Rudi's View | Feb 10 2016
This story features A2 MILK COMPANY LIMITED, and other companies. For more info SHARE ANALYSIS: A2M
In This Week's Weekly Insights:
– Oilmageddon; The Spiral That Hurts
– Bellamy's & The Conviction Trade
– Nigel NoMates: Having Lots Of Fun
– Stern Warning From CLSA
– Witnessing The Expert Blues
– Nothing Ever Changes, Or Does It?
– Rudi On Tour
– Rudi On TV
Oilmageddon; The Spiral That Hurts
By Rudi Filapek-Vandyck, Editor FNArena
“The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence.”
At times, so it seems, the world of finance & investing is governed by simple truths and golden rules that do not require any scrutiny or in-depth analysis. It's just the way things are.
Low interest rates stimulate housing markets and business lending. Economic recessions only happen after bond markets invert. Gold and the US dollar are each other's opposites. Bubbles always burst. Equities generate the highest return in the long run. Buy cheaply and you cannot go wrong. Bear markets do not start without monetary tightening from the Fed.
And cheap oil? It's good for consumer spending and most businesses, so expect a boost to the global economy in about 18 months' time.
This easily explains the gap between what economists and commentators say markets should be focusing on, and what is actually happening in these markets as 2016 unfolds. Sometimes a bit of scrutiny opens up a wealth of insights.
Extremely Cheap Oil = Major Problem
Cheaper oil might still work its wonders through the global economy later this year and into 2017, but first we will have to deal with extremely low oil prices and the inevitable fall-out that will come well before the world will notice any of the benefits.
It starts with debt and leverage inside the global financial system as the oil sector is a major debtor and many a balance sheet in the industry is simply not meant to be dealing with the current low price. Not for such a long time.
Cue banks. Derivatives. Counter-party risks. Government deficits in oil producing nations: less petro-dollars traveling around the world. Government subsidies in Emerging Markets. Sovereign wealth funds that are called upon to raise funds.
Also, the post-GFC world is one characterised by below average growth, with the USA unable to grow sustainably above 2.5%, despite extreme stimulus from the Fed, and with China's slow-down affecting Emerging Markets, keeping global growth well below pre-GFC levels.
One would think that with the Federal Reserve ready to start normalising interest rates, cheaply priced oil is exactly what the world needs as an offset.
The problem with the latter is the energy sector had been one of the growth pillars in recent years. Now the damage from low oil prices is hitting through write-offs, capex cuts, lay-offs, project deferrals, capital raisings, dividend cuts and cost reductions thus removing one of the pillars under already below-par growth rates.
And debt defaults will be the next shoe to drop.
Joseph LaVorgna, Chief US Economist at Deutsche Bank, on Monday cut projected GDP growth estimates for the world's largest economy in Q1-Q3 this year to 0.5%, 1.0% and 1.2%, respectively in real terms. No surprise, with a tepid forecast like that, Deutsche Bank only sees one sole rate hike by the Federal Reserve in 2016, at the December meeting.
Not everybody necessarily agrees with LaVorgna, but consider the major items that support his numbers: tighter financial conditions (lower equity prices, wider credit spreads, stronger US dollar and tighter bank lending standards), elevated inventories, weak global growth and depressed energy-related capital spending.
Says the Deutsche Bank's Chief US Economist: "This backdrop has already produced a contraction in the factory sector, which has the potential to spill over into the services sector."
True to form, GDP projections for the USA are pretty much twice as high in 2017, which is still not fantastic by historic standards, but a lot better than what is penciled in for the quarters ahead of us. Note LaVorgna's peers are making similar adjustments to their GDP growth projections for the world on similar considerations.
Oilmageddon; The Negative Spiral
I first came across this term in a report by Citi strategists in Europe; Oilmageddon. It refers to a bad combination of factors that is currently hitting the global economy, at risk of creating a self-reinforcing negative spiral for which central bankers and governments may not have a solution ready.
Think about this as an interactive negative feedback loop whereby each factor strengthens the next one, creating a powerful vortex. The four elements are:
– stronger US dollar
– weaker oil prices
– weaker world trade/capital flows
– weaker growth in Emerging Markets
Analysis by Citi seems to suggest the weaker price of oil is at the centre of this spiral. It's the most influential factor. This is why financial markets are now merely asking one question: what's oil doing?
The Citi strategists note, among many observations, the circa 70% fall in crude oil prices since mid-2014 is amongst the largest in the past fifty years, while the rally in the USD since then is equally up there with the strongest rallies in modern history.
Citi research also shows many developments since 2014 have changed/taken place in ever increasing correlation with weaker oil prices. In many cases, such correlations were weak or even non-existent pre-2014.
Citi's conclusion: "Given the implications of much lower oil prices/higher USD, and the reverse, this suggests that the direction of oil prices (and USD) are likely to remain centre stage for financial markets and the global economy through the coming quarters".
At least, now you know why.
Bellamy's & The Conviction Trade
There is no denying that sometimes whatever is happening in the share market does not seem to make a lot of sense. At times when anxiety and discomfort are being fed by ever greater volatility, the risk for illogical and ill-informed market moves rises exponentially.
Which is why my first story in 2016 stated investors best rely on their conviction when coping with Mr Sharemarket's tempers and tantrums, which, on my assessment, are going to stay with us for much longer.
The past few weeks have generated noticeable interest from FNArena readers and Sky Business viewers, as well as through my personal Twitter feed, about organic infant formula star performer Bellamy's ((BAL)), otherwise known as the Pride of Tasmania.
Bellamy's is part of the FNArena/Vested All-Weather Model Portfolio because it fits in with the underlying strength story I have been referring to for a while now. Common interests between China and Australia to increase inter-country trade and to favour high quality food product imports into the Chinese market means this thematic is not going to disappear overnight from the Australian share market. Quite the contrary, I would argue.
Of course, there are more elements involved such as maintaining product quality and accessing sufficient supplies to feed strong demand, but Bellamy's managed to lift its prices by an average 20% and you don't see too many companies doing the same in this ever-lasting low growth environment. Hence the premium valuation and the immense popularity among investors who love a rising share price (which is essentially all of them, with exception of the shorters).
Suddenly, after 27th January someone pulled the rug from under the share price and a free fall developed taking the share price from $14 to above $11 in only a few trading sessions. After which management decided it's probably best to inform the herd out there things really are going great. I mean, what's to discuss with underlying operational profits pre-tax expected to rise by more than 300%? New guidance for the first half beat stockbroker Morgans, unfortunately the only one covering the stock in the FNArena universe, by no less than 49%.
Of course, I hear you thinking, what about Bellamy's valuation? Admittedly, on Morgans' revised forecasts the Price-Earnings ratio for this year (FY16) now sits at 37.5x, but look one year out and the number drops to 20.3x, which looks rather cheap when taking into account the above average growth that is on offer. For a high PE stock such as Bellamy's, which has a large number of shareholders on its register with large paper profits and an equally large number of investors who are simply on the register because the share price simply kept on rising last year, such volatility and day-to-day shenanigan's are to be expected.
It should, however, not blind investors to the solid growth story that is on offer (for everyone who wants to see it). Bellamy's is one of this year's conviction holdings we are happy to keep in the Model Portfolio. Most Top20 stocks in Australia would give their right arm, plus some, to be in a similar position.
On Monday, CLSA issued a 70 pages report on the consumer milk industry on both sides of the Tasman Sea with initiations of coverage Buy ratings on A2 Milk ((A2M)) and on Blackmores ((BKL)) with price targets of $2.20 and $225 respectively.
Bellamy's only received an Underperform rating as the analysts are less convinced it will be able to source sufficient supply to feed future growth in the same manner as its competitors can. Plus organic milk is costing more.
So what CLSA is essentially saying is there's more upside for investors in owning A2 Milk and Blackmores than there is in sticking with Bellamy's, but the broker's maiden price target of $13.80 is still above today's share price.
Nigel NoMates: Having Lots Of Fun
Those among you who keep track of my Tweets on Twitter are already aware, but NigelNoMates and myself have had lots of fun in the first week of the new month.
Nigel came along to the Sky Business studios, where guests and staff proved overly enthusiastic to take a picture or pose with Nigel.
He wasn't allowed on camera when I hosted Your Money, Your Call on Wednesday evening, but nothing could dent our enthusiasm on that night, or the rest of the week for that matter.
Stern Warning From CLSA
Chinese authorities have set their sights on illegal funds outflows from the country and analysts at CLSA warned on Friday things are looking to get really messy with possibly dire consequences for Australia in the form of a collapse in apartment prices.
Worst case scenario, reports CLSA, is for a downward spiral of falling prices, slowing sales, rising borrowing costs and declining LVRs, constraints on foreign capital (from China and Australia) and settlement defaults.
Timing could hardly be worse, argue the analysts. They believe the apartment development market in Australia looks "now more fragile than it's ever been". CLSA is not taking any chances, reducing earnings forecasts for all building materials producers. This has seen recommendations being downgraded to Underperform for CSR ((CSR)) and Adelaide Brighton ((ABC)).
But the most affected is Lend Lease ((LLC)), for which the rating was downgraded to Sell from Outperform. Report the analysts: "LLC has a whopping $5.15bn (June30) of apartment pre-sales which will settle all the way up until June 2019."
Witnessing The Expert Blues
In January I caught up with a funds manager, as I occasionally do. After exchanging some holidays pleasantries, our conversation quickly turned to global equity markets.
We both agreed it wasn't looking flash and the short term outlook, at the least, was likely to provide more angst and weakness. I told him how I had decided to raise the level of cash for the FNArena/Vested Model Portfolio in December, before spending three weeks in Africa.
Of course, in early January that looked like a wise and prescient decision. By mid-January, however, it looked like the move hadn't nearly been aggressive enough. Harry Hindsight! I told him the Model Portfolio was lifting the level of cash.
He agreed that was probably the right thing to do, but he wouldn't do it. In a case of damned if you do and damned if you don't, this funds manager explained to me clients do not appreciate experts like him moving into cash. Who needs an expert to be in cash? Also, he said, if he did move into cash and markets turned direction, he would look like a fool.
Further into our discussion, we discussed parallels between 2008 and 2016, starting with nobody really being sure about what exactly was causing the bad start to the new year.
I explained how I can make a case for numerous parallels with potentially a similar outcome. Not sure whether there was something in our beer, or maybe it was the weather, or the moon shining through the clouds, but I could swear I saw his face turn green, then purple, right in front of me.
After a few minutes, he said let's talk about something else.
There are a few lessons in this, but I am not going to spell them out. Beware of an industry that is simply not set up to get you out of the market, any time.
Nothing Ever Changes, Or Does It?
Tell me again: investing in the share market never really changes, does it? No really, those four words are only to be used at bubble tops and only as a contrarian indicator.
I know, I cannot genuinely blame investors to actually believe that everything's still the same in the share market, because that's what the majority of experts and commentators keeps on repeating every day.
Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).
Here's the link to Amazon: http://www.amazon.com/Change-Investing-Low-Growth-World-ebook/dp/B0196NL3KW/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1454908593&sr=1-1&keywords=change.investing+in+a+low+growth+world
Rudi On Tour
– I have accepted invitations from Perth chapters of both Australian Shareholders' Association (ASA) and Australian Investors' Association (AIA) for presentations on Monday 9th May, both afternoon and in the evening.
– I have accepted an invitation to present at the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.
Rudi On TV
– on Thursday, Sky Business, Lunch Money, noon-1pm
– on Thursday, Sky Business, Switzer, between 7-8pm
(This story was written on Monday 8 February 2016. 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: firstname.lastname@example.org or via Editor Direct on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?
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