UBS says the best insurance against a recession is … probably insurance

In troubled times, there’s nothing like defensive stocks for reassurance. And UBS reckons health insurance could be just what the doctor ordered.

I, for one, am shocked. Picture: Getty Images

Some pretty weird stuff has been happening on the economic front of late.

Nevertheless, the sharp shooting economists at UBS say their “base case” is still that Australia avoids a hard landing.

But they do not sound entirely convinced, or that convincing. and there’s a fair bit of the sort of “having it both ways” talk common to any decent investment bank.

The first rider on this declaration made late last week was to acknowledge that “the risks of an economic recession are non-trivial” and will continue to weigh on the equity market.

Like not having cancer yet weighs on the lifetime smoker.

---

For the latest ASX news, sign up here for free Stockhead daily newsletters

---

UBS added that more recent developments – such as the RBA’s trajectory of rate hikes, and soft retail updates – also reinforce its view “that soft landing hopes are sliding”.

QED: ” … an increasingly defensive investment stance is warranted.”

“Valuations of domestic macro sectors are not priced for a recession, with PE ratios still sitting above mid-cycle levels,” UBS says.

“Previous recession risk periods saw single digit multiples through consumer and banking stocks, and although we don’t expect such a compression to valuations in this cycle (given bond yields are still low by historical standards), current ratios still look unrealistically optimistic, and ill-prepared for the further earnings downgrades.”

Perhaps most interestingly UBS says – contrary to popular perception – the end of an RBA hiking cycle like this one doesn’t necessarily herald a revival from cyclical equities.

Consumer-detached stocks

Looking at the performance of Australian equities through previous RBA “rate-plateau” periods, UBS notes that amid overall market falls, the stocks which are most exposed to the domestic economy continue to underperform defensive sectors.

“The most cyclical sectors and styles only start performing closer to the period where the RBA is cutting,” the bank says.

In UBS analyst’s view, this leaves a big tick for the less cyclical components of the ASX200 “that are detached from the consumer":

1. Technology
2. Insurance
3. Healthcare
4. Infrastructure and utilities

UBS’ overweight stance on the Healthcare sector has prompted it to add CSL (ASX:CSL) to its most preferred stock list with the business experiencing commercial tailwinds in all divisions.

ResMed (ASX:RMD) also joins on an improving product mix that should see gross margins returning to pre-Covid levels.

The ASX (ASX:ASX) itself and Super Retail (ASX:SUL) have been added to UBS’ least-preferred list.

Of the stocks which UBS identifies as most vulnerable to a consumer slowdown, the following feature prominently among the many which are still trading at 20 per cent or more above year-ago prices:

Building Materials: Brickworks (ASX:BKW), Boral (ASX:BLD), CSR (ASX:CSR) Online Classifieds: REA Group (ASX:REA), DOMAIN (ASX:DHG), Carsales.com (ASX:CAR), Travel: Qantas (ASX:QAN), Webjet (ASX:WEB).

---

MORE FROM STOCKHEAD: Rick Rule’ keys to finding a 10-bagger | Best biotechs for FY23 | Cheers, Maggie Beer!

---

UBS global macro strategy

What triggers a sell-off when a recession is considered consensus?

UBS believe that economic growth is weaker than investors perceive and much weaker than priced in markets.

Eventually, this will lead to lower earnings estimates – for now, companies are carrying over easy financing and a strong backlog of orders. Thus, it will likely take up to Q3 earnings for market estimates to be revised downwards.

The 2024 earnings estimate of $246 per share looks much too high in the bank’s opinion.

Notwithstanding this, UBS believe that earnings estimates are out of kilter with reality, with tech earnings growth already expected to be around 2 per cent higher than in the previous decade, and these high earnings are being valued at a multiple consistent with real rates at -0.8 per cent, more than 230bps lower than where real rates are currently priced.

A US recession is widely considered “consensus” and thought to bring about weaker earnings, and therefore, weaker equities.

However, that’s not been the case at all.

Gangbusters US markets got off to a strong start this year, thanks to economic growth surprising to the upside.

After global growth surprised at the beginning of the year, global growth is now annualising below 2 per cent (versus a long-term average of 3.5 per cent).

Adding to this, the peak in global inflation was November 2022 and it has fallen aggressively since, paving the way for a “central bank pivot/pause/cut” narrative to drive stocks higher.

Part of the issue with these factors is that they are now in reverse – economic growth is coming in weaker than expected as the lagged impact of tighter monetary policy starts to impact.

---

Visit Stockhead, where ASX small caps are big deals

---

Consequently, this has resulted in the market all but pricing out central bank pivots – the first Fed rate cut is not priced until May/June, and is, in fact, priced for another hike.

Lastly, the Fed balance sheet has again begun to decline, and we are set to see an acceleration of the liquidity drain over the second half as the US Treasury refills its coffers post the debt ceiling.

In essence, this means that valuations will likely get compromised before earnings do.

After this valuation unwind, credit rating downgrades and defaults should be a precursor to weaker earnings (and ultimately, weaker equities).

Health Insurers: a relative haven

Following its Private Health Insurance (PHI) Survey for 2023, UBS reckons consumer sentiment towards private health insurance policies has improved to multi-year highs.

Consumer perception of value-for-money in PHI has jumped to its highest levels in five years.

They expect this to underpin further increase in participation and policy numbers into FY24 and that the tailwinds supporting PHIs are more durable and persistent than market expectations.

Historically, greater participation rates have been short-term. However, UBS believes there are more structural drivers at work, including:

1. Public hospital bottlenecks
2. Customer givebacks continuing
3. PHI repricing below CPI
4. Product enhancements (more for less)

While tighter household budgets will inevitably scrutinise PHI costs, the UBS survey results do highlight the handsomely defensive characteristics of the insurance sector.

For Medibank (ASX:MPL), UBS is forecasting 2.8-3.0 per cent increase in policy numbers in FY24-25 (consensus 1.8-2.7 per cent); for NIB Holdings (ASX:NHF), it is forecasting 3.2-3.6 per cent (consensus 3.1 per cent).

UBS adds that better retention and relatively low claims inflation to support above-average net insurance margins all the way into FY25.

This, combined with strong net migration supporting growth, has resulted in a near sector-wide increase for price targets – to $4.20 from $4 for MPL; and to $9.70 from $9.20 for NIB, the most notable.

Although the stocks are not cheap – Medibank Private and NHF trade between about 18x and around 19x PE multiples respectively, based on UBS FY24 forecasts – “resilient earnings, with upside risk, is likely to see multiples remain elevated.”

Valuations are already capturing a favourable outlook and the bank notes that in the current crappy environment, the PHI sector provides “defensive characteristics, healthy margins and interest rate leverage.”

Earnings are reasonably predictable (relative to other insurance segments) and earnings risks are skewed to the upside if the favourable PHI purchasing intentions evident in the latest UBS survey turn out to be accurate.

This content first appeared on stockhead.com.au

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.

SUBSCRIBE

Get the latest Stockhead news delivered free to your inbox. Click here