Rudi's View | May 25 2016
This story features TRANSURBAN GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: TCL
In this week's Weekly Insights:
– The Trend Is Your Friend Until It Ends
– It's A Joke
– The Bubble Called Lithium
– Oil's New/Old Paradigm
– Catching Up On The (Bear Market) Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV
The Trend Is Your Friend Until It Ends
By Rudi Filapek-Vandyck, Editor FNArena
"Are we waiting with ever-growing impatience for the economy to get back to normal, or has the economy shifted to a 'new normal'?" (…)
"Trouble is, neither I nor anyone else can say with confidence what the answer is."
[Sydney Morning Herald economics editor Ross Gittins]
Just as well we are coping well amidst a global equities bear market.
No. It's not a typo. US-based market trader and publisher of his own daily The Gartman Letter, Dennis Gartman, with more than thirty years of uninterrupted, hands-on daily financial markets experience, just about every other day or so reminds his global subscribers Gartman's index for global equities is still down around -17% from last year's peak. Year-to-date the index is down around -3.5%.
Similar to my own view, Gartman adheres no value to the oft referenced -20% rule, which he suggests is for morons and brainless commentators only.
Investors should keep in mind that with US equities holding up as well as they've done, the situation/performance of equities outside the USA has been a lot worse. Australia sits somewhere in the middle, with the ASX200 balancing on a fine demarcation between positive and negative performance since January 1st. Including dividends, the index is up circa 2% year-to-date.
The schism identified by Gartman between the general view and what has actually occurred globally post May 2015 is quite striking, to say the least. It also identifies an equally striking gap between equities in the USA and in most markets across the rest of the world. That difference might have become more important than ever.
It's A Bear Market
Analysts from global investment researchers and wealth managers GaveKal Dragonomics visited Sydney last week and true to form for an independent collective which was two-thirds founded by French-born Gaves (Charles & Louis-Vincent), there is no strict house view, but instead healthy discussions internally about key dilemmas and where financial markets are at.
Part of GaveKal's view suggests we are only at the early stage of yet another nasty bear market. This view is easily illustrated by the chart below, showing the MSCI World index and how it ostensibly peaked in May last year, then rolled over with two visible counter-trend rallies in the meantime.
If history is our guide, and the trend post May-2015 remains in-line to what appears the path of least resistance post such market peaks, then there's little denying it appears there's a lot more downside yet to show up before we can start talking about a genuine new bull market for equities again.
It's A Bull Market
In line with the inconsistency also identified by Gartman, the opposing view inside GaveKal is that US equities are most likely experiencing another strong bull market trend upwards. As the leader among global equities, this should bode well for the rest of the world with those markets poised to play catch up once investors and policy makers get their heads around current headwinds and uncertainties.
This view of a new bull market is illustrated by the S&P500 chart below. It represents a key justification as to why experts globally see a continuation of the new "Risk On" environment that has announced itself since mid-February on the back of a market supportive Federal Reserve.
Lower For Longer Still The Trend
Assuming the Federal Reserve finally follows through on its intention to "normalise" US interest rates later this year, it remains yet to be seen whether this will break the back of the Lower for Longer trend that has remained firmly established post Lehman Brothers' collapse in late 2008.
Most investors would not have noticed, but bond yields are still falling in Emerging Markets and the Reserve Bank in Australia is now back on the path of monetary loosening. It's the key reason as to why Australian equities do not seem to want to go down this month.
Analysts at Platinum Asset Management equally presented their views to clients, media and investors recently. Their base case is rising interest rates are now a danger to global stability; in a world that has accustomed itself to low rates for such a prolonged time even the tiniest change to the upside can have major ramifications.
Platinum doesn't think the Federal Reserve can muster a lot of ambition when it comes to "normalising" interest rates. Otherwise, if they do, they'll be confronted with today's new reality and its limitations. Cue market turmoil in January and February.
Short term turmoil and market uncertainties aside, Platinum is predicting a new era for central bank policies around the world. This time policies are aimed at supporting inflation from the downside, instead of suppressing it, which means interest rates and bond yields are poised to remain below annual consumer price inflation (CPI) for a long time. Think 20, maybe 25 years.
In Platinum's view, we are only in year eight since the GFC effectively gave birth to the present Lower for Longer. This implies we are likely not even half-way through this monetary adjustment/healing process.
Platinum's analysis incorporates historical research done by Credit Suisse which identified two precedents in human history. Both the 1890s and the 1930s required at least 25 years before bond yields started "normalising" in substantial manner.
Investment Strategies For The New Era
How does Lower for Longer affect investment strategies? Platinum believes there's only one modern precedent for investors to take lessons from and that is Japan post the late 1980s. Since the late 1990s, Japanese equities have only generated returns to the tune of 1.5% on average annually, so blindly following the nation's main index doesn't seem to be the best strategy going forward.
Platinum's own Japan Fund has generated 14.5% on average per annum since 1998. What were the strategies that helped the fund outperform the moribund broader market in Japan? (Note also: Japan now has had official interest rates at 1% or below since July 1995; approaching 21 years and still counting).
Extrapolating the Japanese experience into today's global context, buying companies with the fastest growth under their belt is not the best strategy to employ, explains Platinum. In Japan, buying companies with circa 7% growth at a Price-Earnings multiple of 20 has proved the superior strategy. Other strategies that have worked well are buying "yield", oft the highest in each sector, as well as undervalued companies.
On my own observations, Platinum's experience in Japan merely supports the key trends witnessed in the Australian share market post-GFC. Yield stocks have widely outperformed the broader market and they continue to do so year-to-date in 2016. Buying the highest yield, however, is not necessarily a guaranteed success as investors have been quick to abandon ship in case of operational difficulties and uncertainties. This is why REITs and stocks like Transurban ((TCL)) and Sydney Airport ((SYD)) have significantly outperformed Telstra ((TLS)) and the banks.
But maybe the above sentence should be turned on its head: if the banks and Telstra had not encountered the growth problems they have, their performance might have kept pace with REITs, Transurban, Sydney Airport and the like. If, however, lower interest rates/bond yields continue to command investors' focus, then even the banks and Telstra will perform. As a matter of fact, a reversal of fortune appears to be taking place right here, right now.
Also, investors might feel heartened that, no matter the general climate or new context, buying assets that have fallen out of favour and that are therefore heavily undervalued remains a valid strategy. This is the old tried and proven Warren Buffett/Intelligent Investor through-the-cycle market approach. However, in a world wherein sustainable growth is harder to come by, buying cheap assets might require a more active buy-and-sell strategy. Recent experiences in Australia suggest once stocks such as Fairfax Media, Billabong International and WorleyParsons recover from their lows, they are not by default destined for ongoing sustainable gains.
Also, needless to say but "cheap" doesn't always translate into "excellent value", especially not in the short term. Flight Centre ((FLT)) shares must have looked genuinely attractive to all and sundry last week when they sank to well below $40. Having issued yet another profit warning (this is turning into a miserable track record), the shares fell nearly 9% on Monday. Kudos to the team at Macquarie who last week downgraded on the conviction a profit warning was but a matter of time (See Stock Analysis on the FNArena website).
What in particular intrigued me was that the best performing strategy has been to buy moderately growing companies at relatively premium valuation, yet not too elevated. Platinum Asset Management obviously has not done the same market analysis I have done, they are probably not familiar with my personal research and analysis at all, but I can smell a striking resemblance with my own All-Weather Performers. Many of these stocks have not shown spectacular growth post-GFC, but their share prices have consistently been at a market premium.
Their performances for shareholders have been exceptionally sweet (as anyone can see from the monthly update on share prices FNArena produces for paid subscribers, see also bottom of this story).
Many All-Weather Performer also displays a remarkably lower volatility in share price. This is not something that has come up in the past six weeks or so. This is one of the key characteristics as to why these stocks are very much tailored for the modern investment context, as I have argued on many occasions prior.
Hence why, again, I see an overlap with the following market observation published last week on US equities:
"Low-volatility stocks have been handily beating their high-volatility peers. Over the past 12 months, returns in low-beta stocks have been good, while high-beta stocks have been horrid. The difference in returns is the largest since 2002 and historically when low-beta stocks have so greatly outperformed high-beta ones, it led to trouble for stocks in general. It didn't pay to focus on high-beta stocks until they started to outperform again."
[Jason Goepfert, SentimentTrader]
In particular technical traders are very much unaware of anything new under the sun amidst falling bond yields and decelerating global growth. In their universe "low volatility" automatically means "Risk Off". However, every astute market observer in Australia has by now discovered that "defensive" stocks such as Amcor ((AMC)), Burson Group ((BAP)), CSL ((CSL)), Sydney Airport, Transurban and the likes, do not simply outperform when things get hairy in the share market; these stocks have outperformed for years now, and they continue their outperformance in 2016 (I am referring to sustainable gains, not including temporary upswings for volatile, high risk propositions).
Commodities Post The Bottom-Up Rally
Contrary to the All-Weather Performers mentioned above, commodities and shares in commodity producers have not performed well post 2011. There is an argument to be made that commodities already peaked in 2007 and only temporary stimulus from China instigated a temporary reprieve from the post-peak downward move. Alas, as China stopped stimulating, the sector as a whole embarked on a gradual slide into relentless shareholder misery.
Broader picture, global growth remains sluggish, inflation is low but the US dollar has been stopped in its rally and China is stimulating again. The latter two factors proved strong enough to trigger both an unexpected and unexpectedly strong come-back for the sector. Individual commodities such as iron ore and crude oil also enjoyed supply disruptions, which further enhanced their rallies.
Production cuts are happening, here and there, but higher prices are not helping the necessary market rebalancing. Most analysts, including the aforementioned Platinum Asset Management, cannot get excited because, in general terms, over-supply still dominates while China's stimulus is seen as temporary only. For how long exactly remains a matter of public debate.
I do believe divergences in supply-demand & inventories dynamics will become increasingly important from here onwards and this should translate in more specific price action for each commodity independently. As things stand, the outlook for the likes of lead, zinc, cobalt and lithium looks better than for aluminium, LNG, copper and nickel, but things can move quickly in this space. And there's absolutely no consensus regarding what you just read.
I remain equally unenthusiastic about gold at the current market juncture. A more placid US dollar on the back of moderate interest rate expectations in the US is no doubt a positive for gold, but only in a relatively mild sense, and probably already priced in given bullion's 20% gains thus far this year. Low inflation removes yet another (flawed) argument.
Of course, if the pro-bear market argument wins the case in the year ahead one should be pleased with plenty of gold protection/exposure, but aren't markets positioned for the pro-US equities bull market at the moment?
It's A Joke
Three investors are engaged in a discussion on the status of financial markets in a famous steak house in the Big City.
At one point a knife falls off the table and plants itself in the foot of one of the men (of course, they're all men).
Clearly hurting, the guy asks his neighbour: why didn't you try to catch it?
The second investor responds: I am a technical trader. We avoid catching falling knifes. Why didn't you move your foot?
The first investor responds: I am a fundamentalist. I didn't think it would drop so low.
He looks at the third investor who responds: I am a contrarian. I had my hands knee-high in anticipation of the bounce, but it didn't.
The joke above has partially come to life at casa FNArena. I think it's already amusing as is, but I am still opening it up to contributions from our audience: tell us, how can we make this joke even better. Any suggestions?
Send your tips/ideas/improvements to [email protected]. If we really achieve a better, crowd-contributing end result, we'll come up with a suitable reward. Surely the challenge is on?!
The Bubble Called Lithium
How do you know when a bubble is forming? Maybe when every mining explorer is trying to convince the share market it does have a noteworthy connection with "lithium".
Or maybe when every stockbroker in town starts issuing reports on the sector? Commodities analysts at Citi were the latest to join the queue on Monday and the following might well be the key sentence in that report:
"We remain cautious towards CY17 as new production enters the market but we don’t yet anticipate a significant price correction."
Last week, Canaccord Genuity released their in-depth take on lithium for the decade ahead. A brief summary would be: exciting short term, exciting long term, less so in the middle. That part in the middle is when supply, which is starting to kick in already, is believed to put the global lithium market in surplus for up to three years (see base case scenario chart below).
A few base case pieces of advice for those investors (traders?) willing to command their own slice of the overall share market exuberance for everything lithium in 2016: enjoy it while it lasts; don't get stuck with shares in a worthless explorer that is never going to develop anything; draw lessons from Paladin Energy (uranium) and from Lynas Corp (rare earths) and do not doubt the following statement: there will be tears, guaranteed.
FNArena published its own update on the sector on 16th May: The Power Of Lithium.
Oil's New/Old Paradigm
Energy markets have been significantly transformed in years past, not in the least because the strong bloc of OPEC producers essentially is no longer.
Saudi Arabia is playing home-oriented politics these days and judging by the many research reports on the country and its future that have been issued over the past six months or so, the Saudi Kingdom really is focused on survival and a lot less on what Venezuela and Iraq might think about production and price for a barrel of heavy or sweet crude.
That much is general knowledge these days. But have investors properly thought through all the consequences of this new environment for crude oil prices?
Research house and manager of funds GaveKal Dragonomics sent two of its founding analysts, Anatole Kaletsky and Louis-Vincent Gave, to Sydney last week to update clients, prospects and media about their left-of-consensus views on various matters. One eye-catching view is that history of oil markets can be marked as "strong OPEC" and "weak OPEC".
In the first environment, oil prices are high and strong and they trade well above long term averages. In the second scenario, there no longer is monopolistic pricing, and the market tends to take guidance from marginal producer's cost levels to decide where oil should be trading at.
Right now, OPEC is gone, done and dusted, argues GaveKal, which means much lower prices should be expected. GaveKal thinks US$50/bbl is going to act more as a ceiling for the time being.
This is definitely more subdued than what analysts at Goldman Sachs are forecasting for the years ahead. Now that fears about US$20/bbl have been put to bed, Goldmans updated long-term price forecasts are for a trading range US$53-63/bbl (Brent) long-term.
This forecast is based upon Goldman's US based experts estimating the US shale industry needs US$50-55/bbl to stay viable. With further technological advances, this could drop to below US$50/bbl by 2020 on their estimation.
These views/forecasts certainly put a big question mark over valuations for many an energy producer in the local share market. The team at UBS, for one, cannot get tired pointing out most share prices imply oil priced above US$60/bbl already.
Catching Up On The (Bear Market) Past
There's no denying a change in the outlook for domestic interest rates is providing support for the Australian share market. Forget about indices revisiting prior lows. Instead, now the hunt is on to participate in equities on the "lower for longer" outlook.
There is no need for #NigelNoMates to stick around, at least in the medium term. Those readers who'd like to look back at the opening stories for the year, when things looked a lot different, can do so via the list below (in reverse order):
Rudi On Tour
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
(This story was written on Monday 23 May 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: [email protected] 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 [email protected]
For more info SHARE ANALYSIS: AMC - AMCOR PLC
For more info SHARE ANALYSIS: BAP - BAPCOR LIMITED
For more info SHARE ANALYSIS: BPT - BEACH ENERGY LIMITED
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: FLT - FLIGHT CENTRE TRAVEL GROUP LIMITED
For more info SHARE ANALYSIS: STO - SANTOS LIMITED
For more info SHARE ANALYSIS: TCL - TRANSURBAN GROUP LIMITED
For more info SHARE ANALYSIS: TLS - TELSTRA GROUP LIMITED