Rudi's View | Apr 29 2015
This story features RESMED INC, and other companies. For more info SHARE ANALYSIS: RMD
In This Week’s Weekly Insights:
– The US Federal Reserve And Bear Markets
– Citi’s Checklist: No Bear Market In Sight
– US Equities: In A Sweet Spot
– ResMed: Disappointment At The Margin
– Hidden Barriers – The (Interactive) Sequel
– Share Buybacks – Who’s Doing It?
– Rudi On TV
– Rudi On Tour
The US Federal Reserve And Bear Markets
By Rudi Filapek-Vandyck
US equities are back in positive territory for the calendar year, but only just. As a matter of fact, any price chart clearly shows how US equities essentially have been trending sideways since late last year.
The reason? The world’s mightiest central bank, the US Federal Reserve, is changing policy and wants to start raising interest rates.
Very few analysts and investors deny the Fed’s uber-accommodative, super-charged liquidity driven market intervention post-2009 has played a pivotal role in the resurrection of global equity markets. Thus when the Fed turns less accommodative, this is a big event that catches just about everyone’s attention.
The current late April rally for equities is only possible, so it appears, because financial markets continue to push out the time Fed chair Janet Yellen is expected to announce the first rate hike. This could be interpreted as equity markets are simply rallying on borrowed time. At some point, the pushing out will stop and the date of the inevitable move will draw closer, and closer.
How afraid should investors really be?
Market Corrections Are Par For The Course
A market correction of 10% or more is always a possibility. As a matter of fact, US equities haven’t seen such a correction since 2011 while historically 10% corrections occur on average every two-three years or so, making the current correction-less period already quite exceptional. At some point, of course, such a correction will occur.
The reason as to why many experts believe a 10% correction might just occur this year is because head winds are building for US equities. Apart from a change in the outlook for interest rates, there’s the stronger USD, slowing growth for US companies and the historically inverse relationship between labour costs and profit margins (to name but a few factors).
But corrections are only temporary set-backs in a longer term uptrend. Surely what investors should be really afraid of is the start of a new bear market? With memories of 2000-2002 and of 2007-2009 still alive and kicking, what are the chances that, with global USD liquidity retreating, global equities are approaching the end of what has been a rather unusual bull market, and soon about to descend into the next bear market abyss?
No need to worry, says Glushkin Sheff’s chief economist and global investment strategist, David Rosenberg. He’s done the data research to back up his confidence.
No US Bear Market Sans Fed Tightening
What investors should worry about is the final rate hike in a Fed tightening cycle, not the first one, his research shows. The first rate hike has never ever in history pushed equities into a bear market.
Assuming the Federal Reserve will announce its first rate hike sometime between September-December this year, it will have been nearly a decade since the last time the world witnessed such a move. So understandably, markets get nervous ahead of such a momentous change. Another way of looking at it is:
“we have had thousands of traders, portfolio managers and market-seers join the industry who have only known about deflation, quantitative easing and zero interest rates – they are the mirror image of the folks who populated the financial business in the 1970s and 1980s when rate hikes were the order of the day”.
Rosenberg and his team have done the numbers and the research on Fed tightening cycles since 1950. On each occasion it took a series of rate hikes before the US economy experienced a recession.
The bottom line is there’s a huge lag between rising interest rates and the ultimate negative impact on economic growth and thus on equities’ fortune and well-being. Rosenberg puts this lag at three years, minimum.
This implies the current uptrend should remain in place until 2018/19.
The Fed And Bear Markets: Historic Data Analysis
Some numbers in support of Rosenberg’s prediction:
– the average length of time from first tightening to the end of the business cycle is 44 months
– the median time is 35 months
– the lag from initial hike till the end of the bull market is 38 months on average
– the median is 40 months
Hence his conclusion: investors shouldn’t worry so much ahead of the first rate hike. Instead they should worry once the Fed stops hiking rates, and the reason as to why that is. History shows there’s always at least one rate hike too many, and with a lag the next economic recession starts building.
Rosenberg’s research suggests the time between the final rate hike and the next recession is usually about one year. Sometimes the Fed and the US economy get lucky and a recession can still be avoided which is what happened in the mid-1960s, mid-1980s and the mid-1990s.
He has done the numbers on US equities too. On average, reports Rosenberg, once the S&P500 manages to recoup the losses suffered during the bear market, it continues to rally for another 45 months for an average gain of 160%. This puts the current bull market run still at sub-par numbers: 25 months so far and a gain of 35% only.
Despite this, Rosenberg is willing to concede US equities’ valuations look a bit rich when compared to previous long economic cycles. On average, it can be argued, the US share market is now 14% too high. However, counters Rosenberg, one must also take into account bond yields have never been this low and this allows for higher valuations for equities.
The current economic expansion hasn’t exactly lived up to expectations, and overall performance in Q1 again disappointed, but what is seldom highlighted is that the current expansion already is one of the longest in history, and at 69 months certainly well above average, points out Rosenberg. If his prediction proves accurate and there are at least another three-four years of uninterrupted growth on the horizon, we could be living through one of the longest economic expansions in modern history.
Bottom line, according to Rosenberg, nothing lasts forever. At some point this economic expansion and equity bull market will end as they do. But they never die simply of old age. They die of excessive Fed monetary restraint. Until then, chill, and treat corrections, no matter the cause, as just that – bumps on an otherwise upward trajectory.
Australia’s Performance Ain’t So Bad
Investors who still feel dismayed about the fact Australian indices remain double digit percent below 2007 highs should take a peak at the overview below, recently published by analysts at Citi. Less than half of all global equity markets have thus far been able to recoup their bear market losses and a handful have done so only just. Some bull market, hey?
All of a sudden, the performance of the Australian share market doesn’t look so bad at all (Note: the share market in Austria is today some 70% below its 2007 peak, with Portugal and Ireland not far in front).
Citi’s Checklist: No Bear Market In Sight
Investors wondering why so many investment strategists remain adamant there is no new bear market on the horizon need not to look any further.
Market strategists at Citi recently published their checklist and it appears there really is little reason, if any, to fear for the worst. Even Price-Earnings (PE) ratios, so often mentioned as being above average (and thus “expensive”) are only seen as “somewhat of a worry”, but not as a genuine threat to future returns.
The only real cause for concern is the load of debt being carried around by global corporates while their ability to pay it all back and carry the costs has diminished from one year ago.
Most items on Citi’s checklist are far and remote from the checklists in 2007 or in 2000; see below.
US Equities: In A Sweet Spot
Those experts who only look at US equities through the prism of “valuations” might well face another year of surprise. The chart below, thanks to Business Insider, seems to indicate that US equities, for whatever quirky reason, might be in a sweet spot that is much more difficult to explain than movements in Fed interest rate expectations or global USD liquidity combined with corporate profits.
Firstly, the chart below combines a whole lot of data since 1988 into one graphic illustration. For those who want to study it more closely: the blue line running across links to the right hand side and shows average twelve month returns for US equities at a particular average Price-Earnings (PE) ratio. The horizontal axis shows all PE ratios, their frequency over the past 27 years and the various twelve month returns associated.
The quirk of this graph is that while a US share market trading on a PE of 15 or 19 does have a heightened chance for a negative return, the year-out performance has never been negative when the market was trading on a PE of 16, 17 or 18. Never. Not once.
History shows, and we are relying on the accuracy of the analysis behind the graph, that a PE of 17 in most cases results in a twelve month return between 10-20%, followed by precedents that generated a return between 0-10%. Another quirk is that were the PE 16 or 18 chances would be higher for a return in excess of 20%.
So even if US equities perform second best this year, the return should still be up to 9% for the year. Unless 2015 turns out the exception that history hasn’t yet seen, at least not since 1988.
ResMed: Disappointment At The Margin
It was the year 1995. I stopped writing stories about media, local politics and Dutch drug lords in Ibiza. Instead I became an online finance reporter.
At some point between then and now, I decided I wanted to look at the share market through the eyes of financial analysts. The ability to do so has helped me on many occasions since.
Friday’s quarterly market update by investor darling ResMed ((RMD)) is a case in point. Forget about Price-Earnings (PE) ratios, capital growth over the past twelve months and sales growth over the March quarter.
What caused the sharp response in the share price on the day was the downward pressure on the company’s profit margin. High growth at a high margin gets rewarded with a high PE in the share market. However, if the margin turns south a reset is required and that can cause quite some damage.
That’s the story of ResMed post Friday’s market update. The graph below illustrates the margin trajectory as now assumed by Deutsche Bank analysts. Of course, not everyone agrees. Bullish analysts believe the margin will recover much sooner. Or the dip might prove out more shallow. Whatever the case: ResMed’s story from now onwards has become a margin trajectory story.
Hidden Barriers – The (Interactive) Sequel
Last week’s Weekly Insights zoomed in on what I labeled “Hidden Barriers”; reasons as to why certain share prices don’t seem to go anywhere that are not necessarily obvious to most observers and/or investors. The story received positive feedback, including from TV host Peter Switzer, which is why FNArena has published a video this week under the same title.
While reflecting on the subject, I came up with a handful of additional stocks whose lacklustre performance of late might be an enigma to many, including Medibank Private, Greencross and Primary Healthcare. But maybe I should open up this question to readers of my Weekly Insights: are there any companies whose underperformance remains a mystery?
Send in your suggestions via email@example.com and I will either include them in the next update on the theme, or respond via email.
Share Buybacks – 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 firstname.lastname@example.org
– Amcor ((AMC))
– Boral ((BLD))
– CSL ((CSL))
– DWS Ltd ((DWS))
– Fairfax Media ((FXJ))
– Fiducian ((FID))
– Finbar Group ((FRI))
– GDI Property Group ((GDI))
– GWA Group ((GWA))
– Industria REIT ((IDR))
– Logicamms ((LCM))
– Matrix Composites & Engineering ((MCE))
– Nine Entertainment ((NEC))
– Orica ((ORI))
– Pro Medicus ((PME))
– ResMed ((RMD))
– 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 Wednesday, Sky Business, 8-9pm, Your Money, Your Call Equities (host)
– 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, 27 April 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. In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: email@example.com or via Editor Direct on the website).
THE AUD AND THE AUSTRALIAN SHARE MARKET
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.
MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS
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 firstname.lastname@example.org
For paying subscribers only: we have an excel sheet overview with share price as at the end of March available. Just send an email to the address above if you are interested.
For more info SHARE ANALYSIS: AMC - AMCOR PLC
For more info SHARE ANALYSIS: BLD - BORAL LIMITED
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: DWS - DWS LIMITED
For more info SHARE ANALYSIS: FID - FIDUCIAN GROUP LIMITED
For more info SHARE ANALYSIS: FRI - FINBAR GROUP LIMITED
For more info SHARE ANALYSIS: GDI - GDI PROPERTY GROUP
For more info SHARE ANALYSIS: GWA - GWA GROUP LIMITED
For more info SHARE ANALYSIS: LCM - LOGICAMMS LIMITED
For more info SHARE ANALYSIS: MCE - MATRIX COMPOSITES & ENGINEERING LIMITED
For more info SHARE ANALYSIS: NEC - NINE ENTERTAINMENT CO. HOLDINGS LIMITED
For more info SHARE ANALYSIS: ORI - ORICA LIMITED
For more info SHARE ANALYSIS: PME - PRO MEDICUS LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC
For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED