Lincoln: eight stocks for 2018

Photo of Elio Damato, Lincoln By Elio Damato, Lincoln

min read

Opportunities, risks and market outlook - for growth and income investors.

When it comes to crystal-balling the market, most commentators are coy, and if you are also in the business of trying to predict the direction of an unpredictable market you would be too.

Lincoln Indicators does not try to predict the future. Rather, we deal with facts and quantifiable measures that enable us, with some degree of confidence, to understand how the market and more importantly the companies within it, are currently positioned.

Going into 2018 we find global sharemarkets reaching all-time highs, yet ours trundles along less emphatically. So how are we positioned? Let’s weigh up the opportunities and active risks ahead for investors in 2018.

The opportunities

1. Robust Australian economy
Australia is experiencing continued, though moderating, economic growth helped by solid consumer spending, strong investment returns, rising terms of trade and stronger commodity prices.

Damato Commodity price index chart

Further growth is expected to be driven by stronger corporate profits and increased capital expenditure. It is anticipated that an improved level of business confidence should flow through to a stronger employment market and improved consumer confidence.

2. World economies continue to power along
Our largest trading partner, China, remains on a strong growth trajectory. Global manufacturing Purchasing Managers’ Index (PMI), a leading indicator, is at multi-year highs. The International Monetary Fund has revised its global growth forecasts upwards to 3.6 per cent in 2018.

Damato Global Manufacturing chart

The US economy, buoyed by future corporate tax cuts, recently posted two consecutive quarters of 3 per cent GDP growth for the first time since 2014. The Conference Board’s Leading Economic Index (LEI), a good indicator of future economic growth, posted a strong gain of 1.2 per cent in October, well above the 0.1 per cent in September and 0.4 per cent in August, meaning a contraction in the world’s largest economy is unlikely in the short term.

3. Governments remain supportive of growth
Domestically and overseas we see low interest rates, which is great for business and investors in the sharemarket. Income investors will still seek equity investments to fulfil their requirements. Rising rates in the US and other global economies are likely to result in a weakening Australian dollar, which improves our international competitiveness.

Further, a think-tank made up of the Global Infrastructure Hub and Oxford Economics delivered a G20-initiated report estimating that by 2040 the world will need investments upwards of $US94 trillion to support economies. Half the global sum will be needed in Asia and will be driven by governments. Given Australia’s proximity, our companies, both directly and indirectly, stand to benefit from this impending massive investment.

4. Superannuation tide of money
The total size of our superannuation pool continues to grow, with Australia having the fourth-largest pooled pension savings in the world. With mandatory superannuation contributions increasing to 12 per cent by 2025, coupled with the power of compounding returns, that pool is expected to grow much larger. While all that money won’t make its way only to the sharemarket directly, it will seep into the economy through investments such as infrastructure building, employment, business development, profit growth and returns – benefiting investors over the long run.

The active risks in 2018

1. Above average market price-earnings ratio (PE)
Currently our market trades on a PE of 15.8 times, which is above the average for the past 10 years (see chart below) and an average that has risen following the recovery from the GFC. High valuations and low volatility in an environment of political and policy uncertainty raises the likelihood of a market correction.

Damato ASX 200 PE Chart

Bank of America Merrill Lynch, in its Global Fund Manager Survey, also found that a record number of market participants are taking on higher-than-average risk, compounding the belief that the market (particularly in the US) may be toppy.

Any correction would have a flow-on effect of dampening growth and confidence in our businesses, which in turn flows through to the remainder of the economy.

2. Unwinding government stimulus
Overseas governments have already begun the process of unwinding, to some degree, the massive amount of stimulus they ploughed into markets throughout the GFC and in subsequent meltdowns. Equity markets historically have risen with central bank liquidity.

With inflationary pressures starting to rise, many central banks are also looking to raising interest rates. Further, in the US, with tax cuts to come, it is likely that curtailing the pace of government debt growth will become a focus. Therefore, any large cut to government spending could impact the real economy.

3. Political and social uncertainty
Domestically, current government focus on populist policies hinders the ability to collectively implement productivity measures for enhancing economic growth.

Declining building approvals in an environment of low wages growth could compound mortgage stress and reduce consumer confidence and spending, especially if interest rates begin to rise.

4. Health of the market
The health of the Australian market continues to worry us at Stock Doctor. With only 27.2 per cent of companies exposed to manageable levels of financial risk, potentially there could be a significant amount of pain should business conditions worsen and access to capital dries up.

Damato-health of market Nov 2017

Bullish about the market

Notwithstanding all the opportunities and active risks described above, at Lincoln Stock Doctor we are always positive on the outlook of the companies in our portfolios. This view is not delivered from blind faith. Rather, it is formed after years of conditioning and witnessing the power of rolling with quality companies through all market conditions and always holding a naturally diversified portfolio of great businesses.

We know the market is not immune from corrections. It has now been 10 years since the previous peak of the market, so there is a good chance that a correction is near. However, rather than focus on the things you can’t control, such as the many macro themes described above, investors should focus on what they can control – the composition of their portfolio.

Once you have allocated the appropriate amount of your total wealth to the market and have identified your objective of growth, income or both, then it is your duty to remain disciplined and diligent in supporting that objective. Nobody can tell you what will happen next.

Eight stocks for the year ahead

With the opportunities described above, we have many Stock Doctor Star Stocks positioned to benefit. Below is a selection that stand to benefit from the opportunities in 2018. All of them currently have rock-solid fundamentals, with the bonus of positive themes and opportunities to aid business development.

However, the fundamentals can change quickly, as can opinions. You need to conduct your own research into these businesses and consider their appropriateness for you and your risk profile before acting on idea in this article, as nobody can guarantee future performance.

Also, a portfolio should hold more than a few stocks. A naturally diversified portfolio of 15 to 20 businesses should be a target.

Damato table 1

Damato table 2

As at 5 December 2017
Credit Corp Limited is both a Star Growth Stock and a Star Income Stock. Eclipx Group is both a Borderline Star Growth Stock and Star Income Stock.
^ Gross dividend yield includes franking credits.

 

 

 

 

 

 

 

 

 

 

About the author

Elio D’Amato is an Executive Director at Lincoln, the creators of Stock Doctor – a leading Australian share research house.

Follow on Twitter: @LIStockDoctor

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The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2018 ASX Limited ABN 98 008 624 691. All rights reserved 2018.
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