Rudi's View | Oct 12 2016
This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP
In this week's Weekly Insights:
– Recurring Themes
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV
By Rudi Filapek-Vandyck, Editor FNArena
"Asset prices seem fully priced for a very benign outcome and thus vulnerable to even small negative surprises".
[from Pimco, Cyclical Outlook, September 2016]
The Federal Reserve is ready for a 25bp rate hike in December.
History suggests the Fed likes to see US Treasuries price in at least a 70% chance of a rate hike, before actually hiking, and with about two months left until the December FOMC meeting, US Treasuries are pricing in a circa 66% chance for a hike. Almost there.
Assuming December will bring the next US rate hike, it will have been twelve months since the last rate hike, which was the first hike since June 2006. Against a background of historically low rates, negative bond yields, central bankers still overly stimulative in the UK, Europe and Japan, and with asset prices elevated and global growth subpar, a raise by 25bp is a big deal.
Yet, on my observation, experts from fixed income markets seem more relaxed about it than their peers in equity markets circles.
This is probably because bonds, at their core, remain a reflection of lower-for-longer global growth and very few believe Janet Yellen & Co are going to repeat their prediction for four more hikes next year, like they foolishly did in December last. We can all speculate at will about the reasons behind that momentary lapse of central bank sanity.
Fact remains, virtually nobody believes there's an acceleration in growth, or in inflation, around the corner. So markets should -all else being equal- adjust relatively smoothly.
This view, however, doesn't take into account the fact this is not even remotely a "normal" interest rate cycle. Things are very different in comparison with all previous cycles. Debt levels globally are at unprecedented numbers (see recent update by International Monetary Fund, IMF). Global growth is expected to pick up, ever so slightly, next year but predominantly in Emerging Markets. And growth in US corporate profits will be challenged by a tightening labour market and potentially a stronger greenback.
One common theme in many outlook reviews published these days is to be "underweight" US equities in 2017, although, of course, not everybody agrees.
Outside the US, accommodative policy is to remain the standard setting. Central banks in Europe and in Japan are nowhere near ending their monetary experiments with extreme stimulus measures. But it has now become clear to all and sundry these experiments have morphed into "pushing on a string" activities with the likes of Bill Gross complaining about financial markets being transformed into casinos. There will be consequences, Gross predicts, exact timing unknown.
Bogeyman Is Called '1994'
Even during the best of times, there are always threats and risks that can potentially derail the uptrend for equity markets. Right now most attention goes out to political risks stemming from the US presidential election and the Constitutional vote in Italy, expected by late November-early December. The FOMC hike (meeting) is scheduled for mid-December.
Next year brings the actual invocation of Article 50 by the UK government, marking the beginning of the process for the exit from EU-Europe, alongside parliamentary elections in the Netherlands and presidential elections in France in the first half, followed later in the year by general elections in Germany and the 19th National Party Congress in China.
But the real worry among equity strategists can be summarised as "1994". That was the year when the Federal Reserve did not wait until Treasuries had baked in 70% odds for rate hikes and what followed was, simply, mayhem. It is a stark reminder for all investors today that if/when things go awry in global bond markets, there is no hiding in equities, or in gold for that matter. Precious bullion displayed a lot of volatility that year, but ultimately gold ended the year lower than at the start.
The underlying message here is that if something upsets the bond markets, the consequences shall be felt across all markets worldwide.
Ironically, that "something" might be stronger than expected growth, or higher than anticipated inflation, or a more hawkish Federal Reserve. Anything that is currently not expected, thus not priced in.
No wonder, many funds are carrying more cash than usual, and many a strategy report is advocating a more defensive stance. A number of experts feels the downside potential is larger than further upside. Russell Investments admits to adopting a "Buy the dips, Sell the rallies" strategy for equities.
Rotation Is Fashionable
The broader indices might not have gone anywhere over the past month or so, in Australia share market activity has all been about "rotation, rotation, rotation". After five years of persistent underperformance, and after a final brutal sell-down in 2015 and in January-February this year, miners and, to a lesser extent, energy companies have made a noticeable come-back this year, also dragging along services providers and contractors.
Here the general themes are: a resumption of growth after significant cost cutting and a rally in commodity prices, and relatively attractive valuations, even after the strong rallies already on record. Analysts, overwhelmingly sceptical at first, are now firmly in catch-up mode.
This revival serves equity investors on many accounts. One is because a major concern is global asset prices. They do not look cheap when measured against historical values and can only be justified by current exceptionally low bond yields. Resources stocks, cheaper priced than all the rest, have offered refuge, an alternative and a hedge against potentially higher growth and/or inflation next year, and beyond.
Plus in a global context of tepid, if not illusive/artificial, corporate growth, companies like BHP Billiton ((BHP)), Rio Tinto ((RIO)) and the likes are offering earnings per share growth of 100% and more this year. This comes after some dismal years in which many losses accumulated. It may not last beyond the next year or so, but investors are prepared to cross that bridge whenever it appears on the horizon, not sooner.
Here too there is plenty of room for concern. No matter the talk about supply response, infrastructure investments and (thus far) a weak US dollar, when the conversation touches upon iron ore, copper, manganese or titanium dioxide, what matters most is China and inside China the housing market remains the numero uno driver behind demand that over stems all others. Right now, Chinese housing is powering at a speed many find frightening. It's a bubble, according to many.
Always difficult to pinpoint exactly when such bubbles deflate but Deutsche Bank analysts recently looked quite confident when they predicted it'll last another six months. Their prediction made in a report published last week is "by 2Q17 we expect demand side concerns to come to the fore as a result of a significant slowdown in Chinese construction activity".
If Deutsche Bank's concerns are overdone, or mistimed, there could be significant further upside for the sector because of the simple fact that most commodity prices are well below what analysts have put through their models, even after recent mark-to-market updates.
Where Is Cheap?
Resources stocks share their relative cheap valuations with the local banks which still are priced as if there's a recession on the horizon (at least in a relative sense). Or maybe it's because banks won't cut their dividends and nobody sees any growth on the horizon, while regulatory authorities are breathing down their neck, so banks are back at being treated like a utility, offering defendable yield, but little else.
As could be expected, bank CEOs supposedly being grilled by senators earlier this month largely turned into a farce, but UBS released a report on Friday that should have every investor's attention in Australia (since we are all both shareholders and customers of the banks, one way or another).
A proprietary survey involving 1,228 Australians who have taken out a residential mortgage over the last 24 months revealed some 28% of mortgagors suggesting their application was not factual accurate. In most cases, it had been "gold plated" (my choice of words) on suggestion by the mortgage broker. Misrepresentation usually involves household income and/or financial liabilities and/or living costs.
UBS analysts call it "stretching the truth". It does indicate financial stress/duress is higher than official stats suggest. For now, this need not be a problem as the RBA is nowhere near hiking the cash rate and if anything momentum remains to the upside, but don't be surprised when the worm does turn for the Australian housing market, there is potential for some nasty surprises nobody saw coming when focusing on official stats and data.
Buy & Sell Ratings
During the August reporting season I pointed out the Australian share market was somewhat in a quandary with share prices in most cases too elevated to justify a Buy rating (or equivalent) from stockbroking analysts. At the time total Buy ratings for the eight stockbrokers daily monitored by FNArena had fallen to circa 38%+ with approximately 46% on Neutral and 15%+ on Sell. The gap between Buy ratings and the rest had seldom looked so stretched. As I looked it up, these numbers were similar to the situation in 2007, just before everything started to go pear shaped.
I did not forewarn of another share market collapse as I've learned the lesson to not 100% rely on just one indicator.
It turns out the share market rebalanced through rotation into prior unloved sectors of mining, energy and engineering firms and contractors, and various other cyclicals. There have been many more upgrades by stockbroking analysts than downgrades for individual stocks since. This week the numbers are 41%+ versus 43%+ and 15%+ respectively and this looks a lot more balanced. Three out of eight stockbrokers carry more Buy ratings than Neutral.
The situation is far from perfect, but hey, this still is an expensive market overall and it's not like there is a shortage of risks and potential threats.
As expected, the multitude in changes has had a significant impact on the Top Rated stocks in the FNArena universe. These are stocks that carry predominantly Buy ratings, and little else. As of today the Top Twelve consists of:
– Star Entertainment Group ((SGR))
– Qantas ((QAN)) – first two stocks have a perfect record of only Buy ratings
– NextDC ((NXT))
– Lend Lease ((LLC))
– Aristocrat Leisure ((ALL))
– Evolution Mining ((EVN))
– APN Outdoor ((APO))
– Cleanaway Waste Management ((CWY))
– AMP ((AMP))
– Senex Energy ((SXY))
– FlexiGroup ((FXL))
– Macquarie Atlas Group ((MQA))
Before anyone gets too excited about this list: it matters whether brokers rate a stock Buy because not all growth has been accurately priced in, or because the share price is too weak. Hence additional research is an absolute must. History suggests highly ranked stocks are worth pursuing, but there is the occasional dud included, mostly triggered by share price weakness preceding more bad news.
From a personal perspective, I'd rather back NextDC and Aristocrat Leisure than APN Outdoor, for example, even if experience tells me stocks tend to undershoot once out of favour and this may well be the case with APN Outdoor too. Only touch Qantas if you truly believe the world's got it wrong on the outlook for crude oil prices, while Macquarie Atlas Group has been selling off on prospects of higher interest rates.
Of course, for those with a contrarian streak, it can pay off handsomely to peek at those stocks loved by no one among stockbroking analysts. Currently the Bottom Six of Most Unloved Stocks in the FNArena universe comprises of:
On occasion, investors might find a given stock rises like a Phoenix from a totally unloved, out-of-favour and ignored situation. Probably no coincidence the Bottom Three are all bond proxies and yield stocks, while both Monadelphous and Woolworths remain popular among shorters. The Regis Resources share price has been falling off a cliff in October. That's one guaranteed route to disappear from this list.
Special Note: paying subscribers can view these lists in real time via Sentiment Indicator on the FNArena website.
Dow Theory Buy Signal
Last week, the Dow Jones Transportation Average managed to rise and close above its April high. For followers of the Dow Theory, this is confirmation of ongoing bull market conditions for US equities. It was Charles Dow himself who advised investors the Dow Jones Industrials and Dow Jones Transportation need to confirm each other's movement in order to generate a genuine Buy signal. If it wasn't for the many concerns and distractions (Trump and Clinton come to mind) we'd probably heard a lot more about the new Dow Theory buy signal.
Extra Special Note: never rely on just one market indicator.
Rudi On Tour
I will be presenting:
– Christmas Special for Chatswood members of Australian Investors' Association (AIA), December 14, 7pm
– To Sydney chapter of Australian Shareholders' Association (ASA), December 15, noon-1pm, Sydney Mechanics School of Arts, 280 Pitt Street
– 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 10th October 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 August 31st. Paying subscribers can request a copy at [email protected]
For more info SHARE ANALYSIS: ALL - ARISTOCRAT LEISURE LIMITED
For more info SHARE ANALYSIS: AMP - AMP LIMITED
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: CMW - CROMWELL PROPERTY GROUP
For more info SHARE ANALYSIS: CQR - CHARTER HALL RETAIL REIT
For more info SHARE ANALYSIS: CWY - CLEANAWAY WASTE MANAGEMENT LIMITED
For more info SHARE ANALYSIS: EVN - EVOLUTION MINING LIMITED
For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP
For more info SHARE ANALYSIS: MND - MONADELPHOUS GROUP LIMITED
For more info SHARE ANALYSIS: NXT - NEXTDC LIMITED
For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: RRL - REGIS RESOURCES LIMITED
For more info SHARE ANALYSIS: SGR - STAR ENTERTAINMENT GROUP LIMITED
For more info SHARE ANALYSIS: WOW - WOOLWORTHS GROUP LIMITED