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February Reports: Ultimate Polarisation

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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 | Mar 01 2017

In this week's Weekly Insights:

-February Reports: Ultimate Polarisation
-Investor Sentiment On A High
-If History Repeats: The Jan-Feb Signal
-A New Website – The Sequel
-Who's Afraid Of The Big Bad Bear?
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

February Reports: Ultimate Polarisation

By Rudi Filapek-Vandyck, Editor FNArena

The quickest way to put a serious dent in one's investment performance is through buying shares in smaller cap industrial stocks, or so it appears.

Only one year ago disappointing financial performances followed by a decent share market shellacking were still the prerogative of mining and energy companies. Smaller cap industrials were soaking up the limelight with solid growth numbers and an oozing confidence to keep investors on board.

Seldom has the contrast in operational momentum between the two switched so markedly. February 2017 has become the corporate reporting season that allowed resources stocks to rise above the field, carried by elevated commodity prices on top of stringent cost control and accelerated debt reductions.

Shareholder dividends in Australia are firmly on their way to a new record high by mid year, and this year's boost is coming from swelling cash piles among the likes of Rio Rinto ((RIO)), BHP Billiton ((BHP)), Fortescue Metals ((FMG)), South32 ((S32)), and many others.

The swift turnaround for resources companies has been accompanied by better results for Big Banks, and for large, Blue Chip stocks in general.

Which makes it rather remarkable that smaller cap industrials, the Champions from 2015 and the first half of 2016, have quickly become the Killing Fields for many an investor's unfounded hope and misguided expectations. Land mines and booby traps. There were so many around this season, I'd have to hire a dedicated team to keep track of them all (see further below).

Contrarian Good News Stories

Good news stories a-plenty this February, in particular among resources companies for which debt and balance sheet stresses disappeared alongside higher-for-longer commodity prices. But most of it had been widely anticipated. After all, most commodity prices are public knowledge, and available daily. Share prices are no longer dirt cheap, so we need to see a pick-up in general sentiment for BHP Billiton shares to have a genuine crack at $30, but that's what is missing from global markets right now.

The banks did an overall good job in dismissing speculation about the need for additional capital and/or dividend cuts, assisted by extremely low debt defaults. But major bank shares already are trading above consensus price targets.

Hence most of the positive surprises this month came from companies such as CSL ((CSL)), ResMed ((RMD)), Carsales ((CAR)), Amcor ((AMC)), Link Administration ((LNK)), NextDC ((NXT)), Melbourne IT ((MLB)), and WiseTech Global ((WTC)). Their share prices had fallen out of favour and off most investors' radar as large cap banks and resources stocks continued their strong come-back in the second half of last year. This month's financial results proved those absent investors wrong and quick corrections to the upside ensued. We can add Aristocrat Leisure ((ALL)) to this list too.

Meanwhile, while nobody's paying attention, former yield-driven high flyers such as Goodman Group ((GMG)) and Transurban ((TCL)) are establishing a quiet come-back on the back of solid financial performances, and falling bond yields.

The Bear Is Hiding Among Smaller Cap Industrials

Investing under challenging circumstances often turns into a loser's game. No longer are share market returns determined by the profitable investment decisions made, rather they become beholden to the disappointments, the misses, the public punishments and the free fall in share prices that occur instantly.

On Monday, Slater & Gordon's ((SGH)) share price fell yet another -21.88% but general widespread interest in the shares evaporated long time ago. Far more damage will have been caused by the likes of GBST Holdings ((GBT)), Ardent Leisure ((AAD)), iSentia ((ISD)), Village Roadshow ((VRL)), Aconex ((ACX)), RCG Corp ((RCG)), and others. Not to mention larger cap disappointments from Telstra ((TLS)), Magellan Financial ((MFG)), and from Brambles ((BXB)).

In line with past experiences, February 2017 provided ongoing evidence that once a company is gripped inside a bad news cycle, it is not easy to shake off the past and start a new beginning. Probably the most anticipated disappointment this month came from Flight Centre ((FLT)) which released its fifth downgrade in three years, while competitors Webjet ((WEB)) and Corporate Travel ((CTD)) continue to confound the critics and doubters.

Village Roadshow too is building a rather miserable track record, as is CSG Ltd ((CSV)), and OFX Group ((OFX)), and Godfreys ((GFY)), and possibly Blackmores ((BKL)). Looking over the field of casualties, one cannot but reflect back on what has happened to the many growth narratives that inspired many an investor in the years past. The Chinese dining boom. The ageing population. The Chinese tourism boom. From Bellamy's ((BAL)), to Capilano Honey ((CZZ)), to Japara Healthcare ((JHC)), to Mantra Group ((MTR)); many an investor who bought into what seemed like a sustainable growth story, and stuck with the narrative, is post February left licking his wounds.

Below is the share price graph of Mantra Group from the past twelve months. It clearly shows a share price that, through ups and downs, is trending from near the top on the left towards the bottom on the right. Not exactly the underpinnings of a raging bull market. The sad observation is many of ASX-listed smaller cap industrials are showing a similar looking price chart.

Other observations that deserve to be highlighted:

-retail remains a heavily polarised experience; few Champions among many battlers; Nick Scali ((NCK)) keeps breaking all the records

-the legal profession continues to disappoint, including Slater & Gordon, Shine ((SHJ)), IPH Ltd ((IPH)), Xenith IP ((XIP)) and Quantm IP ((QIP))

-competition is fierce, and intensifying, inside the telecommunication sector

-Resources might have become the new defensives, the sector never is fully free from operational risks, including at Doray Minerals ((DRM)), Iluka Resources ((ILU)), WorleyParsons ((WOR)), and others.

Note balance sheet weakness has now become a major focal point for investors at WorleyParsons and Village Roadshow. Capital raisings and asset sales should be expected.

Moderately Below Forecasts

As far as corporate profits are concerned, February 2017 has likely been the best interim update since 2010. Usually analysts' expectations are higher coming into reporting season than they come out of it, but this year the skew was towards increasing forecasts, not reducing them.

Assuming no disasters between now and August, FY17 might well be en route to becoming Australia's strongest growth performance post GFC. This year can possibly beat FY11, the last time resources companies enjoyed an outburst in positivism.

Behind those general statistics, however, hides the ugly truth that outside the resources sector, things remain shaky and unpredictable. No room for complacency, as proven by the numerous disasters among smaller cap industrials. The February reporting season is not yet officially finished, so we don't have as yet have final numbers to crunch. But as things seem to be lining up in these final days, earnings beats and misses seem close to FNArena's calculations at the end of the February reporting season in 2015.

Back then, we registered 36% corporate releases beating expectations, while 26% missed market expectations. These numbers each are near the highest in the history of our analysis starting post August 2013. It doesn't take much to see both extremes as yet more evidence of a heavily polarised share market. Key difference: two years ago smaller cap industrials were the shining beacon in a macro-driven, over-enthusiastic local share market. This time around, smaller cap industrials represent a true boulevard of broken dreams and lost opportunities.

The most used expression in February's stockbroker research reports was "moderately below expectations", and various variations on the theme. One given day I opened one broker's daily overview to find that same sentence prominently in the first half a dozen or so assessments inside the report.

There have been many of such "moderately below expectations" corporate releases this month, but investors did not treat all of them equally. Iress' ((IRE)) share price catapulted higher post the release of a slight miss, but there was no such generous treatment for the likes of Hansen Technologies ((HSN)), Bapcor ((BAP)), Altium ((ALU)), ARB Corp ((ARB)), Baby Bunting ((BBN)), or Magellan Financial.

Here awaits potential opportunity for investors daring to go against the grain.

Also, preliminary calculations suggest this month's average increase in stockbroker price targets for companies having reported might be amongst the most tepid recorded since August 2013. This is not necessarily a reliable signal for further share market upside as behind all calculated averages hides a seldom witnessed polarisation in corporate profits and share price momentum.

Special mentioning: the operational leverage inside slimmed down BlueScope Steel ((BSL)) is simply phenomenal.

More Revenues, Less Spending

Analysts at Credit Suisse make the observation that, overall, corporate Australia is guiding towards higher revenues, while at the same time promising to keep a lid on spending. It appears a general scepticism towards sustainability of elevated commodity prices and ongoing desire to please shareholders is outweighing pleadings from the likes of PM Malcolm Turnbull and RBA governor Phillip Lowe to finally embark on a large corporate spending spree.

My personal take on this remains that businesses shall remain reluctant to spend until they experience a genuine, sustainable pick up in demand. Average wage growth remains dismal. House prices may not provide a favourable background for much longer. Investors should note, however, the combination of more revenues and restrained spending is the main reason why Credit Suisse expects the ASX200 to reach 6000 by year-end.

Corporate Australia's frugal attitude towards business spending is, of course, feeding into a record high dividend payout by mid-year, and possibly beyond.

Special note: stronger sales and weaker capex hasn't happened in over ten years in Australia, according to Credit Suisse.

Equally worth noting: most of upgrades to profit estimates are happening among large cap stocks, not necessarily confined to resources only. Commodities analysts have to date not accounted for any growth post FY17.

The latter will be the background battle to determine whether/when exactly resources stocks share prices can look forward towards the next upswing. Is there a follow-up chapter to the present buoyancy, or will it simply remain a temporary phenomenon?

Investor Sentiment On A High

US equity indices are holding up remarkably well as we approach the end of February, but volumes have been dwindling, making a few analysts and commentators nervous about what might follow next.

Share market volumes are not always a reliable signal, but adding to the general discomfort is the fact market indicators, such as CNN's Fear and Greed Index, are back in euphoric territory. This suggests elevated investor confidence, some call it complacency, and thus an increased risk for some kind of a correction to the downside.

Time to take another look at our very own market sentiment indicator here at FNArena. The signal consists of comparing share prices for the Big Four Banks with where consensus price targets are at. As long as there are no specific bank related problems around, this signal tends to provide highly dependable, and consistent, reads on local market sentiment and confidence.

I don't think it'll surprise anyone that our very own market indicator equally suggests market sentiment looks elevated. All Big Four share prices are trading above consensus target and recent market updates either had no impact on analysts' price targets/valuations, or not enough to push up price targets above where share prices are trading.

History suggests this is not the time to start accumulating shares in the Big Four Banks. It usually means that if those elevated share prices retreat, they'll likely drag the rest of the market with them. It does by no means imply the market is heading for a cliff.

Elevated share prices simply means the odds are moving in favour of downside risks. All we have to work out from here onwards is the exact timing and how far exactly bullish sentiment will allow share prices to fall?

Paid subscribers can check share prices and consensus targets via the FNArena website. See Stock Analysis and The Icarus Signal.

If History Repeats: The Jan-Feb Signal

Analysts at Bespoke in the US have a knack for churning out historical data that often underpin the market's optimistic bias. Their latest finding is no exception.

It appears 2017 is the 28th year post 1945 wherein US equities posted positive returns for both January and February. In the 27 preceding years, reports Bespoke, the S&P 500 gained an average of 19.9%. For the March through year-end period the S&P 500 averaged a gain of 12.4% with positive returns 25 out of 27 times.

History doesn't necessarily repeat itself, and there were two exceptions, but who's going to question the strength in the market's narrative for the year?

A New Website – The Sequel

"The more time I spend on the new FNArena website, the more I like it."

We very much welcome this sort of feedback. It has been arriving in our inbox via multiple messages in the days past.

Of course, we know there are still a few niggling technical flaws, and we are working on resolving those.

Alas, not everyone is blessed with a natural urge to explore, and neither does a busy work schedule facilitate a lot of spare time to look for additional treasures on the newly launched FNArena website. Which is why we are turning the launch of the new website into a sequel the coming weeks.

So stay tuned for more tips and insights about what else is there, waiting to be discovered…

Who's Afraid Of The Big Bad Bear?

Market speculation is rife about when exactly giant international retail disruptor Amazon will be opening its doors in Australia, so to speak, and what kind of impact, devastating or not, this might have on the likes of Harvey Norman ((HVN)), RCG Corp ((RCG)), Premier Investments ((PMV)), and others.

But every Internet shopper in Australia already knows there is a dot com dot au Amazon market place where products can already be purchased in exchange for local dollars. Differences with the US-based Amazon website remain prominent, however. This also includes the availability of my latest book, Who's Afraid Of The Big Bad Bear?

The Australian Amazon allows the purchase of eBook version only, while foreign Amazon websites also offer the paperback version. It's an antiquated legal thing, originally meant to protect local content.

Paying subscribers should note a free copy in pdf is included in 6 and 12 months subscriptions. Look up "Special Reports" on the brand new FNArena website, where you'll also find prior publications, as well as PowerPoint slides of my on-stage presentations.
 

All-Weather Model Portfolio

In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.

This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: info@fnarena.com

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

– Tuesday around 11.15am, Skype-link to discuss broker calls
– Wednesday, 8-9pm, hosting Your Money, Your Call Equities
– Thursday, 12.30-2.30pm
– Friday around 11.05am, Skype-link to discuss broker calls

Rudi On Tour

Your Editor has been invited to present at the Australian Shareholders Association's (ASA) 2017 Securing Your Investing Future Conference to be held at the Grand Hyatt Melbourne from 15-16 May.

The conference details – www.australianshareholders.com.au/conference-2017

Speaker information – www.australianshareholders.com.au/speakers

Program information – www.australianshareholders.com.au/program

Those who register before 31 March 2017 will receive $70 off the registration fee. Telephone: 1300 368 448

(This story was written on Monday 27th February 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 the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) 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.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

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

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