US President-elect Donald Trump’s plan for his first 100 days in office is out and ASX investors will be wondering what it means for the precious share portfolios carefully accumulated to fund their retirements. After eight years of sharemarket volatility, many direct investors are feeling even more rattled by the selloffs on the ASX before the election, the shocking election result and the violent movements over the two days afterwards. In a financial world where already nothing seemed certain, this stunning political development and the uncertainty it brings could make that world seem even more confronting.
Our message is to take a deep breath and feel reassured. There is a way through even this to growing your retirement portfolio, guarding it from capital loss and generating enough income to live off in retirement. We see these as the three most important themes for direct investors in 2017.
The way forward is first not to feel shaken by shock events and market volatility (and we do appreciate this is not easy at times like during election week) but to see them as welcome sources of opportunity. You pay a high price for waiting to buy stocks until there is confidence and calm in the sharemarket, as stocks are more highly priced then and therefore offer less upside. You’ll make your most money in the panics because traders and investors overreact in times of great unknowns, and this creates opportunity.
The next step is to have return objectives for your portfolio. Vague desires to make some money in the sharemarket leave you at the mercy of volatility because you are left without an action plan to profit from it. Far better to have rational and specific return objectives for categories of stocks with different risk-return characteristics. For example, you should aim to earn a greater rate of return over inflation on your smaller companies, which in general offer higher returns but are riskier, than your large-caps. It helps to have specific targets, for example target annual returns of CPI plus six per cent for your large-caps (ASX 50), CPI plus eight per cent for medium companies (the ASX 200 ex the ASX 50) and CPI plus 10 per cent for your small-caps. (ex-200). Objectives like these focus you on the stocks and entry prices likely to deliver them, and help to remove the emotion from responding to market gyrations and confronting events. Suddenly the sharemarket flips from a constant source of worry to a valuable tool for getting you to where you want to go.
Having chosen the companies you would like to partly own as a shareholder, the next step is to have sensible valuations separate from share prices. Then, when prices fall far enough below those valuations to compensate you for the risk of owning the business, you strike.
This value-driven approach is what the StocksInValue model share portfolio has followed since inception in March last year, a period over which we outperformed the ASX 200 index by over 11 per cent. In all the panics of the last 20 months – ASX bank equity raisings, China’s growth slowdown, the oil price collapse, Brexit and now Trump’s election – we aggressively bought undervalued stocks before subsequently lightening them or exiting those positions at prices which delivered against our return objectives.
We think Commonwealth Bank is worth around $78 and buy prices below $70, for a 10 per cent discount, are a sufficient discount to value for the risk of owning a major bank. So in mid-September, when the stock dipped below $70, we bought. This investment is being rewarded. We would lighten into the high $70s and exit over $80.
QBE Insurance Group is worth $11 in our view and we like the stock’s strong leverage to higher bond yields, a macro view we hold with conviction, so we bought aggressively between $9.30 and $10.00, a series of trades now being rewarded.
The strong rallies in many ASX stocks since Trump’s win are just speculation, as no one knows for sure how many of Trump’s self-contradicting policy fragments will become implemented policy. The US president is relatively weak domestically given the need for legislative approval of spending and tax measures and the Republican Party which controls Congress and the Senate contains philosophical wings opposed to Trumpism. These will be a moderating influence on Trump; we do not expect a full-blown trade war with China. We also point to the property developer’s personal interests in a buoyant US economy. The most likely outcome now is a long period of uncertainty similar to post-Brexit, with some of the Trump agenda delivered through next year.
We will continue to use our existing successful framework to selectively deploy cash into opportunities arising from the new presidential administration – and to raise cash when these investments mature:
- Banks: The strong rallies following the election benefited our positions in ANZ, CBA and National Australia Bank. Banks were already pricing in higher long-term interest rates as world growth strengthened, central banks switched focus from quantitative easing to bond yield targeting, and wage pressures in the US labour market picked up. Bank interest margins suffered from the recent ultra-low interest rates. ANZ is worth around $29 in our view, where we would lighten.
- Insurers: At $11.30, QBE shares would price in most of the improvement in profitability we expect from management initiatives and higher bond yields. We would look to lighten.
- Energy: The implications of Trump are mixed. Trump wants to lift restrictions on American fossil fuel output, which would be negative for oil prices, but has opposed the Iran nuclear deal. Cancelling the deal and returning to sanctions would support prices. Watch and wait on this sector.
- Resources: The bullish scenario is infrastructure stimulus on both sides of the Pacific from China and Trump’s US. The question is the timing of the inevitable supply response which would drag prices lower again. The surge in popularity of these stocks makes them riskier.
- Building materials: Boral could benefit from US infrastructure spending but the US only contributes ~10 per cent of earnings. James Hardie is mainly leveraged to housing, not civil infrastructure.
- Retail and property: Trump’s plan for middle-class tax cuts could unleash a wave of retail spending to benefit Westfield’s shopping malls. There could be a switch from QBE to Westfield if bond yields and the Australian dollar overshoot on the upside.
- Amcor and Brambles: Both would benefit from a stronger US economy but are already expensive, so they don’t meet our return objectives at current prices.
We look forward to continuing to update you on our trades in popular ASX stocks through this column.
Originally published in The Australian on Tuesday 15th November 2016.
David Walker is Senior Analyst at StocksInValue. StocksInValue provides model portfolios, stock valuations and research covering Australian and international markets. Start making better investment decisions by registering for a trial at StocksInValue.com.au or call 1300 136 225.