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Slow And Steady, And Lower For Longer

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Apr 01 2015

This story features AMCOR PLC, and other companies. For more info SHARE ANALYSIS: AMC

In This Week's Weekly Insights:

– Slow And Steady, And Lower For Longer
– The Ultimate Dividend Dilemma
– Resources' Bottom, Where art Thou?
– Two Weeks No Insights
– Share Buy Backs – Who's Doing It?
– Rudi On TV
– Rudi On Tour

Slow And Steady, And Lower For Longer

By Rudi Filapek-Vandyck, Editor FNArena

Don't be surprised because equity markets locally and in the US are facing stiff resistance this month. There are some important questions that need to be answered.

At first glance, it appears the Federal Reserve is a little bit in a pickle and any moves from here onwards need to be well-communicated and cautiously executed. No wonder, Fed chair Janet Yellen is using every opportunity to direct the market's attention away from the fact US interest rates need to rise, at some point.

The message Yellen is trying to convey is investors should focus on the pace of rate hikes in the years ahead, and it won't be anything like previous tightening cycles. The lower for longer outlook remains very much intact. On Friday, the Fed chair used her speech, "Normalising Monetary Policy: Prospects and Perspectives" to implicate a "neutral" setting is likely to be found at a lower level of interest rates than in the past.

There are quite a number of obvious reasons as to why Yellen and other FOMC members feel the need to walk as on eggshells. Official data suggest the US economy is again experiencing noticeable deceleration in momentum, with GDP growth numbers halving in Q4 from Q3 and now again expected to halve to 1% or less in Q1, as economists adjust for a weaker than expected performance in data and indicators thus far into the calendar year.

At the same time, weaker oil and a stronger greenback have erased all forecast growth in profits for the S&P500 in 2015. This, understandably, makes a few investors itchy as valuations are not exactly at basement-bottom level.

Question number one on Mr Market's mind is whether QE, or flooding financial markets with excessive liquidity, only really works through a simultaneously weakening currency.

Economic data already are improving in Europe despite QE by the ECB having hardly begun. But the euro has plunged and in combination with some improvement in financial conditions, and plunging energy prices, this is feeding into positive expectations for Europe. But US data are weak and US companies are clearly showing a noticeable loss in momentum. Less cashflows. Less growth (no growth?). Less capital management. Less optimistic forward guidance.

Is the next step lower share prices?

It should not be dismissed. Even the more bullish strategists and analysts these days are incorporating the possibility of a "pull back" or "correction" (whatever the definition for both) in their research reports. I observe the general mood certainly has dampened somewhat amongst chartists and technical analysts the world around.

And the US Dollar, for now at least, has stopped rising.

The All-Important Greenback

It is very much an open question who is leading whom at the moment, but if the Federal Reserve had full control, no doubt Yellen and Co would press the Pause button on the US Dollar's appreciation. No two ways about it.

For years the "printing of money" (QE) by the world's leading central bank caused US bond yields and the USD to weaken and this has finally inserted some healthy looking, solid momentum in the US economy. But now the Fed is looking to reverse its extraordinary monetary policy, while central banks in Japan and in Europe are stepping up their "money printing" policies, the shoe is on the other foot and the easy tailwinds from a sliding USD have now become annoying headwinds as the USD strengthens.

The appreciating USD is not a nasty side-effect just yet, but investors should not underestimate its effect nor importance.

Since mid last year, the USD has risen by 25% against the euro, by 20% against the yen and by 15% on a broad trade-weighted basis. Many an economist compares these moves with a 50bp tightening by the Fed. As pointed out by analysts at Deutsche Bank, "Excluding the financial crisis, which saw the dollar strengthen significantly on the back of flight-to-safety flows, moves of this magnitude during a similar time span have only been observed twice in the last 30 years, in 1985 and 1997."

The consequences of this have already been felt across the globe (even though it never is reported in direct correlation to the Fed's reversal in monetary policy): from weaker oil prices, to a slump in China's property bonanza, to the disappearance of US corporate profit growth, to the worsening economic situation in countries such as Brazil; the importance of the US dollar can be implicated in each of these developments.

The question thus becomes: can the USD potentially derail the Fed's plan to normalise interest rates?

The Fed's Ideal Scenario

Too late to ask the question. It has effectively already happened. Many an economist is today referring to an unexpected policy softening at the FOMC's March meeting, but given the strength of the USD was there for everyone to see, how much of a surprise has it really been? Or: should it have been?

There is little doubt the USD is slowing down the Fed. And it will continue to be an important factor that will be watched closely by Yellen and Co. The good news is a planned first hike in June might well be delayed simply to absorb the impact from USD-tightening. The bad news is that in the short term, it creates an excuse for market volatility and possibly a correction as the negatives are there for everyone to see.

Consider, for example, these two charts from a recent UBS report:

The Fed's hesitation should not automatically stop the rise of the greenback, however. Not in the view of most economists who (on my observation) continue to expect a continuation of the multi-year uptrend for USD. This in itself might imply that any US interest rate moves will be measured, slow and gradual. Not only to not cause too much market disruption, but to also absorb the extra impact from the stronger reserve currency.

If correct, the outlook for US corporate profits looks a whole lot less buoyant than in years past. Whether this also means US equities are best avoided remains yet to be seen. There is a valid thesis in the fact that "lower for longer", once Mr Market feels comfortable about it, might well translate into further expansion of Price-Earnings (PE) multiples and the net effect can still be positive.

There's little doubt in my mind this is the kind of scenario Yellen and Co have in mind. In theory.

In the real world, many more questions need to be answered. One is the historically inverse relationship between rising wages and corporate margins/profits. Throughout the nineties, the last time when US workers enjoyed a prolonged period of wage inflation, US companies found an offset through increased adoption of pc's and automation, which boosted productivity. This time around we have plenty of new and disruptive technologies, but will these also help boosting productivity so that wage increases can be absorbed? Or should we assume that new companies and industries will do all the hiring?

Global USD Liquidity – The Sleeper In The Background

It doesn't attract much attention in the mainstream media or in financial newsletters, but whenever the Federal Reserve tightens, in particular after an extended period of USD abundance, a shortage of US dollars occurs, usually in places where USDs are most needed, and unintended consequences follow.

One example is cheap and abundant dollars invite governments, corporates and households to take on more debt, but when tightening happens debt burdens rise while liquidity shrinks. This is not so much a problem inside the US as everywhere else. For example, it has emerged Chinese property developers have co-financed their splurge in recent years with cheap USD debt. Is it just coincidence Chinese property markets are going through a slump when USD strengthens and the Fed gets ready to start raising interest rates?

Your call. But it does bring home the message the Fed cannot risk unintended disaster stories unfolding across the world simply because it moves too fast or because markets misinterpret its outlined path.

Consider, for example, the significant increase in China's USD debt exposure since 2008 (graph courtesy of UBS):

Now consider the chart below which is UBS's calculation of global liquidity in USD. This chart, say UBS analysts, is the real reason as to why the FOMC turned more dovish in March. The world needs more USDs, not less.

If UBS's calculations and interpretation are correct, the Federal Reserve will be forced to wait a lot longer. There's even a chance it may have to turn accommodative again. No second guessing as to why the analysts have turned bullish on gold.

RBA Might Cut In April

RBA governor Glenn Stevens doesn't like to say it out loud, but monetary policy in Australia is very much held hostage by international dynamics, in particular by the USD and US Treasuries and by any decisions made, or not made, by the Federal Reserve. In the short term, a pause in the USD strength and the unlikelihood of an imminent rate hike in the US, have increased the chances of a local rate cut in April, if not May. Certainly several economists I've read in recent days expressed a similar view.

Note: a number of economists are by now leaning towards two more rate cuts this year, which would pull down the official cash rate in Australia to 1.75%.

The most feared enemy amidst all of the above would be an unexpected come-back of inflation, forcing the Fed and financial markets to suddenly adjust to a much steeper trajectory for global interest rates. No sign of such reversal seems on the horizon for as far as the eye can see.

The Ultimate Dividend Dilemma

Below is a graph from a Goldman Sachs research report, confirming my own mantra from the years past: superior investment returns are generated by stocks that combine dividends and growth. Many among you might recognise the graph as it is one of my favourite slides when standing on stage and presenting to the investor community throughout Australia.

The last time I stood on stage, in front of members of the Australian Investors' Association (AIA) a few weeks ago, the same dilemma was raised from the audience as has been consistently the case in years past: what does one do when a given investment ten years later generates, say, 25% in annual yield and then the company lands in trouble?

Often such dilemmas end up with a public debate as to how investors should value their investment. Does one calculate the yield from the original investment or does one recalculate the yield from the last share price, thus also taking into account the share price appreciation/depreciation? Defenders for both methodologies can be quite unforgiving towards another.

The disadvantage of method number one is obvious: it completely ignores what has happened to the share price and that can be a bad thing. The disadvantage of method number two is that it tends to underplay the importance of dividend growth and investors who only look at stocks this way, on my observation, oft end up selling too early, while they also fail to capture a true understanding of how accumulating growing dividends can do wonders to your long term portfolio. A fact even acknowledged by Charlie Munger and Warren Buffett.

This is the reason why FNArena's Stock Analysis also shows dividend yields for stocks if they were purchased three years ago alongside the possibility to make calculations into the future (see Stock Analysis on the website).

But there's no denying that when investors pick their growing dividend stocks correctly, they will eventually run into that dreadful dilemma: the company might be in trouble, but my investment is generating 20% per annum, plus franking, what do I do?

The answer is you don't stare yourself blind on the yield, but you take a more holistic approach by combining the total value of your investment and then considering whether there is a better alternative. For example, 20% (or any other high number) might seem impressive from your initial investment of $5,000 but if the total value of your investment by now represents $50,000 and you can re-invest it at 5% while also reducing your risk, than that is probably a better alternative.

In simple income terms: 20% from $5,000 means you'll be receiving $1250 in the year ahead from dividends. But 5% from $50,000 represents an income of $2500. I am purposely using easy maths to get the basic idea across.

All those happy shareholders in Monadelphous who bought shares in 2004 and held on to them until today have made exactly that mistake. Had they sold when the share price was above $20 (not to mention at its peak of $28) and re-invested elsewhere they would have been much better off today. Instead many preferred to look over their shoulder and they simply could not say goodbye to a stock that had been so good to them for so many years.

There are many more lessons to be learned from this, but let's keep it simple today and stick to the one that counts, for now. It's better not to combine dividends with weakness, and that goes for all layers of dependency and vulnerability.

Resources' Bottom, Where art Thou?

2015 has (thus far) proved yet another tough challenge for investors in resources stocks, despite the occasional brief rally here and there. I observe BHP Billiton shares are struggling to stay north of $30 notwithstanding a clear dividend focus, including the soon to be spun-off South32. The latter has already been labeled the only truly diversified resources company once it starts life as a separately listed entity. There's a whole lot of irony packaged into that observation.

Is it just me or are investors losing their appetite for energy and mining stocks? On my observation even those commentators who tend to be undeterred bullish no matter what have gone quiet or are now advocating restraint as finding the elusive bottom has played out like a script of Samuel Beckett's En Attendant Godot (Waiting For Godot).

Amidst the share market carnage, one voice stood up and it was not to bring any encouragement. Denham Capital, headquartered in Boston, is a private equity firm specialised in the energy and resources sector with some US$7.9bn in invested and committed funds. One would thus assume any insights from its principals carry some weight across the investment landscape.

On Saturday the AFR's China correspondent Angus Grigg quoted Denham Capital's managing director Bert Koth as saying: "We believe we are still two years away from the bottom and then we are going to stay there for at least four to five years".

This however won't stop the bravest among us for trying regardless. For those, resources analysts at BA-Merrill Lynch have produced a neat overview of grades, costs, price discounts and "geared adjusted costs" for all the major producers of iron ore in Australia. Unfortunately, shrinking the table to fit in this email merely renders the data useless (too small to read). But I promise when this story will be published on the website on Wednesday, it will contain that table.

Two Weeks No Insights

This doesn't happen often but there won't be any Weekly Insights for the coming two weeks. Next week's long Easter weekend creates havoc with my travel requirements (I will be in Melbourne) and the week thereafter I will briefly pay a short visit to Europe. Next Weekly Insights thus won't be due until April 20th. Stay healthy and level-headed in the meantime.

Share Buy Backs – Who's Doing It?

Below is an incomplete overview of companies buying in their own shares this year. We very much appreciate all contributions and suggestions at

– Amcor ((AMC))
– Boral ((BLD))
– CSL ((CSL))
– DWS Ltd ((DWS))
– Fairfax ((FXJ))
– Fiducian ((FID))
– Finbar Group ((FRI))
– GDI Property Group ((GDI))
– Logicamms ((LCM))
– Nine Entertainment ((NEC))
– Orica ((ORI))
– Pro Medicus ((PME))
– Rio Tinto ((RIO))
– Seven Group ((SVW))

Wants to buy in own stock (but still awaiting shareholders approval): Intrepid Mines ((IAU))

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Thursday, Sky Business, noon-12.45pm, Lunch Money

Rudi On Tour

I have accepted invitations to present:

– May 19, ATAA Canberra
– May 29, CEOs lunch French Chamber of Commerce
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Monday, 30 March 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)



This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.



Odd as it may seem, but today's share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to

For paying subscribers only: we have an excel sheet overview with share price as at the end of February available. Just send an email to the address above if you are interested.

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