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Aussie Equities: Where Is True Value?

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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 | Jun 06 2018

In this week's Weekly Insights:

-Aussie Equities: Where Is True Value?
-No Weekly Insights Next Week

-Rudi Talks
-Rudi On TV
-Rudi On Tour

-At The AIA Conference

Aussie Equities: Where Is True Value?

By Rudi Filapek-Vandyck, Editor FNArena

And after all that was said and done, the Australian share market entered the final month of financial year 2018 with a total gain (incl dividends) of less than 1% for the first five months of calendar 2018.

Most investors, I have little doubt, would prefer a larger bonus given the risks, the headaches, the uncertainties, and the volatility that has kept the world on edge since global equities (seemingly) peaked in late January.

As illustrated by the excellent graph below from Blue Ocean Equities' strategist Mathan Somasundaram, this year's sideways moving pattern is far from the first "correction" period since this global bull market was born in early March 2009.

The prior time Australian equities went sideways for an excruciating number of months occurred last year, and that period doesn't even feature in the graph below because US equities simply soldiered on.


 

As is the custom in financial markets, the longer these sideways patterns persist, the more doubt creeps into our collective mindset. Could it be that we are witnessing the final chapter before this raging bull gets kneecapped and experiences a face plant?

On my observation, the number of expert calls for more caution and predictions of potential heavy weather ahead is much larger this year than all of last year. At face value, this makes a lot of sense given the Federal Reserve is now a couple of rate hikes further in its normalisation process, while the shine has come off the global synchronised growth story, plus the global bull market for equities is yet another year older.

There is plenty to worry about ranging from pending inflation in the USA, structural problems inside the eurozone, rising bond yields, and the darker side of the Trump presidency, including growing opposition to the US slapping trade tariffs on selected imports. That list is by no means complete.

Locally, Australians are now facing the prospect of weakening house prices, amidst an ongoing squeeze on household budgets, with average wage increases near all-time lows, while Royal Commissions into franchises and the finance sector continue to unwrap corporate scandal after scandal. Meanwhile, the digital disruption and transformation of yesteryear's economies goes on unabated.

The direct result of all of the above is a share market that has rarely looked as polarised as it is today. Most investors are well aware of the sharp dichotomy between the "Haves" and the "Have Nots" in the share market, but they also have found it difficult to obtain full benefit from it.

This is because Australian investors, be they seasoned fund managers or self-managing SMSF operators, are in large majority "value" investors. They buy low and assume this will guarantee them positive outperformance in the long run. But it's not just Vocus Communications, iSentia and Telstra that have inflicted a lot of damage to investment portfolios, it's the popular top end of town, sometimes referred to as "blue chips", that has kept a lid on the performance of many a value-centric investment strategy.

Consider, for example, that while the broader Australian share market has failed to keep up with international peers in years past, the ASX200 Accumulation Index still returned 7%+ per annum on average over the past 5.5 years. The ASX Top20, however, has only managed some 6% p.a. over the past five years, and no more than 3% p.a. all-in over the past three years.

Now consider the fact that CSL ((CSL)), whose share price has more than doubled since a temporary dip in December 2016, is also included in the ASX20, as are BHP, Rio Tinto and Woodside Petroleum – all part of the resources sector which, as a group, rallied some 150% since the low point in early 2016. These numbers highlight how tough life has been for investors whose strategies do not include cyclical resources and/or high growth companies.

Experts like to point towards global synchronised growth as to why miners and energy producers have regained positive momentum over the past two years, but equally important have been greener policies in China, and elsewhere, infrastructure bottlenecks in the US and a sharp reduction in sector capex overall. Most importantly, these sectors are widely considered "late cycle", implying today's outperformance shall be followed by a much less conducive environment at some stage. Also, prior to early 2016 investors in the sector had to endure five long years of sheer misery.

Nobody likes to highlight it, but value investing has generated more disappointments than successes post 2013. This because the reasons as to why share prices weakened were of a longer lasting, if not permanent nature. Think increased competition. Downward pressure on consumer spending alongside changing spending patterns. Increased government intervention and regulatory scrutiny. We can now also add softer dynamics for house prices.

Buying into cheap looking stocks assumes that whatever is depressing the share price today is of temporary, non-structural origin and shall disappear over time, allowing the share price to resume a firm, sustainable up-trend.

Instead, many an Australian household name has been found unprepared for present day challenges, either because of boardroom and C-suite hubris, or because of structural underinvestment to retain a juicy dividend for shareholders, or because of both.

Such has been the painful truth uncovered at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, but the same machinations have become apparent elsewhere.

Investors need not look any further than Telstra, reportedly the most widely owned stock outside the banks among Australian investors. Its share price more than halved since February 2015 and that 22c dividend looks equally unsustainable as the dry weather in inner Sydney last month.

As for the banks, it seems likely, if not probable, that on a five year horizon today's share prices are offering cheap entry points for patient investors, but with weakening house prices, all-time high household indebtedness, the uncertain consequences from the Royal Commission, plus a potential credit crunch looming, it also remains possible, if not probable, share prices will fall deeper within the next 1-2 years.

That's the real challenge for investors today: identifying which risks are the least dangerous to take on board. Is it the cheap looking stock that is facing structural change and the ongoing potential for more bad news; or is it the glamorous "Winner Takes All"-Champion stock that is being managed by top notch, experienced management but whose share price by now is priced accordingly?

The answer, I believe, lays not necessarily with the individual companies but probably more so with the general corporate climate investors should expect for the remainder of 2018 and the 1-2 years that follow next.

If we do see the Australian economy suffer under too much debt, too little wage increases, banks rationing credit and slowing economic growth internationally, then I don't see a fertile environment for institutional investors to start throwing overboard their investments in high quality, solid growth stalwarts such as CSL, Macquarie Group ((MQG)), Aristocrat Leisure ((ALL)), and others.

If, on the other hand, a more positive scenario were to unfold, one that sees the operational environment for large swathes of today's share market laggards improve much quicker and much more decisively than is currently anticipated, then the risk rises for a repeat experience of the second half of calendar 2016 when money rapidly flowed out of the strong (and defensive) performers at that time and into share market laggards which at that time where cyclical resources and financials, including the banks.

Contrary to general commentary elsewhere (mostly expressed by value-oriented, highly frustrated experts and investors) I do not see a "bubble" in growth stocks. Instead, I believe many of such warnings are based upon one-sided, biased and incomplete analyses.

Most of the strong gains achieved by CSL, Macquarie, Aristocrat & Co over the year past have been underpinned by equally large jumps in corporate profits. But this remains only part of their success story. The failure of AMP, Telstra, the banks, and the likes to offer a positive alternative has equally played an important role.

Herein lies the fundamental dilemma for share market investors as we approach the middle of 2018: are you sticking with what has worked thus far or are you positioning for a decisive break in the trends that have defined performance in the Australian share market over the past five years?

Yes, indeed, it doesn't have to be 100% black and white, and there certainly is room to hedge one's outlook, but when it comes to carrying an overweight bias, I suggest investors do more of what has worked, and less of what hasn't.

All-Weather Model Portfolio

Certainly remarkable in a broader context wherein many calls have been made about an unsustainable bubble in growth stocks, but the FNArena Vested Equities Model Portfolio achieved one of its best monthly performances in May, adding 2.15% between the 1st and the 31st of the month.

The S&P/ASX200 Accumulation Index gained 1.09% over the period. The ASX20 all-in performance was 1.17% during a period when most banks and out-of-season reporters paid out half-yearly dividends, for an 11-month financial year to date total performance of 7.02%. Comparable performance for the ASX200 Accumulation Index is 9.44% and for the All-Weather Portfolio it is 14.62%.

As we have been anticipating a more challenging environment, the portfolio has been increasing cash, which in the short term means we have been sacrificing some upside from the portfolio's performance, in order not to get caught out later on.

No Weekly Insights Next Week

Next week starts with a public holiday on Monday (June 11) and, for me, an interstate flight ahead of presentations to investors and members of the Australian Shareholders Association (ASA) on the Gold Coast and in Brisbane on Tuesday and Wednesday. I will also participate in an online seminar for ASA members on the Thursday.

Hence there won't be a Weekly Insights next week. Next edition shall be written and published on Monday, 18th June 2018.

Rudi Talks

Audio interview about falling share prices and when do we, investors, get rid of disappointing underperformers in portfolio:

http://boardroom.media/broadcast/?eid=5b0cc86f7a67720d3fe99acb

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
-Thursday, from midday until 2pm
-Friday, 11am, Skype-link to discuss broker calls

Rudi On Tour

-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, June 29-August 1
-ASA Presentation Canberra, 3 August
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10

At the AIA Conference

As stated in the overview above, I will be presenting at the AIA National Annual Conference at the Marriott Resort and Spa Surfers Paradise, from 29th July til 1st August 2018.

This year's theme is SYNCHRONICITY, Identifying opportunities in a world growing in sync…

 For the first time in over a decade, the world’s major economies are growing in sync.

What does a world that is structurally awash in capital look like?

What will it mean for investors?

http://www.investors.asn.au/events/aia-national-investors-conference/

(This story was written on Monday 4th June 2018 and published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website).

(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.

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(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.)  

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