modest, so the near-term outlook still depends primarily on the extent of second-round effects on consumer confidence and spending.

Still, we remain cautiously optimistic that stimulus will support the recovery in 2H 2023 more than most anticipated. We play the recovery through Australian Resources and overweight to Emerging Markets equities.

Think small

Since the start of 2022 small companies have been in a downward trend with MSCI global large caps outperforming smalls by 9% over the past two years. Rising interest rates, market liquidity and falling investor sentiment have institutional and retail investors alike shying away from this segment of the market.

While it’s too early to call the bottom, we think there are good reasons for reallocating to small companies:

1. Fundamentals have broadly improved post-COVID.
2. Recent trends point to an improvement in liquidity.
3. Small companies typically offer superior earnings growth relative to large cap peers.

Key changes to our asset allocation settings

We maintain a cautious tilt this quarter: overweight cash, underweight developed market (DM) equities and neutral Australian equities. This is because we don’t believe the market has fully discounted the risk to earnings from a global slowdown.

We take a more constructive view on Australian equities with a bias toward small caps. Resilient commodity prices and strong employment conditions should see the Australian equity market outperform global peers.

Figure 1: Morgans recommended asset allocation settings

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.

Your Wealth is a half-yearly publication produced by Morgans that delves into key insights for Wealth Management. This latest publication will cover;

• Why it is important to have a strategic asset allocation framework for your investment portfolio particularly when investing over the long term
• Unpacking the Government's proposal to apply an additional tax on earnings where a person holds more than $3 million in total superannuation
• When is a lump sum withdrawal a member benefit or a death benefit?
• Why the RBA will need to raise interest rates further
• Big Dry Friday 2023; A day to connect city and country, providing support where it's needed most

Morgans clients receive exclusive insights such as access to our latest Your Wealth publication. Contact us today to begin your journey with Morgans.

Feature Article | Understanding asset allocation

Strategic asset allocation (SAA) provides a framework within which investors can target an expected return for a given level of risk. It is one of the most important but overlooked aspects of wealth management. Here we detail how Morgans tailors its systematic approach to suit investors’ objectives versus risk tolerance.

Why is SAA important?

Strategic asset allocation ranks among the most crucial investment decisions as studies show that it accounts for up to 90% of long-term investing returns. That is, the distribution of investments across the asset classes explains most long-term returns, outweighing the impact of decisions made within each asset class such as stock selection

Understanding returns

Below, a matrix of Annual Asset Class Returns highlights the annual variability in returns per asset class. No single asset class will outperform another over the full course of an economic cycle. Each offers its benefits and risks depending on the prevailing economic conditions. It follows that investors should not stay concentrated within any one asset class over the course of an economic cycle.

To read the full coverage from the latest Your Wealth, begin your journey with Morgans today.

Domino's Pizza (ASX:DMP) recently announced significant measures to address ongoing challenges stemming from inflation, internal inefficiencies, and shifting customer demand. In response to these pressures, the company plans to implement radical cost-saving initiatives, aiming to achieve annualized savings of $53-59 million over the next two years. However, despite positive sales trends, margins continue to face challenges, leading to adjustments in earnings forecasts.

Addressing Operational Pressures

Domino's Pizza's decision to streamline its cost base reflects the company's proactive approach to addressing operational challenges. By identifying and implementing efficiency improvements, Domino's aims to enhance its profitability amid a changing business environment.

Trading Update and Forecast Adjustments

The latest trading update indicates a mixed performance, with sales showing improvement while margins remain under pressure. Consequently, we have revised down our EBIT forecasts for FY23 and FY24 by 12%, reflecting the impact of these challenges on the company's earnings outlook.

Investment Insights

Despite the recent headwinds, we maintain an Add rating on Domino's Pizza. While the company has faced setbacks in the past 18 months, we believe in its potential to rebound. Domino's track record of superior operating performance suggests resilience and adaptability, qualities that could drive a successful turnaround.

Domino's Pizza faces significant challenges in navigating the current business landscape, including inflationary pressures and shifting consumer preferences. However, the company's proactive approach to cost reduction and its history of operational excellence position it well for future growth. Investors should closely monitor Domino's performance as it works to overcome these obstacles and regain momentum.

In the wake of the current resource selloff, optimism towards China's near-term growth has tempered, providing an opportunity to accumulate quality sector exposures at a discount.

Commodity Compass and Strategic Insights

Iron ore stands out with surprising strength, closely followed by LNG and met coal, while copper, oil, and lithium chemicals show robust long-term fundamentals.

Preferred Sector Exposures

Discover our top sector picks among large caps, including BHP Group (ASX:BHP), Mineral Resources (ASX:MIN), and Santos (ASX:STO). Small caps present exciting opportunities with key selections like Karoon Energy (ASX:KAR), Whitehaven Coal (ASX:WHC), Strandline Resources (ASX:STA), and Panoramic Resources (ASX:PAN).

Resource Strategy Update

The resource market's value proposition is on the rise amid the ongoing broad selloff; however, a crucial element is still absent with Chinese growth persistently subdued.

This current downturn follows a surge in late 2022 share prices within the resource sector, driven by what we perceived as excessive optimism toward the prospects of a China recovery. It's not that we bear a negative stance on China; rather, we are cautious about paying upfront for a demand recovery without clear visibility.

Remarkably, investor sentiment appears to have swung excessively in the opposite direction, unveiling compelling opportunities within the sector.

While we maintain caution about China's return to growth, we acknowledge this caution is already factored into resource equities' pricing. This confidence in sector value prevails, with a preference for safety over aggressive upside potential.

Commodity Insights

Iron ore stability in view? Our optimistic take on iron ore takes a contrarian stance. Despite the ongoing challenges in China's property market, a surge in infrastructure activity and baseload consumption is poised to bring demand into equilibrium with supply. We anticipate iron ore to remain well-supported within a steady range of US$100-$120/t in CY23, surpassing the highest cost production at approximately ~US$100/t.

Copper emerges as a standout favorite. Despite recent supply increases and a dip in manufacturing and construction activity impacting copper prices, its performance remains superior to other metals. While short-term volatility persists, our long-term bullish outlook on copper is unwavering. Declining average grades mined and limited new supply, coupled with the electrification mega trend, position copper for robust growth.

Coal stands firm in its long-term trajectory. The recent downturn in thermal and met coal prices has been sharp, particularly for thermal coal, where we anticipate further short-term price adjustments. This contrasts starkly with the enduring fundamentals of the coal sector, marked by ESG pressures and sector headwinds resulting in increasingly constrained supply.

Preferred Large and Small Cap Picks

Anticipating ongoing volatility in the short term as markets eagerly await a China recovery, our optimism lies in commodities demonstrating reduced downside risk, specifically iron ore, LNG, and met coal, along with those boasting robust long-term fundamentals like copper, oil, coal, and lithium chemicals. Among large caps, our top preferences are BHP (most preferred), MIN, and STO, while in the small caps arena, key picks include KAR, WHC, STA, and PAN. Emphasizing shareholder returns, we anticipate a focus on earnings or cash flow, acknowledging potential volatility in dividends but expecting them to consistently outperform the market.

Sydney, a city brimming with opportunities and dreams, paints a picture of endless possibilities. However, for women like me, beyond Sydney's shimmering façade, the harsh reality of the lack of affordable housing in casts a shadow over their aspirations. In this blog post, I want to share my personal experience and shed light on the unique challenges women face in finding affordable housing in Sydney, Australia.

The Cost Barrier

The exorbitant cost of living in Sydney has reached alarming heights, making it increasingly difficult for women to secure affordable housing. As a university student and young professional, our limited financial resources are stretched to the brink by soaring rents and high bond payments. Many of us find ourselves locked out of the housing market, burdened by unaffordable rents that drain our bank accounts and leave us grappling for stability.

Gender Pay Gap Amplifies the Struggle

Adding to the financial strain is the persistent gender pay gap that women face in the workforce. It's disheartening to know that our male counterparts may have an easier time affording housing, putting us at a disadvantage from the start. Unequal access to income and career opportunities only exacerbate the housing crisis, perpetuating a cycle of financial insecurity and limited options for women. For example, Average affordable rent for women is lower than men, $482.70 p/w compared with $561.87 p/w ^{(Average weekly ordinary time earnings, full time adults, Australia, by sex, May 2022)} and the average female worker needs an extra year to save for a home deposit, compared to her male peer ^{(ABS 2021 Census, Time Series. Table T14)}.

Mental health and homelessness

The constant battle to find affordable housing takes a significant toll on womens' mental health. The stress and anxiety of navigating the housing market, worrying about rent hikes or eviction notices, can leave us feeling overwhelmed and disheartened. The persistent fear of homelessness or unstable living arrangements adds an emotional burden that affects our overall well-being and hampers our ability to focus on other aspects of our lives, such as education or career advancement. This is realised through the growing rates of female homelessness, particularly for older women aged 65-75 comprising the fasted growing group ^{(ABS 2049 Estimating Homelessness. 2006 Table 5, 2011 Table 12, 2011 Table 1.12)}

Further Domestic and Family Violence (DFV) is a leading cause of homelessness for women and children, with the proportion of Specialist Homelessness Services (SHS) clients experiencing DFV growing from 32 per cent of all clients in 2012–13 to 40 per cent in 2016–17.

Commute and Time Constraints

For women who cannot afford housing close to our workplaces or educational institutions, long commutes become a harsh reality. The hours spent traveling each day can eat into our precious time, leaving little room for self-care, social activities, or pursuing additional opportunities. The mental and physical exhaustion resulting from lengthy commutes further impedes our ability to excel in our academic or professional pursuits.

Demand Outstrips Supply

One of the fundamental problems underlying the lack of affordable housing in Sydney is the immense demand that far exceeds the available supply. As the city's population continues to grow, the strain on housing resources intensifies, leaving women in an increasingly precarious situation. In a city with the second most unaffordable housing market in the world ^{(Demographia International Housing Affordability report, 2022)}, renters and first home buyers routinely come off second-best, with women adding a second dimension to these findings.

Urgent action is needed to bridge this gap and create sustainable solutions that prioritize the needs of women seeking affordable housing, as Australia is currently short affordable housing solutions. If I know anything it's that women like me deserve access to safe, affordable housing as a foundation to tackling the growing intersectional challenges we face in the workforce, the family and greater society.

Kylie Harding is an Investment Adviser who believes in free access to information about building financial literacy at every stage in life has the potential to empower women and inspire economies.

Contact Kylie today on [email protected] or 02 9998 4206.

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: Flight Centre Travel (ASX:FLT), Super Retail Group (ASX:SUL) and Objective Corporation (ASX:OCL).

Removals: Treasury Wine Estates (ASX:TWE), Webjet (ASX:WEB) and Universal Store (ASX:UNI).

Large cap best ideas

Commonwealth Bank (ASX:CBA)

The second largest stock on the ASX by market capitalisation. We view CBA as the highest quality bank and a core portfolio holding for the long term, but the trade-off is it is the most expensive on key valuation metrics (including the lowest dividend yield). Amongst the major banks, CBA has the highest return on equity, lowest cost of equity (reflecting asset and funding mix), and strongest technology. It is currently benefitting from the sugar hit of both the rising rate environment and relatively benign credit environment.

Westpac Banking Corp (ASX:WBC)

We view WBC as having the greatest potential for return on equity improvement amongst the major banks if its business transformation initiatives prove successful. The sources of this improvement include improved loan origination and processing capability, cost reductions (including from divestments and cost-out), rapid leverage to higher rates environment, and reduced regulatory credit risk intensity of non-home loan book. Yield including franking is attractive for income-oriented investors, while the ROE improvement should deliver share price growth.

Wesfarmers (ASX:WES)

WES possesses one of the highest quality retail portfolios in Australia with strong brands including Bunnings, Kmart and Officeworks. The company is run by a highly regarded management team and the balance sheet is healthy. We believe WES’s businesses, which have a strong focus on value, remain well-placed for growth despite softening macro-economic conditions.

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)

A key portfolio holding and key sector pick, we believe CSL is poised to break-out this year, a COVID exit trade, 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 offering good value trading around its long-term forward multiple of ~30x.

ResMed Inc (ASX:RMD)

While we expect the next few quarters to be volatile as COVID-related demand for ventilators continues to slow and core sleep apnoea volumes gradually lift, nothing changes our medium/longer term view that the company remains well-placed as it builds a unique, 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)

We have three key reasons for being positive on ALL. They are: (1) long-term organic growth potential. 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; and (3) strong platform for investment. ALL has funding capacity for organic and inorganic investment in online RMG, even after the recent buyback. Its current available liquidity is $3.8bn.

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 re-opening increase in demand during 1H’CY23. 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.

Santos (ASX:STO)

The resilience of STO's growth profile and diversified earnings base see it well placed to outperform against the backdrop of a broader sector recovery. While pre-FEED, we see Dorado as likely to provide attractive growth for STO, while its recent acquisition increasing its stake in Darwin LNG has increased our confidence in Barossa's development. PNG growth meanwhile remains a riskier proposition, with the government adamant it will keep a larger share of economic rents while operator Exxon has significantly deferred growth plans across its global portfolio.

Seek (ASX:SEK)

Of the classifieds players, we continue to see SEEK as the one with the most relative upside, a view that’s based on the sustained listings growth we’ve seen over the period. The tailwinds that have driven elevated job ads (~210k currently, broadly flat on the robust pcp) and strong FY22 result appear to still remain in place, i.e. subdued migration, candidate scarcity and the drive for greater employee flexibility. With businesses looking to grow headcount in the coming months and job mobility at historically high levels according to the RBA, we see these favourable operating conditions driving increased reliance on SEEK’s products.

Xero (ASX:XRO)

XRO is a high quality cash generative business with impressive customer advocacy and duration. Over the last 12 months rising interest rates and competition have made things harder for Xero. However, we see the current short-term weakness as a rare opportunity to buy a high quality global growth company at a discount to the life time value of its current customer base.

Telstra (ASX:TLS)

After a major turnaround, TLS has emerged in good shape with strong earnings momentum and a strong balance sheet. In late CY22 shareholders vote on Telstra's legal restructure, which opens the door for value to be released. TLS currently trades on ~7x EV/EBITDA. However some of TLS’s high quality long life assets like InfraCo are worth substantially more, in our view. We don’t think this is in the price so see it as value generating for TLS shareholders. This, free option, combined with likely reputational damage to its closest peer, following a major cybersecurity incident, means TLS looks well placed for the year ahead.

Qantas Airways (ASX:QAN)

QAN is now our preferred pick of our travel stocks under coverage given it has the most near-term earnings momentum. Looking across travel companies globally, airlines are now in the sweet spot given demand is massively exceeding supply. 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 EBITDA 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 a A$500m on-market share buyback at its 1H23 result). There is also likely upside to our forecasts and consensus if QAN achieves its FY24 strategic targets.

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