Rudi's View | Jul 12 2017
In this week's Weekly Insights:
-Two Threats To Conquer
-Conviction Calls: Citi, Bell Potter, Canaccord, and Morgans
-Aristocrat Leisure: It's Not A Gamble
-2016 - L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
Two Threats To Conquer
By Rudi Filapek-Vandyck, Editor FNArena
Never underestimate financial markets' ability to surprise.
Events and outcomes during the FY17 financial year are an excellent case in point. Commodities and resources stocks were left staring into the abyss of eternal oblivion at the start of calendar 2016, but by December they were the star performers, destined to continue their rally, but all fell apart pretty quickly into the new calendar year.
Gold stocks who had become everyone's favourite all through 2015 and during the first half of 2016, quickly deflated, then rallied again, fell off a cliff, rallied again, fell, rallied, and then fell more.
Banks had turned into everyone's favourite whipping boy, but that rally in late 2016 made them a lot of friends, again. May once again proved a bridge too far and shareholders are since left licking their wounds.
And High PE growth stocks and yield/income providers such as Transurban ((TCL)), Sydney Airport ((SYD)) and Goodman Group ((GMG)) experienced a lot of turbulence after years of steady climbing share prices, thanks to sudden sell-offs in government bonds.
There was a collapse in the oil price, an unexpected outcome in the Brexit vote, a change in policy direction at the Federal Reserve and then the election of That President in the USA.
Quite amazing, really, that throughout all the turbulence, and the unexpected surprises contrary to market predictions, the Australian share market (ASX200) has managed to return 14.1% for the twelve months to June 30, 2017.
The total return may look mightily impressive, in particular against the background of two low returning years prior, the broader context is a lot less so. The ASX has actually been one of the softer performers over the year, especially in the second half when dividends proved necessary to scrape in a positive return for the six months to June.
As a comparison, the global MSCI returned almost 10% just in the second half. For the June quarter, the ASX200 fell -2.4% to post its worst quarterly return since 1Q16 when the index declined -4.0%. In both cases a weaker oil price was partially to blame.
Further adding to the string of ongoing surprises, shares were hit by a sudden spike in volatility during the final days of June, just when it appeared that window dressing by institutions would allow the local market to finish the financial year on a strong and positive note.
As it turned out, central bankers in Europe and elsewhere stood up to crash the global party. Not that any of this will stop the industry from greasing the marketing machines in the weeks and months ahead. Double digit returns cannot be advertised in every year. Gotta make hay while the sun shines.
The FNArena/Vested Equities All-Weather Model Portfolio rediscovered its mojo in the second half, outperforming in all five months post January, pipping the broader market at the post for the half. It has been a great come-back on the back of having no exposure to banks and resources stocks.
Investors would be wise to pay attention to the two major forces that have held back the share market's performance in the second half. In my view, those forces are a benign outlook for corporate earnings growth and the potential for higher bond yields.
The latter is spooking part of the investment community and one can hardly blame investors. Rising bond yields look scary and they can inflict a lot of damage in the share market, as witnessed, for example, in recent share price action for Newcrest Mining ((NCM)), Healthscope ((HSO)), Westfield Corp ((WFD)), TechnologyOne ((TNE)), CSL ((CSL)), Macquarie Group ((MQG)) and Carsales ((CAR)), to name but a few. Yes, indeed, the pull back in all of these share prices can largely be retraced back to rising yields on government bonds since June.
It is my personal view that 10-year government bonds globally should not continue to climb in the six months ahead, with central bankers merely trying to shake up market complacency in the absence of inflation. But one should never underestimate the potential for market mayhem as the central bankers' wake up call from June is now forcing large funds, hedge funds, and many others to reposition their portfolios. This is not by default a process that guaranteed will unfold smoothly and without any hiccups.
Attention must thus be paid to the potential for further weakness ahead.
Subscribers who've missed my assessment from Friday, can still read Rudi's View: My Name Is Bond via the Rudi's Views section on the FNArena website, or use the following link: https://www.fnarena.com/index.php/analysis-data/rudis-views/
When it comes to profit forecasts, Australia is about to experience its best reporting season since August 2014. Forecast average EPS growth could come out as high as 17% next month. But that is not the number to focus on. The significant turnaround in fortunes for miners and energy producers is artificially pumping up the market average. Underlying, a large number of companies and whole sectors are seriously struggling.
Earnings forecasts in Australia started to top out in January and they have been in steady decline since. Today, as analysts are preparing for the reporting season in August, many more question marks are being asked about whether companies will be able to meet market expectations, or even their own guidance, without last minute accountancy tricks or one-off benefits.
More importantly, such question marks seem rife for the outlook beyond FY17 when weakness in domestic housing and/or consumer spending can have a pronounced impact.
All this is happening in a share market that is, on average, trading at premium valuation, meaning vulnerabilities can open up quickly in case of negative surprises from either central banks, bonds, governments, or simply reported profits.
Then again, one should never underestimate companies' abilities to provide compensation and/or upside surprise. Link Administration ((LNK)), Viva Energy ((VVR)) and Hansen Technologies ((HSN)) all announced well-received acquisitions in recent weeks. Beleagured Telstra ((TLS)) is rumoured to be working towards securitisation of its recurring NBN receipts. The BHP ((BHP)) board remains under pressure to release more shareholder value. Rio Tinto ((RIO)) is believed to be one of few only in the resources sector with ample cash flows to extra-spoil shareholders.
There will be plenty of dividends from miners and energy companies, but maybe not as much optimism looking forward as during the prior two reporting periods.
In general terms, companies that are not running out of puff and whose business models and sector dynamics can facilitate ongoing growth, even when things get tougher for large parts of the Australian share market, remain in my view excellently positioned to withstand increased volatility and challenges in the year ahead, even in the face of rising bond yields, as long as the latter don't trigger a share market rout or a rampant reflation trade a la late 2016.
It's the companies that land in struggle street or whose outlook is turning ex-growth that investors should be wary of. Despite a benign confession season thus far, August is going to reveal plenty of surprises either way.
Every reporting season builds up its own character and market impact, through multiple surprises and disappointments. This is why forecasts about the share market's outlook are best made after August instead of in June.
However, unless the mood changes markedly during the local tsunami of corporate releases and updates throughout the four weeks of August, I am inclined to stick with a cautious and benign outlook for the Australian share market.
In practical terms, this means I am more sympathetic to the view as expressed by UBS strategists recently that the ASX200 by year-end may well not be far off from where the index is sitting today as opposed to others who publish forecasts a la 6400 by mid-2018.
The prospect of twelve percent upside over twelve months is by no means out of the question, and certainly 2016 has shown us all it can be done in a heartbeat, but somehow it makes a lot of sense to assume further gains will be harder, in the face of the challenges ahead.
Conviction Calls: Citi, Bell Potter, Canaccord, and Morgans
Shares in casino operator The Star Entertainment Group ((SGR)) have found it difficult to attract a lot of love and affection from investors over the year past. One glance at the twelve month price chart shows exactly that.
But is it justified? Star Entertainment enjoys a perfect score on the FNArena Sentiment Indicator of 1.0, meaning every single broker in the database with an opinion on the stock is rating the stock a Buy, or an equivalent of Buy. Consensus price target of $6.07 suggests the share price is some -20% too cheap (dividend payouts not included).
The latest to step into the limelight and sing the praises of the stock, Citi, didn't hold back either. Calling the stock "THE" value opportunity on the Australian share market, Citi has elevated The Star its Top Pick among Gaming stocks in Australia, predicting double-digit growth in FY18 will overwhelm investor scepticism and this should lead to a re-rate for the shares.
On Citi's assessment, the price should be more than 30% higher, at $6.65. Admittedly, this is the highest target among the brokers lined up on the FNArena website, but even the lowest target is more than 12% above where the share price currently trades.
A classic case of show me concrete results first? Or are the brokers missing something? August will probably deliver the answer.
Tech sector analyst Chris Savage at Bell Potter has lined up his favourites ahead of the August reporting season. Favourites are always selected according to relative valuations, so don't expect any of my personal favourites to show up anytime soon. The best stocks such as Altium ((ALU)), WiseTech Global ((WTC)) and TechnologyOne ((TNE)) can hope for is a Hold recommendation, and that's exactly how Bell Potter is rating them at the moment, alongside Melbourne IT ((MLB)).