Rudi's View | Jun 29 2016
This story features RAMSAY HEALTH CARE LIMITED, and other companies. For more info SHARE ANALYSIS: RHC
In this week's Weekly Analysis: Special post-Brexit Edition!
Are You Brexhausted Yet?
By Rudi Filapek-Vandyck, Editor FNArena
"The impact of BREXIT is so vast that we may never fully understand its effect"
[Technology writer Shelley Palmer]
"From now onwards I'll write aluminum, color, lift and gasoline. That'll teach them!"
[One of many popular jokes emerging in continental Europe post-Brexit]
Internet traffic received a significant boost over the past three-four days and it had nothing to do with s_x, g_mbling, celebrity escapades or a popular sporting event.
At first, the world wanted to know how the population in the United Kingdom had voted. Next a global scramble ensued because nobody was genuinely prepared for an overwhelming yes to Brexit.
They did what?!? Now what?
Many thousands of pages have been downloaded and forwarded in PDF reports about potential scenarios and consequences post Brexit. There should be no doubt: Brexit is a seismic event. One that is going to change the world, but predominantly in Europe.
For investors in Australia, key potential impact can be established through three separate, but interconnected factors:
– A retreat in global risk appetite
– Sharp movements in FX crosses
– Downward pressure on global growth
All three factors already had significant impact on financial assets and investment portfolios since Friday. Let's investigate each of them with a little more detail.
Global Risk Appetite Takes It On The Chin
Absolutely flabbergasted was I in the week leading into the vote. Having completely ignored the referendum and its possible outcome up until that point, global investors had a sudden panic attack first, then decided bookies know best, so let's just trust them and instigate a rally in the days leading into the vote.
Complacency all around. No matter the fact polls about voting intentions continued to show a tight race and possible victory for the Leave campaign. Ah well, Harry Hindsight… Markets do NOT always know best. You can bet I'll be referring to Brexit a lot in the years ahead.
Is Brexit of the same magnitude as once upon a time the fall of the Berlin Wall, the collapse of LTCM or Lehman Brothers' demise? It all depends on what follows next. Take 2008 as an example, the last time things really went pear shaped around the world. Investors did not need to push crude oil futures prices to US$147/bbl in a hurry. The Reserve Bank of Australia did not need to hike domestic interest rates. Authorities in the USA did not need to allow Lehman Brothers to fall by the wayside.
In the same vein, it's not what happened on Friday that is going to determine what comes next for the world and for financial markets. That'll be dependent on actions and effects in the aftermath of Friday's historical outcome. Because there are so many unknowns and so many potential negatives, it's but logical for investors to look for safety and shift to a more cautious outlook.
Strategists at Credit Suisse for example, previously among the uber-bulls in Australia and forecasting the ASX200 would be revisiting 6000 by year-end, have now re-adjusted their December 2016 target to 5500. If you think that's not fair, Credit Suisse's new target for the S&P500 is 2000, which is below where the US equities index sits on Monday.
Market strategists at Morgan Stanley, who very much represent the bear camp in Australia, suggest a gradual de-rating for equities might be on the cards now that Brexit is going to highlight the lack of growth and persistent deflation to shaken investors globally. It only requires a few more adverse events from here, suggest these strategists, for their year-end target of 4800 (unchanged) for the ASX200 to be breached to the downside.
Global Growth Takes Yet Another Knock
The underlying message of all of the above is: don't rely on what you thought was going to happen pre-Friday. Scenarios for the remainder of 2016 and following years will need to be re-written. Assuming Ireland and Scotland stay with the Brits, separating the United Kingdom from the European Union is going to weigh on consumer sentiment and on investing and spending intentions of businesses. Not to mention the government's new workload. Apparently a grand total of 80,000 pages in regulations and deals with the European Union need to be revised and renegotiated. This is why many economists are now -base case- predicting an economic recession within 12-18 months.
One logical prediction to make is London's financial hub is going to shrink with Dublin (?) and Frankfurt seen as potential beneficiaries. Europe will not allow its financial centre to be located outside its own boundaries and legal and physical control. The UK is predominantly a provider of services to the continent, of which finance is a major component.
The UK also runs a trade deficit with Europe. It is the second largest member-economy, after Germany, but bigger than France and Italy, and it is a major financial contributor, so there will be a knock-on effect for the continent too.
Luckily, for the rest of the world, Europe might be the world's largest economic region, its contribution to global growth has been marginal at best. Even if Chinese exports were to take a hit, with flow-on effects for demand for natural resources, authorities in Beijing won't hesitate to launch yet another domestic stimulus program, if need be.
Up until now multinational corporations saw the UK as the gateway into Europe. From here onwards staff and offices shall relocate to the continent. The regional government for Wallonie, in Belgium, is already offering sweeteners to businesses considering their options. Morgan Stanley announced it is moving 2000 staff to Dublin and Frankfurt, though the decision was apparently made before Friday's outcome. London's financial hub represents 7% of the UK economy. Some 700,000 people work in the city's banking and finance related industries.
Of more worry is whether there will be a knock-on effect on London's property prices with many a property owner up until the eyeballs in debt.
Time Will Be The Ultimate Judge
Ultimately, the process of divorcing the UK from the European Union will be a lengthy and arduous process. If you're tired of hearing the term Brexit, get ready for its successor: Brexhaustion.
Oddly enough, this might be the saving grace for financial assets and for investor sentiment. Nobody likes to be held back indefinitely by scenarios of doom and gloom that may, or may not, happen sometime into the future. It is well possible that once the dust settles, and everybody gets comfortable with the process taking place, that risk appetite and financial assets recover quicker than anyone dares to predict today.
Then again, Friday's shock has weakened the global economic and financial constituency and it would only take one negative follow-up event to pull financial markets into a negative spiral once again. Back in 2007 investors and policy makers thought all the pain was concentrated in Bear Stearns and a handful of cavalier hedge funds. Turned out there was much more brewing underneath the surface of the US mortgage industry. We don't know yet who has been caught out, what is the damage and whether anyone is fighting for survival after Friday's shock event.
Article 50 of the Lisbon Treaty, only put in place since 2009, determines the UK and the European Union have up to two years to negotiate the intended separation. Time starts when the UK government sends in a formal request, but the current government and its current leader seem in no hurry to do this. Apart from this, nobody believes a separation of this complexity and magnitude can be achieved in only two years. Then there's the realisation sinking in of what it all means. A new referendum to right the wrong? Don't laugh. I grew up in Europe. I have seen crazier things happen.
Ultimately, I believe, the long-winded nature of this saga is likely to assist in the return of risk appetite, exact timing unknown. As said, this is on the assumption no follow-through events are on the horizon.
Meanwhile, spare a thought for central bankers in London, in Frankfurt, in Tokyo, in Beijing, in Washington, and possibly also at Martin Place in Sydney. Models are being updated, revised and re-adjusted as I write these sentences. Maybe there won't be one single rate hike from the US Fed in 2016 after all.
This is why gold (finally) breaking through resistance at US$1300/oz could prove to be one of the pivotal financial events of calendar 2016. (Again: one's exposure should be reverse correlated to the level of comfort with the world post-GFC).
View From Australia
As expected, the three factors mentioned at the beginning of this assessment have done noticeable damage to the Australian dollar and the Australian share market. For investors it now becomes crucial to determine what is the main source behind the retreat in share prices?
If it was purely risk aversion/investor sentiment related, then one should not worry too much. In fact, if that's the sole reason why a good stock has been sold, one might consider snapping up some extra shares, turning the portfolio into a beneficiary of Friday's shock event.
Things are worse if a company has substantial operations or sales in either the UK or Europe, or both. Already, weakness has gripped the British Pound and it is not inconceivable both GBP and euro might be noticeably weaker in months to come. But if translating weaker GBP/euro revenues into AUD remains the core issue, any damage should be short-lived. Investors tend to focus more on underlying operations instead of taking full guidance from FX fluctuations.
Ask yourself, for example, whether weaker currencies are the main game that's going to determine the outlook for Ramsay Health Care's ((RHC)) private hospital operations in the UK and France? Are Amcor's ((AMC)) flexible packaging services for food, beverages, medicines and tobacco products now doomed? Are the utilities in Europe using Hansen Technologies' ((HSN)) software and support facing a lasting downturn in energy demand and prices?
While the overall risk profile for these companies has unmistakably risen, it remains yet to be seen whether there will be any medium term impact outside of FX-related conversion. Regardless, it is probably fair to assume investors will adopt a more cautious approach until a much clearer picture emerges. Apart from the companies mentioned, I think a sizable number of Australian multinationals and exporters find themselves in this position today, including CSL ((CSL)), ResMed ((RMD)), Cochlear ((COH)), Brambles ((BXB)), Domino's Pizza ((DMP)) and Treasury Wines ((TWE)).
At this point in time, I wouldn't worry too much about the small exposures at Wesfarmers ((WES)) and Harvey Norman ((HVN)). Investors will be closely monitoring property markets and prices in the UK to gauge any backlash for the likes of Goodman Group ((GMG)) and Lend Lease ((LLC)).
Things might be more tricky when sales are dependent on consumer sentiment or business and government spending. I'd be a lot less sanguine on potential impact for Flight Centre ((FLT)), for McMillan Shakespeare ((MML)), for Ansell ((ANN)), for SAI Global ((SAI)), and for ex-NAB offshoot Clydesdale ((CYB)), among others. Given the August result season is only weeks away, it might take a while before investors obtain a reliable insight into what goes on inside these operations post-Brexit.
Qantas ((QAN)) flies to both Europe and the UK where weaker currencies might put a lid on overseas travel plans.
And then there are companies whose operations are closely linked to European financial markets. For them, short term expectations may have to reset at a lower level medium term. Such companies include Henderson Group ((HHG)), BT Investment ((BTT)), QBE Insurance ((QBE)), Insurance Australia Group ((IAG)), Westfield ((WFD)), Computershare ((CPU)), Iress ((IRE)), Macquarie Group ((MQG)), among others. Potential impact for these companies can be nothing short of "large" in the short to medium term and investors have exactly taken this view with share prices for these companies yet to show any sign of recovery.
Whatever happens in July, investors will have a new point of focus when companies report in August: what's the impact of Brexit on offshore sales and operations?
Rudi On Tour
I will be presenting:
– 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)
– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Melbourne, 7 July (almost sold out)
– To Gold Coast chapter of Australian Shareholders' Association (ASA) on Tuesday 12th July at Robina Community Centre, commencing at 9:30am
– To Brisbane chapter of Australian Shareholders' Association (ASA) on Wednesday 13th July at the Wesley House, 140 Ann St, Brisbane, commencing at 11:00am
– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", Gold Coast, Wednesday 13 July (tickets still available)
– 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
– To Perth chapters of Australian Investors' Association (AIA) and Australian Shareholders' Association (ASA) on 7 February 2017
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
– Later on the same day I will also make an appearance on Switzer TV, Sky Business, between 7-8pm
– 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 27th June 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. Last updated until May 31st. (Next update before next Monday). Paying subscribers can request a copy at [email protected]
For more info SHARE ANALYSIS: AMC - AMCOR PLC
For more info SHARE ANALYSIS: ANN - ANSELL LIMITED
For more info SHARE ANALYSIS: BXB - BRAMBLES LIMITED
For more info SHARE ANALYSIS: COH - COCHLEAR LIMITED
For more info SHARE ANALYSIS: CPU - COMPUTERSHARE LIMITED
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: DMP - DOMINO'S PIZZA ENTERPRISES LIMITED
For more info SHARE ANALYSIS: FLT - FLIGHT CENTRE TRAVEL GROUP LIMITED
For more info SHARE ANALYSIS: GMG - GOODMAN GROUP
For more info SHARE ANALYSIS: HSN - HANSEN TECHNOLOGIES LIMITED
For more info SHARE ANALYSIS: HVN - HARVEY NORMAN HOLDINGS LIMITED
For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED
For more info SHARE ANALYSIS: IRE - IRESS LIMITED
For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP
For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED
For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED
For more info SHARE ANALYSIS: QBE - QBE INSURANCE GROUP LIMITED
For more info SHARE ANALYSIS: RHC - RAMSAY HEALTH CARE LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC
For more info SHARE ANALYSIS: TWE - TREASURY WINE ESTATES LIMITED
For more info SHARE ANALYSIS: WES - WESFARMERS LIMITED