Rudi's View | Sep 13 2017
In this week's Weekly Insights (published in two separate parts):
-Not In The Mood
-Conviction Calls: CLSA, Morgans, Wilsons, CS, Ord Minnett, Citi
-Post August Share Price Impact
-CBA And The Premium Gone (Vol 3)
-Rudi On BoardRoomRadio
-Post August Broker Research Nuggets
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
[Note the non-highlighted items appear in part two on the website on Thursday]
Not In The Mood
By Rudi Filapek-Vandyck, Editor FNArena
Earlier in the week, Glenn Miller's In The Mood popped up inside my brain while I was reflecting upon the multiple dynamics exerting their influence on the local share market. Unfortunately, if I now somehow planted this classical tune full of brass exuberance in your head, you will have to undo it, because, if anything, this market is not in the mood.
Not in the mood at all.
Whether we focus on the de-rating for Australian banks since May, or on the failure of industrials stocks to outperform or at least solidly meet market expectations during the August reporting season, or on the fact that higher power prices and a much stronger Australian dollar have presented themselves as serious headwinds, the fact remains, outside of the occasional short-duration rally, the Australian share market hasn't shown any direction since May, with a bias to the downside, albeit not in a major fashion. (And we haven't even mentioned North Korea, Trump, US treasuries and/or the USD).
If it wasn't for the dividends, there would have been no gains worth mentioning for local share market investors, at least not at the index level.
Making matters worse, and contrary to prior years, portfolios stacked to the gills with dividend paying financials and industrials have not outperformed, quite the contrary as these were the large cap stocks that most prominently disappointed in August.
The FNArena/Vested Equities All-Weather Model Portfolio continues to chug along in a non-spectacular fashion, slightly better than the ASX200, with the portfolio taking a step back in July, then returning almost 2% in August, adding a mildly positive extension into September.
Overall, the reporting season allowed a number of high quality companies inside the portfolio to showcase their true value and in this we specifically think of Carsales.com ((CAR)), Orora ((ORA)), Altium ((ALU)) and NextDC ((NXT)), but even so, many of the subsequent rallies were soon overpowered by macro-considerations and downswings in general risk appetite.
Sometimes, history tells us, the market just is not in the mood. Instead of trying to move mountains, we sit tight and observe further developments.
Post August Share Price Impact
The impact from companies reporting their financial results extends much longer than the first few days post market update. Deutsche Bank analysts reminded investors about the lasting effect on share prices after having delivered a "beat", a "meet" or a "miss" during reporting season.
In simplistic terms, companies that "beat" expectations in August typically outperform by 2.5% over the first week after the release; and then by an additional 3% over the following six months. These numbers are averages derived from backward-looking data over the past decade.
In contrast, the best a company can hope for in case of a "miss" is for its share price to keep up with the market over the subsequent six months.
Deutsche Bank research also shows that if a company manages to "beat" expectations, but its share price fails to outperform, the next six months are likely to continue that underperformance.
The strategists put forward their own favourites among companies that delivered a "beat" in August: Medibank Private ((MPL)), Oil Search ((OSH)), Santos ((STO)), Star Entertainment ((SGR)), Tatts ((TTS)), Flight Centre ((FLT)), Fortescue Metals ((FMG)), GPT ((GPT)), Orora ((ORA)) and Perpetual ((PPT)).
Paid subscribers have access to FNArena's full assessment of the August Reporting Season, including excel file with all beats, meets and misses, plus stockbroker responses via the following link: https://www.fnarena.com/index.php/2017/09/05/fnarena-reporting-season-monitor-36/
CBA And The Premium Gone (Vol 3)
According to Martin Crabb, Chief Investment Officer at Shaw and Partners, Australian banks are now one standard deviation "cheap" in comparison with the rest of the Australian share market. The underlying suggestion here is there might be a trading opportunity at hand even if Crabb himself is not yet calling the sector an obvious (and outright) Buy.
He suspects share prices might get cheaper still, before embarking on the thus far elusive mean reversion move upwards.
On Crabb's analysis, bank share prices become irresistible when prospective total return (dividends plus share price appreciation) reaches 20%, but he's clearly not using FNArena data to underpin that research as the Big Four Banks, on FNArena data, are nowhere near 20% their twelve month return potential.
One quick look at the Big Four in Stock Analysis, on the FNArena website, does show prospective returns are solidly in the double digits, and we don't even need to include franking to come to that observation. Also, and in line with earlier observations, CommBank ((CBA)) and Westpac ((WBC)) shares are trading -6.1% and -7.7% below their respective consensus price target, while the gaps for ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) respectively are only -5.2% and -3.1%.
For good measure: everyone can interpret these numbers any way they like, but I happen to think they do not suggest CBA and Westpac offer the best value; I think we are witnessing a change of sector leadership.
Making matters worse for CommBank shareholders: this is the only Big Bank whose price target is in decline, on the back of AUSTRAC and other scandals, and with sector analysts wrestling with the key question: how much damage exactly from the reputational descent, and how to translate it into financial numbers?
Equally interesting, I think, is the chart below, thanks to Deutsche Bank's most recent sector update. The chart depicts the banking sector's devaluation since mid-2012 as expressed through average Price-Earnings (PE) ratios relative to the industrials.
The horizontal black line shows the long term average discount is -18%; meaning banks tended to trade at a little above 80% of the broader market's valuation (best to ignore that spike to 105% as that was the result of share prices tanking in the midst of the GFC).
Since mid-2012, the relative valuation gap has expanded to -22%; meaning banks generally have traded below 80% of the broader market's valuation. Currently the gap between industrials and banks has stretched out to -31%, which explains why market strategists like Martin Crabb are getting interested again.
Note the chart shows the gap has been as wide as -35%, in mid last year, and what followed was a sharp rally. I also note banks haven't traded near their five-year PE discount average since May 2015. So here's the "other" observation that I have yet to come across elsewhere: the relative de-rating for Australian banks is still ongoing and that red line (past five year PE discount average) will be reset at a lower level, at some point.
Traders can get set for that catch-up rally, if they want to. Investors should be mindful of the second aspect. (Even though, admittedly, it's still better buying near the bottom of that chart than it is higher up).
Before anyone starts thinking that what has been happening to Australian banks is simply a big beat-up in a teacup; UBS sector analysts shared some worrying insights with their wholesale clientele on Monday afternoon. In-house research has taught the analysts one third of all mortgage applications in Australia in 2017 are not factual or accurate. The latest numbers gathered from Australians having done their mortgage application signalled a statistically significant deterioration from a similar survey in 2016.
The outright suggestion here is that the pressure is on for Australian households, and they lie more about their finances and income, to make sure all requirements set forth by the banks are being met. This also means mortgagors are more stretched than banks, and their shareholders, believe.
UBS's conclusion is this might translate into higher-than-expected losses if/when that long anticipated downturn arrives in Australia. No guessing as to why the house view is Underweight Australian banks. The analysts remain "very cautious" regarding the medium term outlook for the sector.
Misrepresentations are more prevalent through the broker channels, reports UBS: "Given the rising level of misstatement over multiple years we estimate there are now ~$500bn of factually inaccurate mortgages on the banks' books (ie 'Liar Loans' – a term used in USA during the Financial Crisis for mortgages where documentation was not accurate)"
[Note: CBA And The Premium Gone, volumes 1 and 2 were published in the previous two weeks – see Rudi's Views on the FNArena website]
Rudi On BoardRoomRadio
Last week's audio interview:
2016 – L'Année Extraordinaire
It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.
If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).
For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
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: firstname.lastname@example.org
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Friday, 11.15am Skype-link to discuss broker calls
Rudi On Tour
– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update
(This story was written on Monday 11th September, 2017. It was published on the day in the form of an email to paying subscribers at FNArena. This is part one. The second part will be published on the website as a separate story on Thursday).
(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: email@example.com or via the direct messaging system on the website).
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