Rudi's View | Sep 14 2016
This story features TELSTRA CORPORATION LIMITED. For more info SHARE ANALYSIS: TLS
In this week's Weekly Insights:
– September Weakness: More Than Meets The Eye
– Rudi On Tour (note change of date)
– Nothing Ever Changes, Or Does It?
– Rudi On TV
September Weakness: More Than Meets The Eye
By Rudi Filapek-Vandyck, Editor FNArena
"It is safer and more prudent to acknowledge the possible existence of a bubble before and not after it bursts. Be very wary of low-yielding bonds. I prefer the safety of one-year term deposits at 2.5% for the moment."
[Peter Warnes, Head of Equities Research, Morningstar]
Despite the oft used moniker "Mr Market", I believe the share market is female. Everyday she tries to communicate, asking questions and sending out messages, but we blokes on the sidelines (most of us are) we'd be lucky, at best, if we actually understood what the share market is trying to tell us.
We need tools, lots of them, to interpret and to translate the many messages that are thrown at us. Hence why we use charts, quantitative analysis, momentum indicators, Price Earnings (PE) ratios, economic data and surveys, moving averages,.. and yet, we are but fortunate if we truly understand a little bit of what is going on around, inside and underneath the great female enigma in front of us.
Of course, put any of us men in front of a camera, or on stage, and we boast, we show confidence, and we issue big statements about the share market and its future direction. That's how we roll, we men. But our accuracy is dreadful. The key difference between politics and finance is in the world of equities and investing one can be wrong half the time and still keep his job, his status, and boast about it. No further questions asked.
Everybody knows the old joke about men and women acting differently when in unfamiliar terrain, lost for direction. We men, we simply try to figure it out. And we will. Eventually. Hopefully. Women have no ego-constipation. They ask for directions. Simple. Effective. Fast. And uncomplicated. The share market is very much like that too. She'll ask for direction just about every single day.
The share market asks questions for direction so often, it almost literally drives us male observers on the sidelines completely mesjogge. Crazy. Nuts. How many times would we like to shout: for goodness sake, we know where we are going, stop asking for direction! But no, she must ask again, and again, and yet again.
Underneath these female virtues, is a world that is powerful, cruel, merciless and unrepentant, often rewarding, sometimes not, yet always covered in sweet attraction. It's why we keep coming back.
Share markets both here in Australia as in the USA and mostly elsewhere too, have been remarkably placid over the past two months. All that changed towards the end of last week and now it appears Mrs Market has decided the path of least resistance is to the downside, for now.
As you can expect, there are usually more factors in play at the same time, even though the media might pick the one that sounds most plausible and is the easiest to "market" to readers. This is then picked up by expert commentators and repeated time and again. The advantage of all this is Mrs Market's woes are being nicely summarised into one single theme. For investors who like to respond in shrewd and most appropriate fashion, it's probably best to take into account all the inputs that are causing this year's traditional September month weakness.
Before we move on, I need to point out that, as I am my mother's son, there's no guarantee I am any better in deciphering what Mrs Market is saying. The below is no more than the best of my attempts.
1. There's general complacency in financial markets and the Fed doesn't like it. As one would when walking in their shoes. Markets must price in at least a reasonable chance of rate hikes in the near future, otherwise mayhem is the logical outcome and the Federal Reserve finds itself in an ever deeper hole, forever unable to act in a relatively smooth and gradual manner. I don't think a September rate hike was ever genuinely on the cards, but the Fed has to play the game in order to keep market complacency within acceptable boundaries.
Here's what economists at CommBank had to say about it on Monday morning: "The US economy is not strong enough to absorb two rate hikes in 2016 and it may not absorb two hikes in 2017". History shows low rates for longer is the most likely scenario for the years ahead (might even be the decade ahead) but that won't stop anyone panicking who's not positioned for a 25bp hike in the short term.
2. Have we reached the limit of Central Bank policies? One of the hottest Fed publications right now is David Reifschneider's "Gauging the Ability of the FOMC to Respond to Future Recessions", released last week by the Federal Reserve of Washington, D.C. No doubt, both the author and the regional Fed board had different ideas when releasing this document, but investors worldwide are reading it as "central banks are running out of heavy ammunition", hence renewed fears for "QE forever", without any signs these extreme policy measures are actually working in the real world (i.e. outside of academia's ivory tower).
The full document can be downloaded here: https://www.federalreserve.gov/econresdata/feds/2016/files/2016068pap.pdf
In addition, both the Bank of Japan and the European Central Bank seem to have run into limitations with their extreme market interference, while not getting any closer to reaching their goals. It's all well and good to try to push the initiative onto governments and the people's chosen representatives, but, realistically, stimulus through infrastructure is a long distance game and, outside some minor initiatives like in premier Baird's NSW, where exactly is there a fertile environment for parliament to vote in favour of a decisive plan to invest billions in infrastructure, financed with cheap debt?
3. Portfolio rotation away from crowded trades. Most investors, by now, are all on the same page about what works and which companies and sectors are preferred and performing well. In Australia, it's not the Top Twenty but in the same breath, how much more can one buy in small cap emerging stars, in healthcare, and in infrastructure and in Real Estate Investment Trusts (REIT) without stretching overall portfolio risk too far, not to mention sending stock valuations into the stratosphere?
Some strategists have stuck their neck out this month and called for a rotation into cyclical stocks. Last week in Australia, Macquarie strategists declared the time seems ripe for a switch in market leadership, away from sectors that have enjoyed strong tailwinds in years past (bond proxies) in favour of sectors that had only headwinds (commodities, capex and consumer-oriented). Equally important, Macquarie predicts a volatile and uneven transition period of 12-18 months, though I doubt whether many who eagerly read the report paid attention to so much detail.
In the USA, economists at Goldman Sachs believe most economies across the globe are either near the bottom of the industrial cycle or at the relatively early stages of an industrial upswing. This too implies a switch in share market preferences should become inevitable. A little disconcerting, maybe, is Goldman Sachs' conclusion a better pulse for the global industrial production cycle is not by default a positive for equity markets, but it is almost certainly a signal that global bond markets will begin to underperform, as will their proxies inside equity markets.
4. A wobbly and questionable come back for resources stocks. It took one more savage, across the board sell-off in January-February to trigger a remarkable and sustained come-back for resources stocks. By then, the rubber band in relative valuation between expensive defensives and the broadly despised, hated and under-owned mining and energy stocks had been stretched out too far, and a swift correction in relative valuations seemed but logical.
Small differences have made big impacts, such as a change in coal policy by Chinese authorities and supply detraction and delays for iron ore, but overall many a fundamental analyst continues to fight a mental battle between spot prices and underlying market dynamics. At face value, stockbroking analysts are well behind the curve and some big upgrades will need to be made, implying mining stocks are still "cheap", irrespective of significant gains booked since the February lows. But such assessment, of course, requires commodity prices hold up at current levels, and that is far from certain.
Commodities analysts at Citi warn investors better not expect a resumption of a prolonged upswing for commodity stocks. The analysts acknowledge the overall climate seems a little better today than was the case during three previous attempts of a sustainable come-back post 2011, but they certainly would not give up on their defensives, and certainly they'd not be chasing cyclical resources stocks post recent rallies.
If Macquarie and Goldman Sachs strategists are proven correct in 2-3 years from now, today's share prices for miners, explorers, contractors and services providers might turn out real bargains, but between now and then a lot is likely to happen meaning investors will have to stomach volatility and uncertainty, not to mention the downside risk attached to scenarios of a stronger than anticipated US dollar, another stumble in China, or a general retreat in risk appetite across financial assets.
5. Doubts about the outlook for the US economy, and for US corporate profits. This might come as a surprise amidst all the talk about how strong the US economy is when compared to other developed economies, except the miracle Down Under, but economic data and surveys are actually flagrantly inconclusive and if anything, a strong case can be made the world's largest economy remains stuck in second gear, with only hope, no evidence, for faster growth ahead. See the CommBank quote earlier.
So far nothing new. This has been the case since the world recovered from 2009 lows and central banks lend their support. In recent times, strategists on Wall Street have (yet again) started to question the outlook for corporate profits in the USA. For example, here's Deutsche Bank's David Bianco on this matter: http://www.zerohedge.com/news/2016-09-11/deutsche-warns-companies-will-sharply-cut-2017-earnings-expectations-next
It goes without saying disappointing corporate profits and elevated valuations are usually the ingredients for a weaker share market, irrespective of imminent Fed rate hikes or not. Also, strategists at Morgan Stanley have adopted the view the Federal Reserve cannot lift interest rates because economic growth in the US, as well as elsewhere across the world, is too fragile and will remain too fragile.
Funnily enough, Morgan Stanley is taking the opposite view of Goldman Sachs, but both hold a mildly positive view on the outlook for US equities. In Morgan Stanley's view, no interest rate hikes will -all else being equal- act as a slight positive amidst all the various negatives, including There Is No Alternative (TINA).
6. Equity markets look expensive. As I have been pointing out in weeks past, and I was definitely not the only one, shares in Australia looked stretched and expensive against the background of a non-inspiring, disappointing reporting season in August and an RBA reluctant to further cut interest rates. Not helping matters is no action from federal government or parliament and a stronger-for-longer Aussie dollar. Plenty of doubt around regarding the outlook for corporate profits and the direction of the Australian economy.
Thus far, the Wonder from Down Under, the Australian economy in its 26th year without recession, has been confounding friends and foes, but many doubt whether this is more than short term noise which is obfuscating the challenges ahead. Economists at Citi, for example, are merciless in their assessment. Australia is living on borrowed time. The Q2 GDP outcome was "fool's gold". The country's luck will eventually run out, thus forcing the RBA back into an easing bias. These are all quotes from recent Citi reports. You get the picture.
In corporate profit terms this means FY17 might yet show up average low or even negative growth, similar to the five financial years just passed.
7. It's the annual season for volatility and moves to the downside. Late Mark Twain summarised it very succinctly: "October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February."
Following severe carnage up until mid-February, global equity markets have thus far escaped the usual "Sell in May" weakness coming into August, but is September-October a bridge too far? Last week's price action seems to suggest this might be the case. Investors should take note of the fact September is the only month of the calendar that has, on average, generated a negative return for US equities post 1980.
Australia usually follows its Big Brother into turmoil and weakness. Post 2009 September has been fairly consistent with injecting heightened volatility into global share markets.
Equally important is that, on average, weakness tends to kick in around the middle of September with a likely bottom around mid-October, after which a recovery usually kicks in. This year weakness has come earlier. We'll have to wait and find out whether/how this might affect share market performances in October. Since 2000, September has only caused losses for equities in 50% of the years, but when it did, losses tended to be noticeable and large: -11.20% in 2008; -7.10% in 2001; -6.90% in 2011. Losses in 2015 were -2.64%, in 2014 the negative balance stopped at -1.55%. September generated positive results in 2013 and 2012.
8. Watch the come-back of political risk. Are investors too sanguine about a potential Donald Trump surprise in the US presidential election? After Hillary Clinton's "deplorables" gaffe, and pneumonia at the 9/11 commemoration, surely The Donald shall pounce and pounce, increasing scrutiny whether Hillary is fit to lead the world's most powerful nation, and army. Quite a number of respected Wall Street oracles are predicting a Trump victory, with or without their personal endorsement. To state the obvious: such risk is presently not priced into financial assets.
It is possible Europe might command global attention too with rhetoric towards Greece's debt obligations flaring up, and ahead of a constitutional referendum in Italy, where banks are bankrupt but still operating, and yet another parliamentary election in Spain before year-end. On October 2nd, Hungary will vote in a national referendum on the European Union's migrant resettlement plans.
9. Yield stocks look less attractive. After seven years of yield support, REITs and infrastructure stocks look "exhausted", to use terminology used by Macquarie analysts recently. For good measure, cash flows look okay, and so are growth prospects in general and ongoing prospects to pay and lift dividends for shareholders, but share prices are mostly still trading above fair valuation and yield stocks seem to be losing out on relative growth prospects vis-a-vis resources and cyclical stocks (if forecasts prove correct).
Many a retail investor might not worry as long as dividend payouts remain secure (which they are, in most cases) but professional fund managers are searching for "outperformance" and worried about "underperformance". This can create a whole different dynamic. In particular with yield stocks having performed for such a long time.
There is also the potential for negative news flow now that Wesfarmers, Woolworths, Origin Energy, BHP Billiton and Rio Tinto all have reduced their dividends. Woodside shall be next in February. Among the banks, ANZ Bank has taken the pain, but is anyone else from the sector going to follow?
In recent times, Telstra ((TLS)) has attracted increased scrutiny as analysts try to assess what life looks like for the Big Aussie Telco post multi-billion NBN payments from the Australian government. Early assessments are not positive. Telstra is facing a significant shortfall in profits and cashflows post 2020. What this means is that, unless current management can find a solution, Mrs Market will increasingly zoom in on the deteriorating operational growth and cash flow dynamics.
One big change that has already happened is analysts have removed any upside from the current annual 31c payout to shareholders. In other words, Telstra is now seen as "defending" its 31c payout, until it will have no other choice but to cut. Just like BHP, Rio Tinto, Woolworths and ANZ Bank ultimately did.
The dilemma for yield investors is thus between short term certainty for an annual 31c payout (6%+ yield plus franking on current share price) and the prospect for capital erosion. Telstra shares closed below $5.00 on Monday, a level not registered since 2013, and a far cry from the $6.60+ reached in the opening months of 2015. Memories of the bad old days pre-2010 instantly return, when shareholders were promised 28c per annum, but the shares just kept on falling as time passed by.
Many an income-hungry investor might be better off outside the equities market from here onward.
10. The times they are a-changing. At least, such is the catch cry among those who believe central bankers are running out of options, and they will pass on the baton to governments and parliaments. Cue billions of investments in global infrastructure, financed by cheap debt, or by central bankers; either way, this seems all but a surefire way out of the current low growth, low inflation moribund state of the global economy.
Even if this proves to be the case, it'll be a longer term prospect, at best. In the shorter term, the times might be changing in that investors have to get used to the fact central bankers are not going to continue providing excess liquidity as a one-stop solution for all possible ailments and threats. That in itself might bring about a mental shock, while corporate America might be less willing to take on additional debt to finance even more share buybacks and dividends.
The flipside to all of this is that in the absence of political action, and with ongoing low growth and low yields, companies can switch focus to merger and acquisitions in order to secure future growth. This can potentially create a whole new dynamic, but, again, no such signals are apparent right now.
Knowing Janet Yellen and her colleagues at the Fed have pretty much frozen every time financial markets sank into turmoil, the danger right now is that Mrs Market might be willing to once again test the Fed's mettle and send stocks deeper into the red. Until one of the two ladies blinks.
Let us all hope this won't devolve into a "be careful what you wish for" outcome.
Rudi On Tour
Please note the date change for upcoming presentation in Chatswood.
I will be presenting:
– To Chatswood chapter of Australian Investors' Association (AIA) on September 14, 7.15pm, Chatswood Club at 11 Help St
– Christmas Special for Chatswood members of Australian Investors' Association (AIA), December 14, 7pm
– 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
– On Thursday, I will appear as guest on Sky Business, 12.30-2.30pm
– 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 12th September 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@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. Last updated until August 31st. Paying subscribers can request a copy at firstname.lastname@example.org
For more info SHARE ANALYSIS: TLS - TELSTRA CORPORATION LIMITED