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The Question Every Investor Has To Answer

FYI | Aug 16 2017

By Peter Switzer, Switzer Super Report

Donald and Kim – the question every investor has to answer

This is a make it or break it week for Aussie stocks, with reporting season getting serious. And while the Donald Trump versus Kim Jong-un ‘fire and fury’ battle hangs like a black cloud over the stock market, it will be earnings and economics that will have a more enduring impact on where stock prices head.

But all this makes it timely that an important question for all investors has to be answered and that is: Are the key market signals telling you it’s time to bail?

An AFR story last weekend talked about how the next reason for stocks to crash, like they did in 1987, with the dotcom crash in the USA and the GFC drama of 2007-08, is staring us in the face but we’re not seeing it!

The author of the scare piece didn’t really help us out, so we can’t see exactly what it is, but did suggest that maybe it will be Exchange Traded Funds. They’re growing and what they might mean to the next really big sell off for stocks could turn a correction into a crash. Of course, there are ETFs not to worry about because they’re actually backed by bought stocks held in trust but the ones that could do damage are the exotic ones that are effectively derivatives.

Like CDOs — collateralised debt obligations — linked to sub-prime loans with the GFC, we could be ignoring the implications of many of the modern market innovations we now work with in financial markets.

We see other potential curve balls out there — China debt levels, the bond market bubble and what happens if interest rates rise too fast and too far, and, of course, there’s the potential Donny and Kimmy nightmare!

Obviously, no one really knows what will happen in North Korea, but Wall Street’s small fall to date says the collective view is that diplomacy will prevail.

AMP Capital’s Dr Shane Oliver has given a guess/snapshot view of what could happen to stocks if North Korea’s threats become more worrying.

If diplomacy/no war-sabre rattling prevails before a resolution is reached, the “share markets could correct maybe 5-10% before rebounding. An historic parallel is the Cuban Missile Crisis of October 1962 that saw US shares fall 7% before a complete recovery after the crisis was resolved.”

If a significant military conflict happened with “missile attacks against South Korea (notably Seoul) and Japan causing significant loss of life — this would entail a more significant impact on share markets, with say 20% or so falls before it became clear that the US would prevail.”

I’m betting on the former and not the latter scenario and that’s why I remain fully invested but if I was a more nervous investor, I’d be cashing out of stocks that I could lose a lot on.

On the other hand, if my entry price on the likes of CBA, Telstra and other good dividend players was 20% below where they are now, and there a lot of investors in this category, I’d be hanging tough, as I am.

I’m working off a playbook that August/September and even October can be challenging for US stocks, so a sell off can’t be ruled out, but I like the run of economic data in the USA, Europe and Japan. My view on the Oz economy is similar to my best guess on earnings that they’re on the improve.

We will see the latest employment/unemployment story for July on Thursday and I hope it continues the trend of great full-time job creation we saw over May and June. This would add to the historically high business conditions and confidence numbers, which I suspect all adds together to be the prelude to an improving overall economy.

I will admit the low inflation number seen in the USA over the weekend did not help us because it keeps our dollar too high but when that pesky currency falls, our economic picture will improve even more and so will earnings.

Nearly every economist I’ve interviewed — positive and negative ones — can’t see a recession on the horizon neither here nor overseas, so that makes me positive towards stocks.

Meanwhile, the view on earnings was nicely summed up by Doc Oliver: “The US June quarter earnings reporting season is now 90% done with 78% beating on earnings, 68% beating on sales and earnings up around 11% year on year and earnings growth seen in the June quarter is even stronger in Europe at 35% year on year and Japan at 37% year on year.”

For local earnings, it’s still early days, but as only 25 or so major companies have reported, it’s hard to make call. Some 45% of results have exceed expectations, which is around the long-term norm of 44% but 72% have reported profits higher than a year ago, while 82% have increased dividends from a year ago.

This is why this week is so important for earnings, stock market optimism and the overall index.

The brokers, Morgans, have put their views on the line when it comes to the list of show-and-tell companies this week and the following have “add” ratings ahead of their reports:

  • Centuria Industrial REIT (CIP)
  • Blue Sky Alternative Investments (BLA)
  • Flexigroup (FXL)
  • AVEO Group (AOG)
  • Computershare (CPU)
  • Sonic Healthcare (SHL)
  • Senex Energy (SXY)
  • Villa World (VLW)
  • IPH (IPH)
  • Think Childcare and Education (TMK)
  • Viva Energy REIT (VVR)

Morgans have 21 “holds” this week and only one “reduce” and ironically it is ASX!

If these guys are right, this week looks like it could be a good one for companies, with six adds, 22 holds and only one reduce but five days in reporting season can be a long time for investors like us.

So, let’s get to the question about bailing out right now.

Well, both the earnings and economics stories are convincingly positive and, arguably, getting better, without a recession threat staring us in the face.

Financial system threats are always potentially there and what happens to the worldwide debt challenge has to be recognised as a ‘come back to bite us’ issue, but when?

The one offsetting saving grace for our debt concerns is the historically low level of interest rates. They are so low that it doesn’t make conventional economic and market analysis as relevant as it has been in the past.

For example, a P/E of 20 used to worry me when interest rates were 5% but now I’m more likely to worry at a P/E of 25 or 30.

Provided Donny and Kimmy play a smarter game than they’re playing right now, I think any sell-off remains a buying opportunity.

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

Content included in this article is not by association the view of FNArena (see our disclaimer).

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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