Rudi's View | May 11 2016
In this week's Weekly Insights:
– It's A Schizophrenic Market
– Honey, I Shrunk The Break
– Australian Super Stock Report
– RBA Cash Rate: Low, Lower, Lowest?
– Catching Up On The Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV
It's A Schizophrenic Market
By Rudi Filapek-Vandyck, Editor FNArena
"The average tenure of an iron ore futures contract on the Dalian Commodity Exchange is under 10 hours, while a steel rebar futures contract on the Shanghai Futures Exchange is even lower at ~4 hours"
[Quote from a recent CBA Commodities report]
Those among you who pay attention to my guest appearances on financial TV would have heard me saying that same expression: it's a schizophrenic market.
What I mean to say is that investors are now willing to add more risk to their strategies and their portfolios, but they are not willing to abandon their safe havens at the same time. Is it because confidence is still too feeble regarding the sustainability of the resources rally? Or is it that we all feel we are living and investing on borrowed time, with only excessive central bank intervention preventing a return of the Abyss?
The calendar now shows May. Surely, with last year's experience still fresh in memory, many an investor is feeling the reflex to position just a tiny little bit more cautiously? (May itself was relatively benign last year, but that didn't last long).
It doesn't help either that many a local strategist is pointing out the market's PE ratio is now at its highest point since the GFC, similar to where it was in May last year. And US equities, they are still rolling over, supposedly, after a rather non-inspiring Q1 reporting season.
On the flipside, there clearly is firm buying support underpinning the local index now the RBA has rewritten the outlook with potential additional rate cuts.
No Inspiration From The Banks
The share market's valuation dilemma was perfectly captured by UBS analysts this week. The chart below, showing industrials stocks ex financials, suggests Australian stocks ex banks and resources are now trading at their most expensive level since prior to the bear market of 2007-2009 when banks and resources wsere virtually annihilated on the back of GFC and global growth meltdown.
Yet, the Big Four banks, prominent indicators of investor risk appetite in Australia, are now rapidly approaching their consensus price targets. History tells us this often translates into a general realisation that things might have run up a little too far, too fast.
It's not like the Big Four have just released interim market updates that inspired greater confidence and enthusiasm among investors. One could argue quite the opposite, except that if the RBA seems hell-bent on further lowering the cash rate, it automatically refocuses investor attention to those juicy looking yields.
ANZ Bank ((ANZ)) shares, yielding some 6.6% pre-franking, are still trading 8.1% below the consensus target of $26.70, but National Australia Bank ((NAB)), 6.8% yield pre-franking, already is trading above its consensus target. Westpac ((WBC)), offering 6.0% pre-franking, still has a gap to close of some 3%. CommBank ((CBA)), yielding 5.5% pre-franking, only has 1.5% left.
Probably no coincidence National Australia Bank is widely considered to have delivered the best financial performance this season, even though some analysts have accused management of window dressing in the bad & doubtful debts department.
For good measure: these valuation gaps suggest the share market is steadily pushing into danger territory, but not quite far enough to start talking about the next correction just yet.
At times of unbridled exuberance all bank shares have been known to trade several percentages above their respective targets. CommBank usually moves past its target to show off its relative sector premium, but I'd still argue that with Westpac within 3% reach of its freshly updated target, it doesn't look the right time to take on board a lot more risk. At least not in the short term.
Industrials Are Not Cheap
To prove my point about the industrials ex-financials & ex-resources:
– CSL ((CSL)) shares are now trading above consensus target of $107.72 (+1.9%)
– Amcor ((AMC)) shares are now trading above consensus target of $14.88 (+7.0%)
– Sydney Airport ((SYD)) shares are now trading above consensus target of $6.63 (+9.9%)
As a matter of fact, the R-Factor on the FNArena website, which monitors share prices in relationship to consensus price targets, at present shows no less than 158 stocks trading above target while another 24 are less than 3% below target.
Amongst these we find many popular outperformers to date, such as Harvey Norman ((HVN)), Orora ((ORA)), Ramsay Health Care ((RHC)), Goodman Group ((GMG)), Treasury Wine Estates ((TWE)) and James Hardie ((JHX)), as well as long established quality names such as ARB Corp ((ARB)), Iress ((IRE)), Brambles ((BXB)), Wesfarmers ((WES)) and Technology One ((TNE)).
Plus many from the new kids on the block, including Orocobre ((ORE)), Yowie ((YOW)), Costa Group ((CGC)), Capilano Honey ((CZZ)) and Smartgroup ((SIQ)). Resource stocks are represented as well: Alumina Ltd ((AWC)), Iluka Resources ((ILU)), Sandfire Resources ((SFR)), New Hope Coal ((NHC)), et cetera.
Bottom line: valuation constraints in itself can be a lousy indicator of when the next pull back/correction might arrive, but it does signal equities are becoming increasingly vulnerable to when risk appetite makes a turn for the worse, exact timing as yet unknown.
Laggards Are The New Black
All of the above suggests the local share market has made a swift transformation from staring into the abyss of a new bear market less than three months ago to now wanting to break out of the trading range that has remained in place since August last year, but buyers are increasingly running into valuation constraints. The latter suggests genuine bull market conditions, similar to late 2007.
What usually happens at this point in bull markets is investors start to concentrate on the laggards and narrow the valuation gap. This process has already started judging by the fact stocks like iSentia ((ISD)), Sirtex ((SRX)), OzForex ((OFX)) and Estia Health ((EHE)) seem to have rediscovered some of their previous oomph. The same goes for a2 Milk ((A2M)), Bellamy's ((BAL)) and Blackmores ((BKL)). And what about the strong rallies for McMillan Shakespeare ((MMS)), EclipX ((ECX)) and peers following that press statement issued by Bill Shorten's Labor party?
There's probably little appetite to jump on board of companies such as Orica ((ORI)), Decmil ((DCG)) or Cover-More ((CVO)) given fresh bad news announcements, but there are still plenty of laggards around without having to venture deeply into the darkest corners of the market.
From bear market dynamics to genuine bull market conditions within the space of less than three months; 2016 truly is shaping up as a remarkable year for investors.
Resources: The Stubborn Enigma
Nothing is ever easy and straightforward when it comes to deciphering the riddle that is the outlook for commodities, but 2016 is shaping up as a master class in humility for those who believed they had it all figured out. Down the sewage in January, on top of the hill by April. And now what?
Most sector analysts had been left scratching their heads post mid-February and it is easy to dismiss the strong sector upswing as driven by speculation and USD-weakness, but fair is fair there have been changes in fundamental market dynamics too.
There is no doubt the most powerful factors in support of the sudden revival for resources have by now mostly run their course:
– fund managers being heavily underweight the sector
– valuations at multi-decade lows
– valuation gap between resources and defensive industrials at an all-time high
– a weaker USD which reinvigorated global risk appetite
– the rise of Chinese speculators
On top of this comes a slight improvement in supply-demand dynamics:
– China buying to top up its reserves
– China launching stimulus and adding liquidity
– Weak players going out of business
– Unscheduled supply reductions in markets such as iron ore and crude oil
– Bull market conditions for Chinese steel producers with low inventories
Though markets for iron ore and crude oil are now much more in balance than was expected only a few months ago, the irony is that much higher prices probably means less supply is going to disappear and in fact it won't be long before new supply might start ramping up again.
What was that old Chinese proverb (supposedly) again? Oh yes: may you live in interesting times.
Honey, I Shrunk The Break
Weekly Insights from 18th April mentioned a three week break, but miscommunication between various participants meant my scheduled presentations in Perth had to be canceled, hence why Weekly Insights has returned one week sooner than planned.
Australian Super Stock Report
Once upon a time, not even that long ago into the past, the regular updates of FNArena's Australian Super Stock Report used to be a genuine event. Investors, whether they be paid subscribers or not, couldn't get their hands on the latest edition quickly enough to see which stocks ranked highly and which ones didn't according to the selection of stockbrokers that make up the FNArena universe for Australian equities expert research.
A lot of the gloss fell off when the bear market of 2008 arrived. Nowadays, FNArena only publishes updates in excel format, servicing those paying members who like to put raw data through their own software programs and trading systems.
What equally has happened is stockbroker research has become a lot less uniform and a lot less synchronised too. Out of the seven stockbrokers who cover Flight Centre ((FLT)) in our database, only three had managed to issue research updates by Monday morning following the company's trading update on Friday. Only a few years ago, this seemed unthinkable.
Clearly, the stockbroking industry still thrives on memories about real bull markets in the past. If the present one is supposed to be one too, most keep on wondering why nobody has told their clients as yet. The no hurry approach when it comes to issuing research reports is but one direct admission to the new reality.
Another change is that research coverage has abandoned the previously unwritten rule that all large caps need to be covered in-house. No longer true. In fact, as a direct response to poor performances overall of the Top Twenty in Australia over the past 2-3 years, research has very much expanded into medium and small caps where growth stories with exciting appeal remain very much in abundance. For FNArena, this has led to more companies now being covered by only one or two brokers.
Sectors for which broker research has dropped off significantly include contractors and services providers and resources stocks in general. Their places are being occupied by aged care accommodation providers, outdoor media companies, cloud-oriented platform developers and healthcare entrepreneurs.
It makes investing in the Australian share market a richer experience, no doubt about it. But it also creates thinner synergies and less overlap between research produced by the eight brokers in the FNArena universe. I cannot remember the last time all eight carried a Buy or Sell on the same stock whereas once upon a time this was a rather regular occurrence.
The times they truly are a' changing.
FNArena has published the latest update in excel, available on the website for paying members. Below is the Top 22 of all stocks at least covered by three stockbrokers and ranking 0.8 or higher on the FNArena Sentiment Indicator.
RBA Cash Rate: Low, Lower, Lowest?
The RBA under outgoing Governor Glenn Stevens is very much worried about falling short on its mandated inflation target to keep underlying consumer price inflation inside an annualised 2-3% range. If anyone needs convincing, simply download and read Friday's Statement of Monetary Policy.
Australia has traditionally carried higher price inflation than, say, the US because an island economy with 25 million people spread around a vast continent automatically implies whoever is market leader has a lot less competition to deal with. Those barriers from the past are disappearing, however, but clearly there's more to this matter than initially meets the eye.
All kudos to those economists who predicted Australia was about to join the rest of the world in terms of disappearing inflation. The team at UBS comes to mind.
Does this also mean the RBA is now ready to join its peers in developed economies with exceptionally low interest rates? Economists at Macquarie seem to think so. Their take-away from the latest shift in RBA focus, and following on from Friday's SOMP, is there is but one message every investor should now understand: interest rates have only one way to go: down.
How far down is still up for debate of course and a lot will depend on whether the Federal Reserve in the US finally embarks on a steady path of tightening. Thus far it's all talk and no action from Janet Yellen & Co. Despite all those assurances that June is still very much a live and open meeting virtually nobody in the market thinks this is genuinely the case. Economic data should strengthen in the second half, but then that has been the forecast for each year now since 2010 and it simply never seems to materialise.
No interest rate hikes soon from the Fed translates into more extreme measures from the BoJ, and probably also from the ECB and BoC. And for the RBA? Macquarie's latest update on the matter mentions 1.50% as an immediate target (next cut in August?), but also 1% as a potential risk further out.
Surely not, I can hear some among you think. I am with you, and so is Macquarie, but in a world of extreme central bank intervention, and a Federal Reserve unwilling to upset the apple cart, it is a prospect that cannot be completely dismissed. Note the team at Deutsche Bank already is convinced the RBA will cut two more times in the year ahead, pulling the official cash rate to 1.25% by mid next year.
The share market is as yet not fully convinced. Last year, under similar circumstances, the ASX200 in no time reached for 6000, but this time around there is clearly more hesitation.
There is another side to the argument too, with respected economists Saul Eslake and ANZ Bank analyst Richard Yetsenga using the weekend AFR to call for a national debate on whether the RBA should go down the path of ever lower interest rates, or should the new Governor and his team simply acknowledge there's very little real firepower available unless Yellen & Co genuinely change market perception about the outlook for the Fed's Funds rate?
Former RBA Governor Bernie Fraser thinks the latter.
There seems to be very little hesitation, if any, inside CommBank, where the inhouse forecast is for AUDUSD to return to 78c by year-end. Oh dear.
Let's just state the obvious: central bankers have dug themselves one mighty hole and it was so much easier while digging it than now trying to get out of it without pulling the rest of the world into it too.
Catching Up On The Past
In case you missed some of the preceding stories, here's your chance to catch up (in reverse order):
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 a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Sydney, 26 May (sold out)
– To Melbourne chapter of the Australian Shareholders' Association (ASA) on 6 July
– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Melbourne, 6 July (sold out)
– At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.
– To Chatswood chapter of Australian Investors' Association (AIA) on September 7, 7pm, Chatswood RSL
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: 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
See also further below.
Rudi On TV
– On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
– I will be appearing as guest on Sky Business, 12.30-2.30pm, on Thursday
– On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
– On Friday, I swill be appearing as guest on Sky Business., Your Money, Your Call Fixed Interest, 7-8pm
(This story was written on Monday & Tuesday 9-10 may 2016. It was published on the latter 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).
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?
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): https://www.fnarena.com/index2.cfm?type=dsp_signup
FNArena has reformatted its monthly price tracker file for All-Weather Performers. We have updated until April 30. Paying subscribers can request a copy at firstname.lastname@example.org