Rudi's View | Aug 26 2015
[If you think you’re having a bad Monday, spare a thought for your Editor who had to spend part of his day without electricity. Luckily, I escaped the rain when I briefly ventured outside. Bottom line: it could all have been a lot worse]
Share Market Carnage: Life Aint Fair
The feeling surrounding the global rout in risk assets is that life simply is not fair.
Currencies, equities and commodities elsewhere have been correcting for months, but the ever so inward-focused US equities markets managed to largely ignore whatever was happening outside God’s own country, until all hell broke loose last week.
Investors in the Australian share market have all the reasons in the world to feel disgruntled about what is taking place in their portfolios. It’s like battling a nasty flu for weeks and then being run over by a fully loaded truck at full speed.
I wouldn’t spend too much time on technical support levels and the like. This is forced selling and investor panic at full display.
For those who like to put a human face on things, your teenage kids are having a tantrum. They’re blaming the world, the school and those no-good teachers, their parents (you) and the neighbours for everything. Don’t try to reason with them as that won’t work. Later, maybe, when tempers have cooled down. Right now the dominant themes are “shoot first, then think about it and reconsider”, as well as “just get me outta here, will yah?”
A Lot More Than Meets The Eye
What exactly has triggered this awful August rout?
This is foremost about Emerging Markets; their vulnerability because of exposure to USD strength and to China, the world’s most eminent growth engine in the post-GFC era. China sits at the centre of what can possibly go wrong. Emerging Markets now represent more than 50% of global growth.
This is also about unintended consequences from the Fed’s intention to normalise monetary policy after years of extreme stimulus. The prospect of rising interest rates in the US is tightening USD liquidity across the globe and, as one would expect, cracks have started appearing. This always happens.
No doubt Fed chairwoman Janet Yellen and the rest of the policy board had been hoping that given the intention had been flagged, and repetitively repeated, such a long time in advance that the weakest links had had enough time to prepare. But one never really knows who’s been swimming without his speedos until the tide moves away from the shore.
This is also about central bankers’ perceived omnipotence and the credibility of their messages to the markets. China’s PBoC is rapidly losing a lot of lustre, as are the rulers in Beijing, after manufacturing a frenzied share market rally, only to be found out pretty much powerless when the music finally stopped. Observe how Chinese equities, having prior rallied 60% year-to-date, are now in negative territory for calendar 2015.
Quite an achievement if one considers the perceived might of Chinese rulers in Beijing and the efforts put in place to make sure this was not going to happen. Yet, it did.
The Chinese economy is still growing at 7% according to official statistics, but c’mon, who really believes those stats resemble anything but official spin? Emerging Asia is feeling pain and so are commodities. Many stats and indicators outside Beijing’s direct influence suggest growth for the greater China region is much weaker, and faltering.
Meanwhile, on the opposite side of the globe members of the Federal Open Market Committee (FOMC) are preparing for the next meeting in September, but they are increasingly looking at a “between a rock and a hard place” dilemma. Yellen and Co would like to move away from the zero interest rate policy, but they cannot.
There still is no inflation. It’s why economists have invented the term “lowflation”.
At zero interest rates, any form of monetary stimulus means yet another chapter of Quantitative Easing. Contrary to past experiences, however, I don’t think more QE will be as well received as between 2009-2014. This time around it will raise all kinds of questions such as: will the Fed ever get out of its policy quagmire? What if it doesn’t?
Heads off for those investors who confidently stacked up on gold earlier in the year. I must admit I had my doubts, but right now things are lining up for a come-back for bullion, which is not good news for just about everything else. However, do not underestimate the intentions of central bankers and members of plunge protection teams. No doubt, they have gold on their radar and just about everything else (to reverse trend, that is).
History also shows that when forced liquidation becomes de rigeur, gold often becomes a key victim. Why would this time around be any different?
Short Term Worries
OK, I have given you my five cents worth about what is happening behind the panic and the sell-offs. AMP Head of Investment Strategy Shane Oliver published a timely assessment last week and he has a slightly different take on things.
According to Oliver, a queue of short term worries are all conspiring this month, including:
– Softer data from China
– Commodities in a bear market, and falling
– Greece back in focus
– Lowflation and weakening global growth posing threats to corporate profits
– US Fed about to start hiking rates always triggers volatility
– The technical picture for US equities has deteriorated
– Disappointing local reporting season in Australia
– The calendar is approaching the historically weakest two months of the year, on average
Oliver also joins a whole queue of market experts and commentators ensuring investors this is nothing but a “correction”, a blip in an ongoing long term uptrend.
Factors in support of such view include:
– valuations are not out of kilter with long term averages and/or trends
– investor sentiment is far from euphoric
– central bank policies remain supportive, interest rates are low
– lower commodities prices are a boon for consumers
Those interested in reading Oliver’s report on “The correction in share markets” can do so here.
Heroics Best Avoided
Now that you have taken some comfort from Oliver’s soothing analysis, here comes an equally reputed market expert in the person of Dennis Gartman, market trader and publisher of daily The Gartman Letter, having been around for more than three decades, and never afraid to express views in a blunt and honest manner.
From Friday’s edition: “…we fear that the bear market has begun in earnest and that this bear market may last for several more months to the downside. We fear that enormous, long standing and very important trend lines have been or shall soon be broken to the downside. We fear that support in the longer run lies a very, very long way below where the markets are today and we do indeed fear that things are going to become very ugly and remain so for a rather disconcertingly long period of time.”
From Monday’s edition: “…This has obviously become very, very serious and although the pundits on television may argue that this is a buying opportunity it is not! It is an opportunity to get less long; to be less involved; to be protective of your capital et al; to “hunker down” as we say here in the South, but this is not an opportunity… yet… to be a buyer. We are still facing the most difficult periods of time in the market each year: all of September and into-mid-October when the markets characteristically suffer their worst defeats. Dry powder is the order of the day; smaller positions are what should be adopted; selling rallies is the wiser choice; heroics are to be avoided.”
The irony is the views of Oliver and Gartman can both be correct.
Never The Same
Admittedly, two key factors being mentioned by the soothing bulls crowd are undeniably true. This is not a carbon copy of the GFC or even of the Asian currency crisis, and valuations on most metrics were not as expansive as prior to the past two bear markets. In addition, there’s a whole crowd of technical analysts telling us most markets are now screaming “oversold”.
The latter probably means we shall see a sharp bounce back at some point, when the epicentre of forced selling starts wavering.
As far as the first two factors are concerned: there never is a blue print for the next phase of global trouble. The fact that things in 1998 weren’t the same as in 1990 or in 1987 didn’t stop equities correcting swiftly. The fact that in 2000 circumstances were different again didn’t prevent share markets from entering a new bear market then. And valuations are only cheap when whatever lies ahead of us doesn’t materially differ from what has been assumed to calculate and support those valuations.
To put it bluntly: investors who, with a long term horizon in mind, snapped up shares in BHP Billiton below $30 in 2008 must have thought they could never go wrong, as long as they let time do its healing. Yet, here we are, seven years later and BHP shares have just closed below $23. Admittedly, this occurred after spinning off South32 (closing price on Monday: $1.40), but still.
The main conclusion I have drawn from such observations is that not all ASX-listed stocks are of equal value. This should be of ab-so-lu-te-ly no concern to you if you are a trader looking for the next best opportunity. As an “investor”, however, it pays off double -make that triple- to pick and choose more carefully.
Scenarios For The Future
Where do we go from here?
Investors should once again keep in mind that short term movements in risk assets are all about “sentiment”. This can work either way. In the next few days we are about to find out whether value seekers are jumping on the opportunity (probably) or whether a generally cautious mood will soon take over (equally probable), given the sudden carnage that has occurred. Even back in 2008 the selling did stop and it did so regularly. There even were two sucker rallies throughout the year (when numerous experts and commentators were caught out declaring the end of the bear market).
Whatever happens in the sessions ahead, it won’t give us any clues or guarantees about the future. This is because nobody genuinely knows what lies ahead. This wave of selling that has hit global risk assets is at this point driven by concerns, by angst and by fear, and by liquidation of leveraged assets, and by fear feeding upon itself, so that selling simply triggers more selling. Call it whatever you like. It’s not rational (see teenager tantrum above).
The reason as to why nobody knows for certain what lies ahead is because we have yet to find out whether current concerns might materialise and if they do, what form exactly we are talking about. Then there is that other unknown. The fact that bad news tends to bring out more bad news if the pressure is on. So if we assume the pressure will be “on” for the next six months or so, who honestly can reliably predict where the next crack(s) might appear?
Legendary hedge fund strategist, Doug Kass (see http://seabreezepartners.net/), who has had a negative view on US equities for a while, agrees with me in that future consequences and scenarios from all this remain reliant on what exactly lies ahead of us. In his words: “the only certainty is the lack of certainty, and rarely have there been so many possible economic and market outcomes, many of which aren’t good”.
Kass is working off five plausible scenarios, all based upon US economic data:
– Scenario #1: Economic Acceleration Above Consensus (Probability: +10%) – +3% Real U.S. GDP growth, +2.0% to +3.0% inflation and +8% to +12% profit growth. Stocks climb by 7.5% over the next 12 to 18 months. S&P target is 2245
– Scenario #2: Status Quo (Probability: 25%) – +2% to +3% Real U.S. GDP growth, +1.5% to +2.0% inflation and +5% to +9% profit growth. Stocks climb by 5% over the next 12 to 18 months. S&P target is 2195
– Scenario #3: Muddle Along (Probability: 25%) – +2% Real U.S. GDP growth, +1.5% inflation and +3% to +5% profit growth. Stocks climb by 0% to 5% over the next 12 to 18 months. S&P target is 2140
– Scenario #4: A Garden Variety Recession (Probability: 25%) – Negative Real U.S. GDP growth, less than +0.5% inflation and a decline in profits: Stocks drop by 13% to 17% over the next 12 to 18 months. S&P target is 1775
– Scenario #5: A Deep Recession (Probability: 15%) – Negative Real US GDP growth, deflation and a large drop in profits: Stocks drop by more than 20% over the next 12 to 18 months. S&P target is 1625
Combining these five scenarios’ probabilities against his S&P500 targets for each scenario, Kass calculates “Fair Market Value” for the S&P at about 1995, about 5% below Friday’s closing level.
Right now, Kass’s best guess lies somewhere between scenario three and four, to be decided over the next six to nine months.
He’s in no hurry to buy anything just yet.
What To Do?
The golden rule that is oft repeated on Wall Street is that if you are going to panic, this is OK, as long as you do it early on. This is easier said than done, of course, and it is probably fair to say investors have by now missed their chance to panic early. However, it is never a bad idea to have another look at one’s portfolio and/or strategy and get rid of bad apples and obvious mistakes.
I personally have had a negative view for years about commodities stocks, while sticking to the view that engineering contractors and services providers remain too risky for most SMSF investors’ risk profile. The FNArena/Pulse Markets All-Weather Model Portfolio (see also disclaimer below) has no exposure whatsoever to any such stocks. Inspired by my ongoing cautious view, the portfolio has consistently carried about 30% in cash. In hindsight, and despite the warnings in my Weekly Insights over the past weeks/months, it turned out I wasn’t even remotely cautious enough.
If we do decide to buy additional shares in beaten down stocks we intend to proceed with caution and only for a small selection of stocks that fit the profile of what we think are stocks best suited for the likely outlook ahead. Most of the candidates we’d consider are part of my research into All-Weather Performers. A second consideration might be to add more of solid, reliable and sustainable dividend payers.
Paying subscribers have access to two eBooklets on All-Weather Performers, including lists of current members and potential candidates. I have written in the past about my personal favourites for dividend stocks. Paying subscribers who want to refresh their memories can send an email to firstname.lastname@example.org to request another copy of my short list.
The same goes for those who’d like another copy of the eBooklets “Make Risk Your Friend”.
Note that the FNArena/Pulse Markets All-Weather Model Portfolio does not have to remain invested in the share market if the outlook in our view no longer warrants to be in the market. At this point, no such consideration is on the table.
Rudi On TV
– on Wednesday, Sky Business, 5.30-6pm, Market Moves
(This story was written on Monday, 24 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.