Investing in the Year of the Rat

12 January 2020

The new Lunar Year 2020 is the Year of the Rat. In this article we look at what investors should expect in Australia’s equity market in the course of this auspicious year.

2019, the Year of the Pig, has been a great year for investors in the ASX’s more established companies. The benchmark S&P/ASX200 index has risen 17.6% in 2019. And no wonder. Times were good in Australia during the Year of the Pig. Interest rates remained low and went lower through the year. The pro-business government of Prime Minister Scott Morrison, with his centre-right Liberal-National coalition, was re-elected for another three years in the 18 May Federal election, to the pleasant surprise of just about everybody. And that happy event came shortly after the re-election in March of a Liberal-National government in our largest state, New South Wales.

The downturn in Australian residential housing that seemed to be happening in the first half of the year, particularly noticeable in Sydney and Melbourne, reversed itself in the second half. Unemployment remained low at 5.2% in November, the same level as six months previously. And while the rest of the world entered varying degrees of trouble, Australia seemed to remain an ocean of calm.

The pig may not be a smart animal, and, indeed, it’s also considered lazy and clumsy. Moreover, since it likes sleeping and eating it becomes fat. However, pigs behave themselves, have no plan to harm others, and can bring affluence to people. Consequently, in Chinese culture, pigs are a symbol of wealth. No wonder then that the market has risen during the Year of the Pig. The question now is, can the market do it again in 2020, the Year of the Rat.

The Year of the Rat is about starting up new projects

The thing about the rat is that it is the smallest of the animals in the Chinese Zodiac. You’ll recall that when the Jade Emperor, ruler of all gods within the Chinese pantheon, hosted a race to decide which animals made it into the Zodiac and in what order, the animals had to cross a river. The rat had only an outside chance because of his diminutive size, but he was intelligent, agile and quick thinking. He won the contest by climbing on to the back of the ox to get over the river, then sneakily jumped over the ox’s head to cross the finish line. Contrast that with the pig, the last animal to finish, who stopped for a snack during the face and then fell asleep.

The Year of the Pig was fundamentally about completion, self-care and balance. In other words, it was a year for established companies with a track record of wealth creation. The Year of the Rat is expected to be more about progression and starting a new project with great energy. In other words, it’s more about emerging companies. Remember, the rat is a highly perceptive animal that can sense its environment and knows when to act. That’s good for unlocking new business opportunities.

At Stocks Down Under we would say yes, the market can have another good year in the Year of the Rat, although, as with any year, one has to be constantly on the lookout for factors that could upset the apple cart.

We’re always bullish and not afraid to admit it

Before we go any further, let us give a personal disclaimer. We’re optimistic by nature and we spent many years working in stockbroking where the successful professionals tend to be optimists. Consequently, if you ask us is the market going up in 2020, our natural inclination is to say yes. Moreover, we tend to see the positive side of an investment story before we see the negative. That can be helpful if you’re looking for a contrarian angle to an undervalued stock everyone else seems to hate. However, not every stock is going up all the time. As the old Chinese proverb goes ‘When a thing reaches its limit it must turn changing from fortune to misfortune, and misfortune to fortune’. Keep that in mind as you read what follows. Also, it’s best not to try and catch a falling knife.

Interest rates may go even lower

The first thing to note about Australia’s equity market in the Year of the Rat is that there may still be further interest rate cuts to come, in line with a general level of interest rate easing worldwide.  The Reserve Bank of Australia (RBA) engineered three rate cuts in 2019 – in June, July and October. But that still leaves the cash rate at 0.75% so there’s more room for another cut. As of September 2019, the inflation rate in Australia was only 1.7% so you can argue we have price stability for the foreseeable future. GDP growth has been slowing somewhat, and as at September 2019 growth was down to 1.7%, so the RBA might be inclined to give the economy a little more juice with at least one cut of 25 basis points early in the year. I always argue that you should generally stay bullish on stocks until interest rates hit a seven-year high. We don’t get there at the moment until you reach the 2.75% cash rate of May 2013.

Daddy, what did you do during the Trade War?

The next thing to be aware of is the potential for the US-China Trade War to come to a complete end to the satisfaction of both sides. The two countries plan to sign the first piece of the trade pact very soon. If US President Donald Trump can work his usual deal-making magic to conclude the second part of the trade deal with China before 2020 is out, that would be good for the market as well. An obvious beneficiary of an end to the Trade War would be the Australian resources sector, where a Chinese economic recovery could prompt an increase in Chinese imports of Australian coal and iron ore. However, as to when the Trade War will end, it’s worth noting an old Chinese proverb: ‘The merciful do not engage in war, and the righteous do not engage in finances’.

While we’re on the subject of President Trump, his re-election in November 2020 could also be a positive for the market. Like him or dislike him, Trump has by and large been good for equity markets given the President’s natural pro-business stance and his habit of getting stuff done including a wholesale tearing up of unhelpful regulations. Another four years of that kind of thing can’t be too bad for investors, right?

The time to buy is when the Eucalyptus trees are on fire

In Australian politics this year could see two more key gains for the Liberals and Nationals, which are currently more-pro-business than was the case during the period 2015-2018. The Northern Territory goes to the polls in August, and Queensland in October. Changes of governments in these resource-rich jurisdictions could be good for the miners given that Labor currently governs in both. Annastacia Palaszczuk’s government in Queensland may have given environmental approval in June 2019 for the Carmichael Coal Mine in the Galilee Basin, but Palaszczuk and her colleagues have not exactly proved to be good friends to the mining industry since they took office in 2015.

Domestic miners are gaining a short reprieve right now alongside all sorts of exporters because the Australian dollar is weakening against the greenback. The AUD/USD started the year just above 0.70 but has dropped back below 0.69, in large measure because of widespread coverage of the serious bushfires Australia has been afflicted with through the Southern Summer. However, one factor to watch out later in 2020 is a strengthening dollar. An earlier rally for the dollar started in October at 0.66, and until the bushfires started it had been gaining a head of steam.

Speaking of bushfires, Australia has been inflicted by a pretty bad drought since early 2017. Should that drought start to break this year, we believe a number of companies will be strong beneficiaries, most notably the nation’s largest supplier of fruit and vegetables, Costa Group (ASX: GCG), the cattle producer Australian Agricultural Company (ASX: AAC), the dairy company Bega Cheese (ASX: BGA) and the poultry company Inghams Group (ASX: ING).

Maybe bushfires have been the reason why Webjet (ASX: WEB), the online travel management company, is being heavily shorted right now, since tourism in Australia may take a short term hit with the flames. There are rumours out there that Webjet might get acquired in 2020, which makes sense given how strong that brand has become in the travel management market.

Gold, Gold, Gold!

Even without a weaker dollar, a sector in Australia that has the potential to do very well in 2020 is gold. With the yellow metal through US$1,500 an ounce and headed higher in an environment of global uncertainty, companies like Evolution Mining (ASX:EVN), Newcrest (ASX:NCM), Northern Star Resources (ASX:NST), St Barbara (ASX:SBM), Regis Resources (ASX:RRL), OceanaGold Corp (ASX:OGC) and Resolute Mining (ASX:RSG) are all likely to benefit. Remember, each zodiac sign is associated with one of the five elements. In 2020 the element is gold.

Coal, Coal, Coal!

Could 2020 also be a good year to look at coal? Yeah, we know – controversial call but hear us out. After six bad years from 2010, coal prices started recovering in 2016 but that recovery had run its course by mid-2018 and most of it has since been lost thanks largely to lower Chinese demand. As a result, coal stocks have been beaten up badly, even before the climate change activists weighed in with their views about how dirty and unnecessary coal is to emerging 21^st Century economies.

Maybe so, but the world will still need coal for a while yet and Australia is the world’s largest coal exporter.  Coal may not necessarily rebound much in 2020 but the coal sector is so undervalued that stocks could rally on even mildly improved prices data. One for the contrarians, obviously. They should take a look at New Hope Group (ASX:NHC), Whitehaven Coal (ASX: WHC) and maybe some of the emerging coal companies, like Bathurst Resources (ASX: BRL).

The healthcare sector could continue to yield up some interesting stories, as it usually does from year to year. One company we like to look at every now and then is ResMed (ASX:RMD), which sells CPAP equipment for the treatment of that insidious health condition called Obstructive Sleep Apnea. ResMed has a habit of suddenly selling off after quarterly results the market doesn’t like because the growth is slightly lower than expected. Often the stock will rebound quickly. Watch to see if ResMed doesn’t repeat that behaviour in 2020.

The Electric Vehicle revolution is here

Lithium might start to bottom in 2020. It’s believed that global lithium demand could increase sevenfold between now and 2030 thanks in large measure to Electric Vehicles. If 4 million more EVs get sold around the world in 2020, the temporary oversupply we’ve been seeing in lithium in 2018 and 2019 could start to reverse itself and set up this sector for a strong rebound in 2020.

That would be good for a range of companies including Galaxy Resources (ASX:GXY), Orocobre (ASX:ORE), Altura Mining (ASX:AJM), Mineral Resources (ASX:MIN) and Pilbara Minerals Ltd (ASX:PLS). Another battery minerals player that may – repeat, may  – just bottom out in 2020 is Syrah Resources (ASX: SYR), owner of the massive Balama Graphite Mine in northern Mozambique. Syrah was widely considered risky in 2019 because graphite was even more oversupplied than lithium and Syrah needed to work hard to get its costs down. With a 16% short position at the moment, any good news on graphite and Balama could see a violent share price reaction to the upside. One for the punters with hairy chests. While it may or may not be the case that the Chinese word for ‘crisis’ is composed of two Chinese characters signifying ‘danger’ and ‘opportunity’ respectively, in this case we argue that crisis really does look like opportunity.

Oil and gas might prove to be interesting in 2020 simply because, if tensions in the Middle East can eventually raise WTI crude above US$70 a barrel, it might convince investors it was safe to go back in to that sector after they were scared off so badly after the Saudi-led oil price crash of mid-2014. That return to sentiment would be great for Santos (ASX:STO), Beach (ASX:BPT), Oil Search (ASX:OSH) and Woodside (ASX:WPL).

The banks to make a reputational comeback?

The banks might prove great buying in 2020. The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry handed down its final report last February, so enough time has passed for the bad smell surrounding banks to have passed. That will allow the stocks of Australia and New Zealand Banking Group (ASX:ANZ), Westpac (ASX:WBC, National Australia Bank Ltd (ASX:NAB) and Commonwealth Bank (ASX:CBA) to recover. NAB and Westpac have dividend yields well over 6% and the other two are at 5%.

Clicks and mortar

Finally, we argue that one shouldn’t write off bricks and mortar retail in 2020. Visit any shopping mall in a big Australian city and business appeared to be brisk in the second half of 2019, in our view. The electronics retailer JB Hi-Fi (ASX:JBH) and Lovisa (ASX:LOV), a world-leading peddler of inexpensive jewelry, could surprise on the upside once the half-yearly numbers are out in February and show that Christmas wasn’t as bad as the doom-merchants would have one believe.

It’s worth remembering as well that Afterpay (ASX:APT), the buy-now-pay-later pioneer, is currently growing like a storm and that has been good for retailers in Australia, both online and offline. We also argue that Afterpay still looks interest on a price-to-growth view, so it wouldn’t surprise us to see more fuel in this company’s tank in 2020.

Finally, expect the lower interest rates of 2020 to be good for the continued recovery in housing. Which could make GWA Group (ASX:GWA), the Brisbane-based supplier of building fixtures and fittings, worth a look. That stock has been heavily shorted of late on the expectation that house price declines would mean less being spent on the nation’s kitchens and bathrooms. With house prices in Australia now turning around the shorts on this one – currently 12% – might get flushed.

Our dog ate my homework

The important thing about investing in the Year of the Rat is do your homework. Then do some more. You can never do too much learning. As Sun Tzu said in his famous Art of War, ‘The general who wins the battle makes many calculations in his temple before the battle is fought. The general who loses makes but few calculations beforehand’. And in a market where there are around 1,800 listed companies that are not investment companies, there’s always something new to learn. And at Pitt Street Research and Stocks Down Under we expect to be able to provide you with a lot of research material to guide your thinking.

Happy investing in the Year of the Rat.

 

Note: The above is general advice only. Do your own research. And then do some more. The relevant disclaimers apply.