15 January 2020
Everyone likes a good bull market, and in Australia you could say that for over a decade now we’ve been largely in bull-market mode. Following on from the Global Financial Crisis that took the S&P/ASX200 down a disastrous 54% between November 2007 and March 2009, the subsequent recovery has been interrupted by only two relatively bearable bear markets. The first of these bearish episodes saw the ASX200 give up a mere 21% over five months in mid-2011. The second one was just as mild, measuring 20% from top to bottom but this time over 10 months from mid-2015 to early 2016. In the subsequent recovery the ASX200 has gained 46% over an amazing run of close to four years, which has seen the ASX200 recently regain the November 2007 peak.
So we must be ready for another bear market, right?
Well, maybe not. According to S&P Capital IQ the average forward-looking P/E for the ASX200 right now is 18.3. We’ve seen worse in terms of over-valuation. Maybe this wild Saturday night is set to go for a few more hours while the punchbowl of low interest rates and great economic times in America keeps getting passed. That said, the cops may show up at the party at any time and just arrest a few people – remember, if you look at the ASX200 right now, around 40 companies have gone backwards over the last twelve months and their average decline has been about 15%. It’s also worth thinking about all the things that could go wrong in 2020, such as
- A renewal of trade tensions between the US and China;
- A war in the Middle East;
- A major terrorist attack in an advanced industrial country;
- A slowdown in US economic growth;
- Lack of progress on Brexit;
- More anti-government demonstrations in various parts of the world including a renewal of unrest in Hong Kong;
- Continued weakness on commodity prices thanks to slower Chinese GDP growth;
- Drought in Australia badly impacting food prices and causing inflation to increase, which would finally prompt an interest rate increase.
The thing about bear markets is that they sometimes seem to come out of the blue unless you’re watching out for them. The Crash of 1987 happened without warning – or so it seemed to many- and so did the Tech Wreck of 2000 and the Global Financial crisis of 2008. So, in order to assist the thinking of the prudent, herewith follows some advice regarding what stocks could go wrong, or even badly wrong, in 2020.
Mispricing BioTech companies
The first sector to watch out for is Life Sciences. ASX has traditionally been a good market for biotechnology and medical device companies to raise relatively small amounts of capital, but in our opinion it’s not nearly as good at Nasdaq at pricing Life Science ventures. Investors just don’t know as much about biotech as they do in New York, Boston and San Francisco. Consequently, when biotech stocks go out of favour they tend not to decline, but crash. Investors should therefore be a little scared of Avita Medical (ASX:AVH), Clinuvel Pharmaceuticals (ASX:CUV), Polynovo (ASX:PNV) and Pro Medicus (ASX:PME) given the outperformance of these stocks recently.
Oversupply of iron ore?
The next sector we’d be worried about is iron ore. The recovery in that commodity last year wasn’t because steel makers needed more but because of the Brumadinho disaster of January 2019, when a tailings dam at an iron ore mine in Brazil failed. It’s reasonable to expect global supply to outrace demand in 2020 and with it stocks like Fortescue Metals Group (ASX: FMG) may be in trouble.
Disappearance of the Daigou crowd
The China-consumption stories could be in trouble in 2020. The A2 Milk Company (ASX: A2M) and Blackmores (ASX: BKL) owe a good part of their success in recent years to heavy Chinese consumption of the product, in part because of Daigou purchases. When China’s new e-commerce law came into effect in late 2018, Daigou merchants suddenly had to register for business licenses and pay business taxes. It’ll take several years before iconic brands in Australia recover the valuable sales channel controlled by the pre-2018 Daigou crowd. Both A2 Milk and Blackmores are currently on a P/E of 31.
Some Tech stock valuations are way out there!
Tech stocks would also be something to careful about in 2020. Corporate Travel Management (ASX:CTD), EML Payments (ASX:EML), Nearmap (ASX:NEA) and NextDC (ASX:NXT) are a few we’d worry about. On ASX, tech stocks tends to trade at massive premiums once the basic business model looks like it is working. The downside of that market generosity is that it is often withdrawn as soon as the company seems to slip on its earnings. Corporate Travel, which aims to dominate the market for business travel management, is currently on a P/E of 22x. NextDC on 27x and EML Payments on 53x. With Nearmap you can’t yet get a P/E and the price to revenue is a massive 11. That’s right, 1 plus 10. Corporate Travel’s multiple is potentially justifiable, but we’re hearing that the competitive environment for business travel management is heating up at the moment, so the growth momentum for this company isn’t so assured. A better way to play business travel is probably Flight Centre if you’re bullish on the long-term fundamentals of growth in business travel, which we are.
Retail in the firing line?
Most old-fashioned retail in Australia remains in trouble right now, where technology has outmoded the reason why you’d go into the store in the first place. Super Retail (ASXL:SUL), Harvey Norman (ASX:HVN) and Myer (ASX:MYR) could be among the share price victims in 2020 as well as Wesfarmers (ASX:WES). Super Retail looks particularly vulnerable because Rebel Sport is being undermined by the recent French arrival Decathlon, while BCF and Macpac will likely struggle in an environment where people are staying indoors for a while as the country burns. Sure, the P/E is only 13 but there’s also an 8% short position on ASX at the moment.
Food retailing is in trouble in Australia because there’s no price inflation in Australia right now, and Aldi is continuing its long-run campaign of disruption. Consequently Woolworths (ASX:WOW) might not have a good year, and we wouldn’t put it past Metcash (ASX:MTS) to be in the firing line as well.
There’s a couple of non-tech stocks with a habit of going on wild rides to pay attention to early in 2020. One is the pizza franchisor Domino’s Pizza Enterprises (ASX:DMP) and the other is the funeral services company Invocare (ASX:IVC). In the six months to December 2019 Dominos might not have attracted enough pizza outlet franchisees, which is bad when the P/E is 31x. Meanwhile Invocare may not have buried or cremated enough people because the death rate in Australia might be temporarily lower than normal. Good for the people still alive. Not so good if Invocare stock gets killed on the day of the full-year result in February. The P/E here is a massive 28x!
We are perma-bears on old-fashioned Telco’s
Telstra (ASX:TLS) could be one to worry about in 2020. Let’s face it – telecommunications services in Australia is a commodity. We don’t care how strong the brand appeal has historically been, Telstra has to rely more on cost-control than revenue growth to increase its earnings. Sure, they might get a short term boost from new 5G services this year, but at a P/E of around 18x that may be already in the price.
ASX Ltd (ASX:ASX) could be in trouble in 2020 because this might be the year that its smaller rival, the NSX, gets enough listings to, eventually, become a viable alternative exchange. That’s not so good if the ASX’s P/E is 32x. Mind you, in the long run ASX’s move to use blockchain-based distributed ledger technology to replace the work done by share registries could be a big boost to ASX as an exchange, but that’s not coming for a while yet.
One final stock to be a little scared about is IPH Ltd (ASX:IPH). This company has aggregated a number of intellectual property management firms across the region and that aggregation has propelled the company to a market capitalisation of close to A$2bn. Now that the group is more reliant on organic growth it could be in trouble, particularly if professionals without strong shareholding start to leave to start up new firms. The P/E of this company is currently a massive 24x.
One thing is for certain in this year – there will be winners and losers across the board on ASX, because we live in times of rapid and massive change. Which brings to mind the old Chinese curse: ‘May you live in interesting times’.
Note: The above is general advice only. Do your own research. And then do some more. The relevant disclaimers apply.
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