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The Bear Market Diaries – Episode 1

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 | Feb 17 2016

In this week's Weekly Insights:

– The Bear Market Diaries – Episode 1
– NigelNoMates – The Live TV Debut
– Dividend Cutters Facing ETF Back Lash
– Corporate Profits Remain The Beez Neez
– Positive Surprise From RCG Corp?
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

The Bear Market Diaries – Episode 1

By Rudi Filapek-Vandyck, Editor FNArena

There are still those who do not believe that this is a bear market; they are fools of course
[Dennis Gartman]

If you point your personal feelers in the right direction, you can feel how much angst and discomfort the opening weeks of 2016 have caused.

I am not talking about many an investor whose portfolio is looking at double digit losses year-to-date, not to mention the losses endured since April 27 last year, and who no doubt is watching financial markets every day with more than the usual trepidation.

I am talking about the large army of stockbrokers, financial planners, accountants and other financial services providers who have until now ignored what is happening in financial markets, taken no action whatsoever to prepare their clients' portfolios and nest egg savings for tougher times ahead, or who've largely stuck to the mantra that timing the market is impossible and long-term everything shall be alright, as it has always been.

Good luck with that.

Hotel California & The Big Short

In recent weeks I had visions of late 2007/early 2008 when talking heads appeared on TV to tell investors not to panic. Subprime, after all, was but a small problem in a very large financial sector inside the world's largest economy. Why would Australian banks ever be affected? Of course, we all know what happened next.

I am not reminiscing to make a few extra enemies inside the local finance sector and neither am I predicting the world is guaranteed in the process of repeating the 2008 experience, but what investors should have learned from that painful and frustrating experience throughout 2008 is the financial sector essentially operates like a live version of Hotel California: very eager to get your money in the market, but never there to advise you to get out when the proverbial hits the fan.

The same can be said of most newsletters and mainstream media. If the media had as good a memory for financial experts as they have for politicians, and publish flash backs today from back in 2007/2008, you'd find many looking for cover with blood red cheeks and a hint of mea culpa/shame in their eyes.

I went to the movies and saw The Big Short. As per always, the book was multiple times better even though the movie is a commendable effort in making the incomprehensible accessible to a broad, non-finance audience. Even so, the movie is still too high brow for Joe Average and his wife. Better not to expect blockbuster audience revenues.

The key take-away from The Big Short, in my view, is that although fraud and misrepresentation of mortgage loans and related derivatives was widespread, and went on for quite a while, literally nobody in mainstream media, economics or financial markets commentary had been paying attention. Nobody but a few (hence the book and the movie). Note this was happening inside the world's largest and most accessible economy & financial sector. What are the chances something similar is happening right now, say in opaque China, and somehow things will be different?

Good luck with that.

Samuel Beckett Is Smiling

In my younger years I was a fan of Samuel Beckett and contemporary artistic soul mate Eugene Ionesco. You know, Waiting For Godot and similar absurd theatre plays.

Here is, in my own absurd manner, an ode to Samuel Beckett, based upon the experiences of 2000-2003, 2008-2009 and 2016.

Imagine a stage with 25 actors, all in suit and with brief case, representing the shiny end of the financial services industry. Suddenly, out of nowhere, a dead body drops on stage. Blood spatters everywhere. The audience shrieks. Yet, all 25 actors raise their heads to the ceiling, pretending nothing just happened.

[While looking at the ceiling] Body? What body? There's no body? I certainly cannot see any?

Applause for a predictable, but impeccable performance, with conviction.

Technicals Versus Fundamentals

One local market commentator opined back in 2009, when things turn really sour, as they did in 2008, investors are better off ignoring fundamentals (and fundamentally based opinions) and take guidance from price action and technical analysis instead. Think about this for a while. All most commentators do is refer back to economic data. But economic data in early 2008 were nowhere nearly as bad as they were six months later. The situation was similar in 2000. The same is happening today.

Again, I am not predicting a repeat of those two dreadful bear markets, but what I am saying is that economic data (mostly backward looking and available at a delay) are not necessarily the place to look for answers at market turning points.

When financial markets, one after the other, are sagging through all kinds of longer term and nearer term technical support levels, one has to pay attention and start managing risk in a more rigid and stringent manner. BHP Billiton ((BHP)) shares have fallen more than 50% over the past twelve months alone. I know it's a bit late now, but have you ever thought about how long it's going to take to just get back to square again if you've held on all that time?

Good luck with that.

The good news is: many a technical analyst is anticipating a relief rally of some sorts.

Similar to projections and opinions based upon economic and corporate fundamentals, there's equally a plethora in different views from technical analysts and chartists. However, it appears there's some kind of consensus in that the ASX200 is widely projected to eventually fall inside the 4600-4200 region, with a potential overshoot to 4000. These projections don't have to be correct, but it probably signals that without a circuit breaker, and amidst a general downwards trend, the bias remains to the downside.

A few hundred points extra to the downside doesn't seem like much, but consider the following: as at Friday, the ASX200 was down -10% year-to-date. Over that same short period, BHP Billiton shares are down -15%. Lend Lease ((LLC)) shares are down -19%. Challenger Financial ((CGF)) shares are down -24%. Henderson Group ((HGG)) shares are down -27%.

How confident are you that a few more percentages to the downside, or worse, is not going to inflict some serious damage to your portfolio and its future returns?

Hope Is Not A Strategy

If you haven't taken any action yet, it's probably a fair statement to make you have been slow in responding to financial markets turmoil. It's never too late to make amendments to protect your wealth. Talk to your financial advisor or seek advice about your options to limit the chances you might end up as a sour victim in case technical analysts are correct and all those freewheeling talking heads are not.

My favourite slogan in the present context is: manage risk.

During bear market phases, Price-Earnings (PE) ratios contract and investors' focus turns to the downside, meaning overall risks are firmly to the downside. Try to minimise your exposure to potential disappointments. Programmed Maintenance ((PRG)) issued a profit warning. The shares are down -58% year-to-date. OzForex ((OZL)) had a suitor disappearing without a formal offer to shareholders. The shares are down -43% since Dec 31. Slater & Gordon ((SGH)) had a terrible year in 2015, but its board still cannot appease investor angst about its financial accounts and cash flows. Slater & Gordon shares have fallen a further -26% in 2016.

The FNArena/Vested All-Weather Model Portfolio has reduced exposure to stocks we believed contained more downside risks than what we are comfortable with. For example, Macquarie Group ((MQG)) was one of the best performers in the portfolio last year. We sold all shares in January. To date, Macquarie shares are down -29.50%. We are glad we escaped the bulk of those losses. Instead we concentrated on conviction positions including CSL ((CSL)), Transurban ((TCL)) and Orora ((ORA)). Sure, some of our choices have not performed as anticipated. InvoCare ((IVC)) springs to mind, as well as REA Group ((REA)).

This is par for the course during risk-off periods. In general terms, the portfolio has significantly outperformed the broader market. Further, to actively manage risks, we have significantly reduced exposure to the share market (in other words: we raised cash).

It goes without saying, protection/insurance is not universal and dependent on specific portfolios, strategies, compositions and targets. However, anything is better than simply keeping fingers crossed and hoping for the best.

Get rid of your duds. Bear markets are unforgiving (you might want to wait until the next rally to do so).

What's The Real Deal?

Ever since January started off on a weak note, market commentators have been mostly scrambling to find a fitting explanation as to why risk appetite has deserted global equities. Last week, I explained how the fall-out from extremely cheap oil prices has been one major contributor (again one factor largely missed and misrepresented by most commentators). Read my story here:  (Oilmageddon, The Spiral That Hurts)

Macquarie analysts pointed out loss of confidence in central bank policies is another major contributor. I agree, but leave this subject for another time.

In a broad, uber-macro spectrum, I believe everything harks back to one of the main themes in the book I wrote and published last year (see further below): global growth continues to progress at a steadily declining pace. This remains a major problem for central banks looking to spur on inflation and economic activity. Add over-supply post the biggest investment bubble in commodities the world has ever witnessed, plus a world drowning in debt, and it's not difficult to see why investor angst has peaked in 2016. In line with the findings in my book, I continue to believe all roads lead to All-Weather performers and to structural growth stories, no matter how cheap resources stocks get.

How are we going to get out of this mess?

Danske Bank analysts are suggesting what is needed is globally coordinated action by governments and central banks. I think they might be correct, but it also might require a lot more investor patience before we might see such market saving coordination. There's a G20 meeting later this month. One can but hope…

Dennis Gartman

Ok, you've seen the quote at the beginning of this story. You've read my thoughts and observations up until this point. What more can I possibly add that isn't but noise and humbug?

How about the latest commentary from one of the longest active and most experienced traders in the market today?

Here's what Dennis Gartman (The Gartman Letter) had to say on Friday:

"There are still those who do not believe that this is a bear market; they are fools of course.

Why are stocks so weak? They are weak because the global investor class is losing confidence in the political and monetary leadership it sees everywhere and anywhere. They are weak because money growth in the US as measured by the adjusted monetary base is actually falling, not rising, despite arguments that the monetary authorities here have been too monetarily easy.

They are falling because the likes of Mr. Draghi have made the statement that he would do what is necessary to sponsor an inflation of at least 2% and instead deflation seems everywhere to reign. They are falling because earnings are weakening and the investor class knows that in the past much of the earnings growth has been due to cuts in staff and deferred capital expenditures. And now they are falling of their own weight as the margin clerks of the world are united in their urge to raise liquidity at every turn.

Are share prices over-sold? Of course they are. In bear markets, prices get oversold many, many times and more often than not become even more oversold. Too, in bear markets, the rallies are violent and swift, taking the markets from over-sold to over-bought in a blink of an investment eye."

Stop The Silly Rule

I cannot believe the number of times seemingly intelligent people keep on parroting each other about a "technical bear market" being in place once prices have declined by 20%. I intend to amass some concrete examples in the weeks ahead, just to prove my point this is an utterly useless rule/definition, no matter how many times it is being repeated.

Similarly, think about iron ore prices now having surged 20% from their lows. Iron ore now in a bull market? Really? Seriously?

Good luck with that.

Share Market Observations

Looking at the price action from the past seven weeks, there are some easy but oh so important observations to be made:

– investors have fallen in love with gold stocks in the Australian share market
– yield remains popular through infrastructure stocks including Sydney Airport ((SYD)) and Transurban ((TCL)), with A-REITs increasingly in focus as well (see Westfield ((WFD)), for example)
– traditional defensives are firmly back in favour, see Wesfarmers ((WES)), AGL Energy ((AGL)), yes even Metcash ((MTS))
– Fair is fair, a select group of energy stocks and miners has proved remarkably resilient year-to-date, including South32 ((S32), Iluka Resources ((ILU)) and Oil Search ((OSH))
– Some of last year's success stories have been de-rated, such as infant formula & vitamins producers, IT services and outdoor media companies (the growth stories that made them popular last year hasn't changed, however)
– Dividend payers in general have outperformed non-dividend payers
– Wealth managers are amongst the heaviest de-rated stocks in the share market
– There simply is no allowance for disappointment, nor for obvious risk. Whitehaven Coal ((WHC)) shares are down -46% year-to-date. Ten Network ((TEN)) is down -45.8%. Select Harvests ((SHV)) has lost -45%. Mesoblast ((MSB)) is down -35%.

Some Final Advice

It is at times like these, investors look back at some of the good old fashioned Wall Street classics, with lots of sound market advice to digest once more. One of the oft quoted from books these days is "Reminiscences of a Stock Operator" by Edwin Lefevre about the life of Jesse Livermore, according to some the greatest share market speculator in Wall Street history. I read the book a while ago and can absolutely recommend it. One of the best lines in the book (but a quote I cannot find today) is that it's most difficult to sit tight and undertake no action at all. This, I believe, is the most difficult thing to do in particular in a bear market when one is always inclined to jump in too early.

My best advice to investors today is: patience and cash are your most valuable assets. Use both sparingly and wisely.

Ok, one more quote from "Reminiscences of a Stock Operator", to finish off this week's story on a high note:

"There is only one side of the market and it is not the bull side or the bear side, but the right side."

See also: Who's Afraid Of The Big Bad Bear:

NigelNoMates – The Live TV Debut

In case you missed it, #NigelNoMates made his live TV debut last week. Keep an eye out for this week's Rudi On Switzer story/video if you'd like to see the event with your own eyes.

Dividend Cutters Facing ETF Back Lash

There's undeniably a role for Exchange Traded Funds (ETFs) in modern investment times, but I cannot but notice how little (if any) intelligence is often on display when looking through the nitty gritty details for underlying baskets of stocks. My strong suspicion is in many cases someone opened an excel sheet with basic, backward looking data and created a selection after applying one or two filters.

For Australian investors this means there might be a delayed impact for share prices of former high dividend yielding stocks that will be reducing their dividend this month. Sustainable or not, stocks that were once upon a time high yielders are likely to be part of the basket of stocks underlying dividend ETFs and if/when they are removed, automatic selling orders by the operators of such ETFs will ensue. At what point exactly remains at the discretion of ETF operators, but there's a strong argument to be made in case of mid & small cap stocks that the execution of such ETF amendments should now be regarded highly market sensitive information.

[Note: I wrote about this last year when the share price of NRW Holdings ((NWH)) was temporarily subjected to similar ETF related shenanigans].

To prove my point, analysts at Goldman Sachs track the 12 largest dividend ETFs that invest in Asia. They have a combined $9.2bn under management. It is Goldman Sachs' assessment that no less than $4.2bn -46% of total funds- is held in ASX stocks. Given the emphasis on historical yield/data, exposures almost certainly include stocks such Woodside Petroleum ((WPL)), BHP Billiton ((BHP)), Rio Tinto ((RIO)), Monadelphous ((MND)), Mineral Resources ((MIN)), WorleyParsons ((WOR)), et cetera.

The message for investors holding on to many of these battered & bruised, beaten-down resources stocks is thus: once reality hits these over-inflated historical yields, there might be more selling from the passive ETF managers coming. Exact execution timing unknown.

Corporate Profits Remain The Beez Kneez

Amidst all talk (noise?) about recession yes/no, negative interest rates and further central bank stimulus yes/no, it's important to remember for investors in equities that ultimately much of the future outlook and performance comes down to how profitable listed companies can remain amidst sluggish global growth and intensifying competition and scrutiny from authorities.

Zooming in on this matter globally, recently one of the interesting reports was released by analysts at Goldman Sachs. They put together a Bull & Bear case on the matter, ultimately concluding:

"Over the next 2-3 years, we expect the Bear arguments to overpower the Bull arguments and weigh on high-versus-history margins as input cost benefits are competed away, room for further cost cutting shrinks, the headwinds of greater competition (from asset-light business models and EM competitors) gather momentum, interest costs bottom out and social/regulatory pressures become a more sizable part of P/L statements."

Goldman Sachs advises investors should focus on consolidating industries as consolidation decreases competition and thus should support margin expansion in the absence of other negative influences (such as government intervention, for example). Other observations made include new technologies helping create new competition, Chinese companies facing a terrible outlook (marred by rising costs) and years of cost cutting having today made many companies too lean.

Positive Surprise From RCG Corp?

Footware retailer RCG Corp ((RCG)) is one of many small cap stocks that has underperformed the broader market parallel to the ASX200 descending below 4800 this month. However. analysts at Moelis believe the market is getting the wrong idea with the company likely to deliver an upside surprise when it releases interim financials on February 24.

Moelis draws its conclusions from USA company Skechers Inc which reported on Feb 10, while providing positive comments about strong growth momentum in Australian stores. RCG holds the domestic license for Skechers which just happens to be one of its major profit contributors. In other words: an upside surprise from Skechers is more than likely to translate into an upside surprise for RCG as a group.

Investors looking for a bargain post share market damage should look elsewhere as RCG shares are trading around a multiple of 20x projected FY16 earnings per share. The latter is cum upside surprise if we can take Moelis' confidence at face value. Regardless. the analysts believe RCG's premium is more than warranted given track record and prospective above-market average growth potential.

Moelis' projected EPS growth numbers are above market consensus this year, but fall in line in FY17 and beyond (see also Stock Analysis on the website); +49.8% in FY16, +23.7% in FY17 and +21.4% in FY18.

On another, vaguely related matter, I observe how the share market had become overly cautious on Amcor ((AMC)) with the share price surging more than 10% after the release of interim financials on Monday. Remember what I wrote in my opening story for the year: 2016 will be the year of Conviction. Amcor remains firmly held in the FNArena/Vested All-Weather Model Portfolio, alongside sector peers Orora ((ORA)) and Pact Group ((PGH)).

To re-read "2016 Is The Year Of Conviction":

Rudi On Tour – Who's Afraid Of The Big Bad Bear?

They seem to come along every eight years or so, the dreadful bear market so many investors detest, causing risk appetite to evaporate and share prices to reset at lower levels.

Every time the cause and follow-through are different. So what lies at its origin this time and what's going to be the likely outcome?

As a self-nominated bear market expert, I will be sharing causes, explanations, insights and strategies for investors who want more than keeping their fingers crossed while hoping for the best.

I will be presenting:

– To 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.

– At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

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:

See also further below.

Rudi On TV

Due to peak activity in local reporting season, no TV appearances this week.

(This story was written on Monday 15 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: or via Editor Direct on the website).



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?

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible):

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