Rudi's View | Aug 12 2015
This story features AUSTRALIA AND NEW ZEALAND BANKING GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: ANZ
In this week’s Weekly Insights:
– About Risk And Comfort
– Commodities: Buy Signal From Hell?
– US Equities: Divergence And Investor Concerns
– Realities Of The European Union
– Rudi On TV
– Rudi In The Australian
About Risk And Comfort
By Rudi Filapek-Vandyck, Editor FNArena
Investing is not about “knowing” the future. It’s about deciding what risks you feel comfortable with.
Two events last week highlighted this very truth about investing and risk. Firstly, ANZ Bank ((ANZ)) requested a trading halt in its stock in order to announce a $3bn capital raising, dilutive in nature and relatively unexpected having previously indicated asset sales and a fully underwritten dividend reinvestment program (DRP) were the board’s preferred strategy to deal with increased regulatory requirements.
Secondly, the world’s largest supplier of explosives and blasting systems to mining and infrastructure projects, Orica ((ORI)), warned its profits will be lower than market consensus, with no immediate recovery in sight and some hefty impairment charges to be included for the year.
It is always easy to look smart after the event, but in these two cases: if you were completely taken by surprise then, sorry, but you haven’t genuinely been paying attention.
Even excluding Weekly Insights, FNArena has offered numerous stories both on the banks and on Orica highlighting the potential risks. This is why I personally like diversity among the stockbrokers in the Australian Broker Call Report. It’s not about Buy/Hold/Sell ratings, or about who is wrong and who is right. It’s about trying to determine where the risks are, and whether I, as an investor, feel comfortable being exposed.
Mining Services Tragedy
Orica, whose corporate roots trace back to the Victorian gold rush more than 130 years ago believe it or not, has done Australian investors one huge, under-appreciated favour. In 2010 it spun off its paint division which now trades as DuluxGroup ((DLX)) on the Australian share market. One glance at the share price graph over that period suffices to support my view that Orica has given Australian investors one big gift and I do hope the average long term investment portfolio contains a little exposure to this relatively defensive business that offers lower volatility exposure to the booming housing market in Australia.
Late last year, Orica also disposed of its chemicals division and became a full, undiluted mining services provider. This is only a good thing if you happen to believe the cycle is finally turning for this sector. More announcements about capex restraints by the likes of BHP Billiton ((BHP)) and Rio Tinto ((RIO)), plus North American gold producers in pain with a bullion price below US$1100/oz, plus bulk commodities in severe and ongoing oversupply, does not genuinely support such view.
But then there’s a plethora of views out there, and some experts on the sector, or on Orica in particular, are trying to convince you and me the shares represent an excellent buying opportunity at levels around $16 (5.7% yield, partially franked). Supporting their view is the fact the company’s shares have mostly traded with a 2 in front post 2009. But then that was including Dulux and also including Chemicals until last year. Note Orica shares traded above $22 only a few weeks ago (so much for “market intelligence”).
Mining services providers enjoyed a golden run until early 2012 when it became clear the giants in the sector had set their sights on reducing capex, which has been the sector’s downfall until today. Just ask Downer EDI ((DOW)), whose outlook also disappointed last week.
Fund managers, stockbrokers, tip sheets and the like have been rummaging through the carnage in years past, trying to anticipate the turning point, if not for the sector in general then for some individual players. Admittedly, potential rewards can be significant if only because share prices have been absolutely pummelled. But is it worth the risk?
My view has been, and still is, this sector represents without the slightest doubt some fine buying opportunities that will be highly rewarding at some point in the future (exact timing unknown). The problem is there are so many more possibilities to pick a wood duck and suffer from the next profit downgrade (while cursing myself I ever ventured into this space in the first place).
Another way to look at this is: in five years from today, stocks like Orica, Downer EDI and the likes, which are generally considered high quality plays in an out-of-favour sector, will be more than likely trading at a higher price level. While they do offer healthy dividends in the meantime, nobody really knows what’s going to happen in the short to medium term. Your own guess is as good as anybody else’s as to whether this is the bottom of the cycle, or simply a pause in the downtrend, or much better, or much worse.
What I do know is this is not the type of risk I personally feel comfortable being exposed to. I do understand the principle of value investing and I do wish all value investors jumping on board post yet another shellacking all the luck in the world. As far as I am concerned, you need it.
Disclosure: the FNArena/Pulse Markets All-Weather Model Portfolio has exposure to DuluxGroup (see disclaimer further below for more info).
Banks Or No Banks?
Should you invest in Australian banks? The question is as divisive in Australia today as it has ever been. Most retail investors have large exposures to the Big Four banks, larger than is wise from a risk concentration point of view. They are being laughed at because of it by professionals in the funds management industry. Honest is honest though, many retail portfolios have performed better than expected in years past and the banks have played a crucial part in this.
Earlier this year I literally rang the bell when hosting Your Money, Your Call Equities on the Sky Business pay-TV channel. To announce the obvious: the golden era for Australian banks is now over. Don’t look over your shoulder and fall in love with past returns.
Having said so: banks are by no means about to replicate the downturn that killed the bull market for mining services providers. But the way forward is looking a lot more demanding and challenging, and share price sell-offs and de-ratings this year are simply the market re-adjusting for the sector’s new reality.
If anything, recent company announcements seem to indicate the sector has now lost its knack to always deliver a little extra on the positive side and that too is a true signal that times have reversed. The sector is now essentially ex-growth in that most levers that can be pulled, have been exercised in years past, while bad debts and margin pressure plus constraints on property loans are keeping growth in single digits to be eroded by the issuance of extra capital.
From here onwards we can all come up with various scenarios about what can go wrong for the Australian economy, and for the banks, and surely when downturns kick in, the bias is for more negative news to simply trigger more negative news. Soon we’ll see doubt about whether this bank should no longer increase its dividend, or lower the pay-out ratio, or raise more capital.
The key question overshadowing all of this is whether share price valuations are already capturing these increasingly challenging prospects? If not, the bulls will argue most of it should be priced in by now (e.i. more upside potential than downside risk).
Note: despite this year’s de-rating for Australian banks, local share market indices continue to point towards a positive return for investors.
Admirable Track Record On Banks
Most readers of Weekly Insights have been on the mailing list for many years, so I am expecting a lot of nodding heads in the next few minutes. To all others: I am specifically writing the following paragraphs for you. You might appreciate the how, why and what we do at FNArena a little more.
In 2007 (gosh, that’s such a long time ago), FNArena was among the first to understand the importance of what had been going on with subprime lending in the USA. We turned our focus to Australian banks and warned they would not be immune from overseas problems; a view that was held by a small minority only at that time, and for a long time. We pretty much spent the whole of 2008 repeating our view on banks, again, and again, and again.
We turned bullish on the sector in mid-2009. We were not the first, but then we were never going to be. When we make these calls, we want to make sure we are right in our assessment. That time around, we encountered a largely dismissive audience, having been burned in the years prior and not believing my personal prediction at the time that bank shares would offer 100% return over the decade ahead. As we’ve all experienced since, they have done better than that and the decade is yet far from over (2015 is giving some of it back, though).
Last year, we turned more cautious. Earlier this year, I rang the bell to announce the end of the golden era.
I do not believe Australian banks will be detrimental to investors’ portfolios as have been mining companies and energy producers over the years past, especially the small caps in both sectors. But they won’t be “fantastic”, “excellent” or “outstanding” either, even from current price levels. Banks can, and probably will, still generate reasonable returns, not in the least because boards will defend those dividends with everything in their might.
I have a suspicion that once we get past regulatory issues and extra capital raisings, and the Federal Reserve’s first interest rate hike, global bond markets will become more comfortable and settle for a prolonged period of no more rate hikes, and this -all else being equal- will trigger a come-back into favour for the banks. But this is, at this stage, not more than a suspicion.
There’s so much that can still happen between now and then. Make sure you are comfortable with your portfolio and your strategies while bank shares, and equities in general, are sailing rougher seas.
Commodities: Buy Signal From Hell?
“As commodities reach new multi-year lows on a total returns basis and multi-decade lows relative to equities, fundamentals remain broadly weak. Therefore the sector is susceptible to any further deterioration in indices measuring manufacturing and industrial activity which remain narrowly in expansion at 51. Out of twenty commodities, only six are now above their 2000-2014 averages in real terms”.
Those are the opening words to Deutsche Bank’s latest update on the worst performing asset class for four years uninterrupted; commodities. It goes without saying everybody who took guidance from the sector’s dismal performances in each of 2012, 2013 and 2014 and believed a return to favour surely must be around the corner, has now been burned badly, again, by July’s general (and indiscriminate) wash-out.
Yet, there are a number of experts around, and not just in Australia, who are starting to suggest the sector is worth considering. Seriously.
The most fundamentally attractive thesis I came across in these volatile weeks full of turmoil and carnage and despair comes from sector analysts at Citi who published a daring report, essentially pointing out these wash-outs at the end of an enduring down turn (“bear market”, if you like) are usually excellent buying opportunities, even though this may not become apparent immediately.
This is because markets tend to move well ahead of fundamentals.
Citi’s report contains many graphs and charts, not even confined to the commodities space, which may well have been selected by Harry Hindsight, who’s a multi-billionaire by now, as we all know.
Cue: those well-trodden quotes from Baron Rothschild and Warren Buffett that have been used a million times (make that a billion, surely?) about buying opportunities presenting themselves when things look bad, prices tank and investors are running scared. The most difficult part in this process is to overcome the past (full of disappointment), as well as the absence of any fundamental justification (just read Macquarie reports about how much supply needs to disappear).
Not for the faint-hearted. For all others: may Dame Fortuna be on your side, and remain on your side.
US Equities: Divergence And Investor Concerns
US equities are still showing healthy gains for the year. Or they are barely positive. Or they are, clearly, in negative territory now. It all depends on what benchmark investors happen to focus on.
What cannot be denied, however, is that technicals looks vulnerable, again, and divergence has become the new label to use when talking about US equities. Divergence is not a signal of a strong bull market, as we all know, but does this mean it automatically signals the start of a new bear market?
US investors are becoming increasingly worried. Not that we have much contact with investors in the US ourselves, here at FNArena, but whenever we read market updates written and published in the US by large financial institutions, and the topic shifts to contacts with clients, the background colour instantaneously turns grey. US investors are worried. On some indications, probably more worried than we here in Australia give them credit for.
A few snippets from a recent BTIG strategy missive, with BTIG strategist Dan Greenhaus retaining a bullish outlook nevertheless:
“Our client conversations have taken on a decidedly more negative tone of late and with the S&P 500 essentially sitting on its 200 DMA, we can hardly blame them… Further, with five major S&P sectors lower YTD and the type of narrowing leadership we’ve been discussing, many clients have found additional reasons to fret… Some have even brought up the year 2000 for comparison purposes, a year that many remember as hitting its top in March but fewer remember as being virtually unchanged with that peak level by August’s end. It’s been argued that peak was a “process” and this one will be too…”
I have written about US equities divergence myself (see “Time For Caution”, 27 July 2015) and that title continues to illustrate my own view, and behaviour, regarding the Australian share market since the dynamics started to get rougher in May. For those who want to read more on divergence in US markets, here’s a recent update from John P Hussman, from Hussman Funds: http://www.hussmanfunds.com/weeklyMarketComment.html
Be warned: the chart below is from Hussman’s weekly market update and does not increase one’s overall comfort with what’s happening in US markets in 2015.
Realities Of The European Union
I came across this illustration via social media, but a targeted Google search helped me find a copy I can include in this week’s Weekly Insights.
Even if you do not know which countries belong to all the flags on display, I think you get the general idea. And that’s exactly how growing numbers of Europeans are starting to look at the political construction that is today’s European Union.
Rudi On TV
– on Wednesday, Sky Business, 5.30-6pm, Market Moves
Rudi In The Australian
Australia’s national newspaper, The Australian, has edited last week’s Weekly Insights, to be published as an introduction to the local reporting season on page 27 of the Tuesday edition.
(This story was written on Monday, 10 August 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 July available. Just send an email to the address above if you are interested.
For more info SHARE ANALYSIS: ANZ - AUSTRALIA AND NEW ZEALAND BANKING GROUP LIMITED
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: DOW - DOWNER EDI LIMITED
For more info SHARE ANALYSIS: ORI - ORICA LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED