Rudi's View | Nov 23 2016
This story features ARISTOCRAT LEISURE LIMITED, and other companies. For more info SHARE ANALYSIS: ALL
In this week's Weekly Insights:
– The Return Of Growth
– Fool's Gold? Know Thy Enemy!
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV
The Return Of Growth
By Rudi Filapek-Vandyck, Editor FNArena
You are in a minefield. Tread carefully
[equity strategy update, Shaw and Partners]
Investors globally have started to anticipate an acceleration in growth, which should fuel inflation, pushing up bond yields and thus real interest rates.
I don't think there's any controversy surrounding that opening sentence. Yet the multiple ramifications and machinations behind ongoing adjustments in financial markets are probably best served up in bite-size, easy digestible slices, as is the purpose of today's preview on the near future.
The (Limited) Return Of Growth
For six long years the world has remained stuck in a gradual but persistent, decelerating growth environment and it wasn't like things were hunky dory in the years preceding 2011.
Now the world has decided 2017 and possibly beyond should look a lot better. This view is partially centred around tax cuts and infrastructure stimulus in the USA by the as yet to be installed Trump administration, assisted by the Republicans commanding full control of both chambers of Congress.
Two points of contention are generally dividing global forecasters: is GDP growth really going to jump to 4% as The Don has claimed and are Republicans going to facilitate mass increase in government debt to facilitate grand scale economic stimulus?
The answer to question number one appears to be a resounding "negative". The lack of government spending hasn't been the sole factor holding back global growth and the Trump administration cannot fix demographics, globalisation, the modern tech revolution, et cetera. These are all important negative impacts on today's GDP growth in the USA and elsewhere.
Others argue US labour markets already are approaching tightness, while the output gap has been shrinking. Too much government stimulus on top will simply create a lot of inflation, which forces the Federal Reserve into tightening mode and bond markets in an accelerated upswing. This is not positive for investment, real growth or job creation in the country.
Does Donald Trump want an equities bear market in the first or second year of his Presidency?
Probably not. Which is why there remains a lot of uncertainty about what exactly can and will be executed once the President-elect moves into the White House. Meanwhile, it might be easiest to start a man hunt for unregistered, illegal immigrants and to put up a fence along the border with Mexico.
Such initiatives may not be warmly welcomed by investors and other stakeholders across the world.
Note also: US government debt is already projected to rise significantly without the proposed tax cuts and infrastructure spending stimulus.
The Return Of Growth In Australia
Investors should note improving prospects for global growth are at this point predominantly carried by the USA post-Trump and by certain Emerging Economies that have gone through hell in recent years, such as Brazil and Russia. India is one notable exception.
Otherwise, all of the UK, Europe and China are still believed to be in a down trend, and to remain in that down trend. Opinions about Japan remain sharply divided (not that it makes such a big difference).
Australia, like other commodity producers (see Brazil, Russia), will be enjoying the benefits from higher-than-expected commodity prices and this should bode well for government revenues, consumer spending and business investment. This is why economists are revising their forecasts into no more rate cuts from the RBA.
The domestic labour market is only strong at face value; actual jobs creation is weak and a general preference for part-time explains the low increase in real income enjoyed by most Australians. This is the key reason as to why some economists are not as yet giving up on more RBA rate cuts next year.
A similar observation applies to the sudden, sharp improvement for corporate profits in Australia; it's almost without exception resources based, more mining than energy, more bulks than base metals. Underneath the generalised averages and percentages, corporate Australia ex-mining remains very much in struggle street.
Investors do not need to look any further than the AGM updates and out-of-season profit reports this month. In most cases analysts' forecasts are being reduced. In a number of cases, share prices get slaughtered.
Valuations in general are not cheap, with exception of the laggards who've been de-rated in years past (banks, mining contractors) and mining companies whose profit and cash estimates continue to enjoy strong upward momentum.
Current market projections for BHP Billiton, to name one example, imply 260% improvement in earnings per share (in USD) and a 60% rise in shareholder dividends. These estimates remain subjected to further increases, assuming commodity prices do not collapse in the months ahead, so don't be surprised if by next year August the actual gain achieved will be 300%+.
For Whitehaven Coal, projected increase in earnings per share for the current financial year is in excess of 1200% (not a typo).
Hence it is not that difficult to see why portfolio rotation is dominating the Australian share market since reporting season in August. It's probably more of a surprise to observe it has taken most investors this long to finally jump on the band wagon.
A second important factor stems from the bond market. Rising yields for US Treasuries have instantaneously pushed bond proxies and yield stocks out of favour in equity markets. This has made Australian banks attractive again, as they offer relatively cheap valuations, high yields plus franking and a relatively stable low growth outlook.
Good enough to withstand the downward pressure that is currently weighing on infrastructure stocks, REITs and other high yielding stocks, such as Telstra.
Fear for higher bond yields, as well as for a potential rapid return of inflation, is guiding investment flows into cheaper valued stocks. In simple terms: all that didn't work until earlier this year is now becoming popular while all that has been popular since 2011 is relentlessly out of favour. This includes many high growth, medium cap industrial stocks that had been good for shareholders until about seven weeks ago.
Given many a professional investor had been positioned heavily overweight popular defensive and industrial growth stocks prior to August, it is anyone's guess as to how long portfolio re-allocation will dominate the Australian share market. This week's price action suggests it is far from over as yet.
Fear Of Higher Bond Yields
UBS strategists summed it up best last week. If all of the above falls into place and doesn't cause too many ructions and mis-alignments, the ASX200 should be on its way to 5700 by year-end 2017 (base case) or even revisit 6000 under a more bullish outcome. But given the many risks in the months ahead, one cannot dismiss the possibility that somewhere in between now and then a rapid and major sell-down might occur.
The largest sell-down risk comes from rising bond yields. In particular if yields continue to rise at rapid pace, or threaten to become chaotic. This would not reflect positively on other assets, including equities and precious metals. I note many analysts and commentators have been surprised by the sudden demise of gold in recent weeks. They shouldn't be. Sharp spikes in Treasury yields affect the direction of gold bullion just as it does for equities.
Those who've been singing "it's the end of the bond bull market, and we love it" might be careful in what they wish for, because it is in everyone's interest, no matter the financial asset involved, that rising bond yields remain an orderly and gradual process. Given rising yields in the US are likely to push up the greenback, this process automatically doubles its impact on financial assets.
One more reason to be mindful of what can go wrong and which helps to understand why many investors are not that comfortable with the current set-up. Risk appetite is not as high as price action would suggest. I'd be surprised if financial markets do not continue cycling relatively high cash levels on the sideline.
Yet another reason as to why portfolio rotation is having such a marked and oft devastating impact on share prices of former market darlings. There is no natural buyer around when all that is happening is money flowing out of previous popular stocks into new popular stocks.
The change in central bank policy in the US also means quantitative stimulus in the UK, in the eurozone and in Japan can relax a little, meaning less central bank buying, thus rising bond yields. China remains a wild card.
History Unlikely The Best Guide
Rising bond yields need not be a negative for other asset classes. Assuming this process of normalisation goes hand-in-hand with better economic conditions and improving growth, history shows both bond yields and equities can lift at the same time.
Rising bond yields are on par with a stronger US dollar, or a rising oil price. At some point, it does become a negative. History suggests the relationship reverses from the moment bond yields surpass the 5% mark. But these are not normal times.
Most economists remain convinced the natural growth pace for developed economies has substantially decreased post-GFC. For the USA, irrespective of Trumpeconomics, maximum sustainable growth probably begins with a '2' in front.
This means the level at which rising bond yields start turning into a negative should be lower than in the past.
For the RBA in Australia, the outlook has all of a sudden become a lot more complex. Most economists are now anticipating higher growth domestically in 2017, but not necessarily in 2018, while inflation should remain weak, predominantly because the labour market remains weak.
There remains the prospect of a downturn in apartments and an open question mark what it means for consumer sentiment and spending. Maybe this is why coalition governments in Sydney and in Canberra are looking at boosting and extending the local housing construction cycle?
Where Is The US Equities Correction?
Last week, I wrote about FNArena's Buy versus Hold market indicator. When total Buy recommendations are higher than total Hold/Neutral recommendations for the eight stockbrokers we monitor daily, this usually signals a tougher environment for local equities. As this is a coincident indicator at best, with no predictive powers, there is no telling how long the proverbial bear claws will keep equities from rising too far.
The gap is widening. This week total Buy recommendations represent 43.35% of all stock ratings against 41.77% of Neutral/Holds. A less negative interpretation could be that this gap is largely the result of portfolio rotation, and with large cap stocks such as BHP Billiton, Rio Tinto, the big four banks, Woodside Petroleum and QBE Insurance back in favour, the overall news for the ASX200 market need not be extremely negative.
A lot will depend on whether US equities might have a correction ahead of or post Trump ascendancy. One reason I am cautious is because of the chart below (thanks to AxiTrader's Greg McKenna on Twitter).
US equities are rising against the bottom of an upward sloping trend line. While positive, this is nevertheless the vulnerable side of the trend line.
Because everybody always gets it wrong on gold, I've included my analysis from September 2014 below. It's still as relevant today as it will be in 2017.
For what it's worth: UBS's favourite Australian stocks for 2017 are Aristocrat Leisure ((ALL)), Brambles ((BXB)), Harvey Norman ((HVN)), James Hardie ((JHX)), Lend Lease ((LLC)), Orora ((ORA)), Qantas ((QAN)) and ResMed ((RMD)).
Fool's Gold? Know Thy Enemy!
By Rudi Filapek-Vandyck, Editor FNArena
An oft repeated mantra is that gold is the natural protector against value erosion through inflation. However, one quick glance at historical price movements instantaneously shows this is not always the case.
Gold can experience prolonged periods of price weakness and when it does, not only is there no protection against inflation, there's no safe-guarding of your capital either.
So is gold the ultimate safe-haven, or not? It depends. Under the right circumstances, gold can be whatever its owners want it to be: protector against price inflation, safe-haven guardian against capital loss, an insurance policy for whatever black swan is hiding around the next bend in the road. But if circumstances are not right: none of this applies.
Since the price of gold peaked near US$1900/oz in 2011 circumstances haven't been right. That's a pretty easy observation to make. How come, I hear many investors ask? Printing of money by central bankers is still ongoing. War is breaking out in Syria/Iraq. Central banks in Russia and China are believed to be increasing their reserves. How can it be that gold has lost 35% over the past three years?
The answer lies in the fact that gold has many different and often conflicting influences, illustrated by the fact some people consider it part of the commodities sector, a precious metal, while others talk about it as a currency. Not all factors influencing gold are equal in strength and history shows there's a clear order of importance for the masters that influence the direction of the price of gold.
Contrary to popular belief, price inflation is not one of the important factors. This only applies when the circumstances are right and modern history shows a rather chequered and inconsistent track record, at best.
Consider the following conundrum for everyone who likes to think gold is (one of) the ultimate protector(s) against inflation: global inflation peaked in the early eighties, but it was still high throughout the decade and it definitely had not completely evaporated in the nineties. Yet, for those two decades, gold only declined, and declined further in price.
Clearly, the circumstances weren't right. Higher forces were in play. More important factors.
Historically, gold has had a close relationship with the US dollar, but in opposite direction. The eighties and nineties experienced a revival of the greenback. Clearly, a strong reserve currency can be a problem for gold.
The eighties and the nineties combined also represent the longest and strongest bull market for global equities. We might draw the conclusion from this that when everybody is having a good time because of accumulating gains in the share market, nobody is genuinely interested in gold and so it languishes and disappears out of sight, until circumstances turn right again.
Enter: meltdown of TMT mania in March 2000 or global GFC-sell off in late 2007 until early March 2009.
While it cannot be denied there has been an overwhelmingly negative correlation between gold and the USD as well as with equity bull markets, there are times when gold can rise alongside a stronger USD and we have seen between 2004-2007 and between 2009-2011 how both gold and equities can both have a good time at the same time.
There is, however, one iron clad relationship that has not seen one single exception, not ever, and that is between negative US real interest rates and gold. Both always move in opposite direction of each other. No exception to the rule. Never.
As a matter of fact, I suspect this relationship is today responsible for the widespread myth that gold is the ultimate safe-haven against inflation. Gold proved an excellent inflation guard in the seventies, when inflation soared out of control, but maybe that was only the case because higher inflation pushed high bond yields in the negative on inflation-adjusted basis ("real" yield)?
The chart below shows the relationship between gold and negative real bond yields in the US, until 1980-1981. When subsequently US bond yields moved back into the positive, inflation-adjusted, there was nothing else around to stop the gold price from sliding lower and lower, and lower.
Add a resurgent US dollar plus an awakening equities bull and gold simply stood little chance. The circumstances, clearly, were no longer right. Two decades long.
Take a look at the title above the chart: "strong correlation". Now have a look at where US real interest rates were back in 2011. That's when gold soared, one more time, towards US$1900/oz.
(I don't want to even add more to conspiracy speculation, in particular because there's no shortage of it when the subject is gold, but charts like the above have become rare since 2012).
What happened since? US bond yields normalised to a level whereby their yield now exceeds annual CPI inflation in the US. Ouch.
When US bond yields change direction from sharply negative back to positive, gold follows in the opposite direction. No questions asked.
The irony is that even on this, what seems a pretty straightforward relationship, the gold community remains divided about how exactly to determine "real US interest rates". Until recently there was no problem simply using the US 10-year bonds as benchmark, but they have now moved back in positive territory. Some argue US real interest rates are still in negative territory and certainly this holds true for shorter dated bonds, say 2-3 year US government debt. Since the Federal Reserve hasn't raised the Fed Funds rate as yet, it also still applies on that measure.
However, and this is the important point I am trying to make, if you believe the US economy is strong enough to allow Janet Yellen and Co at the FOMC to start raising interest rates from next year onwards, and to continue lifting rates for subsequent years to follow, then it'll be only a matter of time before all measures for US real interest rates/bond yields will move into positive territory on inflation adjusted measures. (Not having a discussion about "real" inflation versus "official" inflation).
If the above unfolds, no matter at what speed or pace, this will provide a constant head wind for gold, at the very least. If a normalisation in US interest rates were to go hand-in-hand with a stronger US dollar plus an ongoing bull market for equities, I think gold investors should prepare for the worst. History might not necessarily repeat itself, but it does often rhyme. The last time all three major influences occurred, sustainably, at the same time was between 1981 and 2000. Just saying…
Of course, there is an alternative and this should be the only "real" reason as to why investors should consider owning gold: it ain't gonna happen.
If it turns out Yellen and Co find themselves in a situation whereby they cannot lift interest rates, for whatever reason, but a weaker than expected US economy and/or labour market come to mind as potential impediments, then gold remains poised to make a come-back with a vengeance. Any delay to current market expectations will have the same effect, temporarily.
The above is my personal view, based upon data analysis from the past and on market observations over the past fourteen years or so. Regardless, I wouldn't consider myself the uber-analyst for all things that concern gold and its future outlook. That title is more suitable to someone like Martin Murenbeeld (Dundee Capital Markets) who dedicates most of his time to analysing gold and its many features, and has been doing exactly that for a long while. When Martin speaks, many listen.
I recently received the slides of Murenbeeld's presentation at the Denver Gold Conference and it is but fair to say that -bottom line- Murenbeeld does not disagree with any of the above. He does question whether US real interest rates can turn positive again before 2016 (but I am sure he'll agree the direction is what ultimately counts) and he even adds one more clear negative: there's still plenty of gold in ETFs that is ready to be sold. On the positive side are rising consumer demand in Asia and central banks adding more gold to their reserves.
Ultimately, governments in developed economies still have a debt crisis to deal with as populations grow older and entitlements are simply too costly, in particular if economic growth is to remain benign. I don't disagree, but I doubt whether investors, short-sighted and one-dimensional as ever, will be taking any future problems on board before it actually features in daily news headlines.
On this basis I remain of the view that gold risks more downside if current expectations for higher interest rates in the US from next year onwards prove correct.
One interesting theory in Murenbeeld's presentation is that, maybe, gold's fall from US$1900/oz has already accounted for the change in US interest rates?
That theory will certainly be put to the test in the years ahead, assuming a first hike by the FOMC next year, in a series of many more to follow.
The chart below shows one more comparison to close off this assessment. Gold bulls are hoping the pendulum swinging back in favour of US equities since 2012 is about to reverse, just like it did in the late 1930s and in the 1970s. Observe how gold has had the upper hand, relative to US equities, from 1999 until 2011. Back in the 1970s the Arabs would create turmoil, and nasty oil price inflation, by turning off the petroleum tab in response to Western support for Israel. Just saying…
FYI: Murenbeeld's price scenarios for gold in the years ahead suggest a mostly sideways pattern, on balance.
Fool's Gold? Know Thy Enemy! was first published on 29th September 2014.
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
– At the ASA Conference 2017, Grand Hyatt Melbourne, 15-17 May 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: https://goo.gl/XVMzmP
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 might appear on Wednesday, 12.20-2.30pm but this has not been confirmed as yet
– 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 21st November 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: firstname.lastname@example.org 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 October 31st. Paying subscribers can request a copy at email@example.com
For more info SHARE ANALYSIS: ALL - ARISTOCRAT LEISURE LIMITED
For more info SHARE ANALYSIS: BXB - BRAMBLES LIMITED
For more info SHARE ANALYSIS: HVN - HARVEY NORMAN HOLDINGS LIMITED
For more info SHARE ANALYSIS: JHX - JAMES HARDIE INDUSTRIES PLC
For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP
For more info SHARE ANALYSIS: ORA - ORORA LIMITED
For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC