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The Market’s Changing Narrative

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Dec 07 2016

This story features ARISTOCRAT LEISURE LIMITED, and other companies. For more info SHARE ANALYSIS: ALL

In this week's Weekly Insights:

– The Market's Changing Narrative
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV 

The Market's Changing Narrative

By Rudi Filapek-Vandyck, Editor FNArena

And those who were seen dancing were thought to be insane by those who could not hear the music
[Friedrich Nietzsche]

Israeli historian Yuval Noah Harari has attracted worldwide attention since the publication of his book "Sapiens: A Brief History of Humankind".

Initially published in Hebrew only in 2011, there are now translations available in more than 30 languages. The least we can conclude is that Hahari's unique and controversial ideas have found a global audience.
 
Why is it that the homo sapiens has succeeded when others failed? To find the answer the author travels through history, starting in Stone Age times.

The answer is not exactly what readers had come to expect. There is no theory about complicated social structures, or a relatively large brain size. There are no extra-terrestrials involved either.

The homo sapiens managed to climb on top of the global food chain, says Harari, because of its ability to invent stories, and to unite behind them.

The answer thus lies within our imagination. We make things up, create a narrative, repeat it, stick with it and believe in it. It becomes a uniting force as these narratives bind and distinguish. This is how religions came to life, as well as kingdoms and empires, economic and political systems, cities and armies, allegiances and feuds.

It is why, says Harari, there is no difference between Gods, nations, money and human rights. They all exist in our imagination. They're a narrative that bonds and binds, makes us believe and accept, and build the concept of cooperation, of identifying as a group, which is ultimately what allowed us to succeed and to survive, develop into modern day society, and keep the narrative(s) alive.

It's all fiction. Imagination. In the head. But it works.

Different Narrative, Different Dynamics

Investors like a good story too. It's what builds confidence in the future.

Behind every investment decision, every corporate success, every financial gain lays a narrative in which we believe and put our trust. On many occasions, it's the narrative that unites us. On other occasions, it's what divides us.

At the start of 2016, we had all succumbed to the fact the world was caught in a slow moving, negative loop and there simply was no quick fix available. Interest rates were lower for longer, and so was price inflation, and thus bond yields.

Now that we are approaching the end of the calendar year, that narrative is quickly being replaced with one of growth, inflation, central bank tightening and rising bond yields. The end of an era, if we ever witnessed one, is happening right here, in front of our eyes.

Not a day goes by without economists lifting expectations for the years ahead, while commodities analysts are busy revising their price projections upwards.

Looking back at the broad narratives that have guided investors in years past, from Commodities Super Cycle, to lower for longer bond yields, to China 2.0, to gold as the ultimate safe haven, etc, these narratives all seem to have one characteristic in common; eventually they come unstuck, triggering heavy share price falls and serious investment losses.

It's an odd forum, the share market, where investors seek safety and comfort in each other's company, but there's no warning when the neighbours decide to leave and one's left with shrapnel and debris, and no more buyers to help out.

Talk to any funds manager who tried to venture outside of the ruling narrative in 2015 or earlier in calendar year 2016 and you can still see the frustration pouring out of their body language. It was h-o-r-r-i-b-l-e. For a few weeks now the boot is on the other foot. If there's one over-ruling characteristic of the Australian share market it is that the ruling narrative pretty much overwhelms everything else.

In simple terms: you're either "in" with the crowd/trend/narrative, or you're "not". If you are, life can be fun, though there are no guarantees. If you are not, you are guaranteed not going to have any fun.

Last week I visited a stockbroker who felt so bad, he had started calling his customers to apologise for the unsatisfactory performance over the past few months. The response from his clients? We have money under management elsewhere, plus we manage our own portfolio still. No need to apologise, you're not at all out of synch.

Have You Been Trumped?

Trump isn't even President yet, but he has already single-handedly upset global financial markets. Sure, there's a valid argument to be made financial markets had started to anticipate a change in dynamics after the Bank of Japan indicated in July monetary policy couldn't possibly stretch much further, but since Trump's victory there's no more gradual adjusting, no more doubt and discussion, there's now one narrative, and one only, with no room left for anything else.

Whatever happened to the old adage that rising bond yields, inflation and a stronger US dollar act as a headwind for equities?

The ruling narrative is those negatives will be compensated for through fiscal incentives and corporate tax cuts, hence the net effect will still be positive for corporate America and thus for US equities.

Here in Australia, the Big Switcheroo has ignited a rally in "value" stocks (cheaply priced cyclicals) and triggered a come-back for Large Caps over Small Caps. These two moves have thus far dominated just about anything else. Shareholders in Aristocrat Leisure ((ALL)), to name but one example, are still waiting for the stronger USD to be priced in the share price, which is what usually happens.

Not this time.

If you're holding shares in Aristocrat you are currently not "in" with the trend, regardless of the fact the company just reported a strong FY16 report that triggered upgrades to future forecasts.

We can all but guess how long it will take before shares in companies like Aristocrat refind their former mojo, but my guess is most investors do not care. They will simply move on to where the grass is greener; commodities and other cyclicals.

Speculation Running Hot

Last week, Peter Warnes, Head of Equities Research Morningstar Australia, warned readers of the old Huntley's newsletter, nowadays retitled "Your Money Weekly", daily iron ore contract volumes in China are up over 400% from 2015 levels.

Warnes joins a long list of others who are worried about excessive speculation behind the recent burst in prices for bulk commodities, and base metals and agricultural futures too. He is correct, of course, and investors participating in the trend du jour should prepare for more volatility, at the least.

But I think what we are witnessing is likely only the early stage of what is colloquially referred to as the reflation trade. It means investors start piling larger chunks of their funds into resources in anticipation of higher interest rates and higher inflation, and in doing so, they are creating the dominant trend in markets, which then attracts more and more trend followers, with the ultimate outcome likely a self-perpetuating process whereby higher inflation becomes the result of higher commodities prices.

Early indications are this is happening right now, and despite serious gains for share prices in BHP Billiton ((BHP)) and Rio Tinto ((RIO)), not to mention Fortescue Metals ((FMG)) or Whitehaven Coal ((WHC)), this process still is in its infancy.

Hence why people ask me when do you think the run in commodities might come to a halt?, my answer is: don't just focus on the potential downside, this is likely to stretch a lot further than you are prepared for.

The Big Revival

Investors who need a little more convincing can draw extra confidence from the latest update on the outlook for commodities by Citi's global team of experts. Under the title "Reflation, Risks and the Rocky Road to Recovery", Citi analysts paint a picture whereby enough elements are falling into place to sustain an uptrend in the price of most commodities throughout 2017 and 2018.

Citi sees most markets re-balancing on the back of higher global demand, supported by higher growth assisted by ongoing stimulus in China and now also the USA under President-elect Trump. Part of the additional supply story is likely to be distorted by rising cost inflation, which is one factor that hasn't featured on many investors' mind lately.

It means that frackers in the USA today can re-start production from US$50/bbl onwards, but when operational costs rise, they are likely to require a higher minimum price level. The same dynamics are in place for iron ore, nickel, et cetera.

To illustrate Citi's bullishness on the commodities space, the report only identifies a few lone commodities for which the analysts stick to a bearish outlook: the bulks iron ore and coal (both thermal and coking) because too much speculation has pushed up prices too far, too fast; soybeans because of exceptional weather and exceptional crops, particularly in the US and Brazil; and gold, because a stronger USD and rising US bond yields are bullion's worst enemies.

In line with Peter Warnes' warning earlier, Citi analysts do note there is a lot of money flowing into commodities in China, if not through government inspired stimulus, or to stock inventories, then from financial speculators.

If Rip Van Winkle had fallen asleep in 2002 and only woken up now to read Citi's latest assessment, he'd think we are about to experience a Big Revival for natural resources, I kid you not. I lost count how many times Citi analysts signal the risks remain to the upside.

Banks And Targets

Looking back over the year past, the price chart for the ASX200 suggests we have gone through five clearly distinguishable peak and trough cycles. The current movement might be number six.

To say the year has been volatile doesn't do it at all justice, in my opinion. But we are on track to put in a better performance than in either one of the past two years; at least if you are a follower of the index or your portfolio is very much in synch with the ruling narrative.

Given commodities and cyclicals are more volatile in their own right, and they are now a core element in the ruling narrative across global financial markets, and given a Trump Presidency is adding to global uncertainties and sensitivies, it might be foolish to expect 2017 is going to offer something completely different than what we've experienced in 2016.

I also note Australian bank shares have, post the January-February sell-off, tried to break above consensus price targets four times. This neatly coincides with the share market temporarily peaking before the next move downwards.

The Big Four Banks are currently again trying to push boundaries. Assuming they fail, this could well mean we should not expect this market to move much higher from here. Instead, we might see some weakness instead before 2017 truly announces itself.

This, however, won't change the core narrative for the year ahead. Though admittedly, if you'd asked me one year ago, I would have told you the same thing, based upon a completely different narrative.

***

This is my final Weekly Insights for the year. I wish you all a wonderful festive season, a healthy break and lots of luck in the share market.

FNArena will be taking a break between Christmas and January 16, 2017. We'll be making final amendments and adjustments to our new website in the meantime.

Here's me hoping you have enjoyed, and will continue to enjoy, my Weekly Insights. See you all in the New Year.

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
– On Thursday, I shall appear on Sky Business, 12.30-2.30pm
– On Thursday, I shall 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 5th December 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: info@fnarena.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 November 30th. Paying subscribers can request a copy at info@fnarena.com

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CHARTS

ALL BHP FMG RIO WHC

For more info SHARE ANALYSIS: ALL - ARISTOCRAT LEISURE LIMITED

For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED

For more info SHARE ANALYSIS: FMG - FORTESCUE METALS GROUP LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED