Rudi's View | Jun 27 2018
In this week's Weekly Insights:
-Safe Haven Shelter In A Dichotomising World
-Rudi On TV
-Rudi On Tour
Safe Haven Shelter In A Dichotomising World
By Rudi Filapek-Vandyck, Editor
What just happened?
US$5.9bn in global investment funds said goodby to dedicated Emerging Markets equity funds during the week ending June 20, 2018. After several weeks of steady outflows, last week marked the largest weekly funds outflows for EMs since September 2015, when things looked genuinely bleak on the back of Fed tightening, USD strength and a relentless five-year down-cycle for commodities.
Equally noteworthy: US$4.7bn of EM outflows stems from ETFs (passive investment products), while EM bond funds reported outflows of US$1.2bn and Japan-oriented funds saw outflows of US$2.9bn. All the while, EU equity funds have now witnessed 14 weeks of net funds outflows; the second longest streak since 2010.
In other words: globally, investors are turning more cautious on the synchronised global growth story that has dominated views and asset allocations since late 2016. Throughout 2018, 'synchronised' has steadily turned into 'de-synchronised' with corporate profits and economic progress in the US looking healthy and strong, but with momentum elsewhere deflating.
With the Federal Reserve turning more hawkish, and the US dollar rediscovering its mojo, a number of global strategists are reviewing their exposure to Emerging Markets, traditionally viewed as beneficiaries of a weaker greenback.
This year's weakness in Asian share markets, including in China, coincides with weakness in European markets and quite a number of equity strategists are now weighing up the prospect that these markets might have peaked for the time being, which then justifies reduced exposure and a more cautious/defensive portfolio composition.
This year's divergence among global equities has been captured in the chart below, thanks to Longview Economics.
What is not included in Longview's chart is that Australian indices have become unexpected beneficiaries from the global rotation, even with the Australian dollar losing more than US2c in two weeks. Traditionally, foreign funds tend to avoid the ASX when the Aussie is facing weakness as it erodes the value of their allocated funds when translated back in the original currency. Somehow this hasn't been the case this time around.
AUD/USD rallied above 81c in January, then fell and range traded between 76-78c, before falling below 74c last week. Yet major equity indices have rallied beyond their early January high and are setting new post-GFC record highs.
The Australian share market, traditionally seen as a benchmark for global growth and risk appetite, has turned into a safe haven for global investors worried the US might become the last one standing tall when all others are starting to reveal their weaknesses.
Just how healthy and sustainable things are in the US remains an ongoing topic of public debate. One thing cannot be denied and that is that corporate profits and economic data and indicators post Trump tax cuts thus far are truly standing out in a world that is increasingly revealing its dichotomy.
Note: Chinese authorities are back in stimulus mode (the People’s Bank of China over the weekend announced a 50bp reduction to the required reserve ratio (RRR) across the board for Chinese banks, effective from 5 July. Economists estimate it will release around CNY700bn of liquidity into the domestic banking sector, with further RRR cuts anticipated later in the year).
One of the oft cited causes for concern is that market breadth in the US share market has been deteriorating fast these past months. This signals US indices are increasingly holding up on support from fewer stocks, which, history shows, is not necessarily a signal that all shall fall off a cliff soon, but various serious market corrections -such as 2008- were preceded by rapidly shrinking market breadth, before, eventually, everything did fall off a cliff.
Over the weekend, Glushkin Sheff Chief Economist & Strategist David Rosenberg pointed out nearly 70% of the S&P500 is trading below the January 26th peak. In addition, the median ex-tech sector for the main US index is down more than -3% year-to-date. Home builders are down more than -20% from their highs. US banks are down -10%. US Industrials are down -9%. The Dow Jones Industrial Average (DJIA) is struggling to stay in positive territory year-to-date.
Nearly half of all S&P500 stocks is now trading -10% or more below their high from earlier this year.
In contrast with the above, Australian investors can only marvel at the unexpected turn in events for Australian equities. Probably the best way to illustrate the turnaround in Australia is by the observation that for the first five months of calendar 2018, Australian equities including dividends had managed to achieve a total return of 0.99% (less than one percent) and the beginning of June wasn't particularly encouraging either.
Now major indices in Australia (and thus a large number of index following "active" fund managers) are poised to clock off on yet another financial year to June with double digit investment returns. With less than one week to go, the ASX200 Accumulation Index is up in excess of 13% for the financial year. This thanks to 8.79% achieved since April 1st. Since June 14th (ten days ago) the ASX200 Accumulation Index has added 3.56%.
116 out of the top 200 stocks in Australia are trading at or near a twelve month high. Howzat for positive market breadth?!
Irrespective of the different dynamics that are currently unfolding in both equity markets, I would still keep a close watch on further developments in the USA before drawing too much confidence about Australia's moment to catch up with the laggard performance vis-a-vis offshore equities in recent years finally having arrived.
Post GFC all-in performances of Australian equities (ASX200 Accum):
Meanwhile, in the real economy, small cap analysts at Canaccord Genuity have counted 192 profit warnings issued since the start of 2018 in Australia. This number compares with 173 profit warnings over the same period last year.
Amongst those who have been particularly naughty are Baby Bunting Group ((BBN)), Blue Sky Alternative Investments ((BLA)), BSA ltd ((BSA)), CBL Corp ((CBL)), China Dairy Corporation ((CDC)), CSV ltd ((CSV)), Evolve Education Group ((EVO)), Farm Pride Foods ((FRM)), Godfreys ((GFY)), InvoCare ((IVC)), Japara Healthcare ((JHC)), LandMark White ((LMW)), McGrath Ltd ((MEA)), Murray River Organics ((MRG)), Pental ltd ((PTL)), Retail Food Group ((RFG)), RXP Services ((RXP)), Thorn Group ((TGA)), Watpac Ltd ((WTP)), Xenith IP ((XIP)), Yowie Group ((YOW)), and -can you believe it?- numerous others who by now have issued multiple downgrades to their operational outlook.
Thus far such profit warnings have not impacted broader sentiment in Australia. Most likely because investors have been well aware of company and sector specific issues and share prices had already significantly de-rated prior to these warnings for both Telstra and Ramsay Health Care.
Nevertheless, I do believe both profit warnings carry a specific message that should have investors' attention.
In Telstra's case, the latest profit warning cum lay-offs/cost cutting and organisational restructure, with implicit dividend reduction, symbolises the struggle of old school oligopolies to adapt to the rapidly changing world around them. It's not difficult to make a similar case for, say, AMP, Woolworths, and, yes, the banks too.
The Telstra board could potentially have acted years ago, but they didn't. Now it remains an open question whether this latest response leaves the company with sufficient time to turn things back in its favour again, while the industry globally goes through intense transformation.
Bottom line: this process of reviving the former monopolist brings along a lot of uncertainty and risk, and execution requires a lot of cost cutting, the shedding of secondary operations, a cultural re-alignment, plus additional spending, but above all, it will require time. All the while, success is by no means guaranteed.
In terms of share market risks, the case for or against Telstra is probably best illustrated by analysts' forecasts for future dividend payouts. According to the bulls (yes, they still exist), Telstra will continue paying out 22c per annum for years to come. According to the most bearish projection, in this case from Citi, the annual dividend will fall to 10c in 2021.
In scenario number one the dividend yield sans franking is no less than 8.2%. In scenario number two, however, the prospective yield is no more than 3.7%.
Take your pick.
The importance of the Ramsay Health Care disappointment is of a completely different nature. Post-GFC, and up until September 2016, the stock had been awarded super hero status in the Australian share market thanks to a long legacy of uninterrupted growth, no matter the circumstances, and with management more often than not upgrading guidance throughout the year.
Companies like CSL and REA Group are in a different category; they are not supposed to issue a profit warning, but now Ramsay Health Care has. And the reasons why are a combination of increased competition, increased scrutiny from governments on the costs of healthcare, compounding pressure on household budgets and governments' inability to fix failing healthcare systems.
Viewed from a broader macro-angle, Ramsay Health Care has fallen victim to the same social inequality issue that has brought us Brexit, Duterte, Trump, hung parliaments, and the return in appetite for trade barriers. In particular the fact that households under continuous financial pressure are opting out of health insurance, preferring cheaper public service instead, or other options to reduce costs, should be on every investors' radar.
What else are these financially constrained households up to? With rising funding costs internationally putting pressure on Australian banks to increase the costs for borrowers locally, should we worry even more? House prices are now falling too.
I believe the risks to household spending are the key uncertainty regarding the outlook for Australia. It is for this reason economists have been pushing out their projections for RBA rate hikes. Is this also the reason why the RBA itself has removed the expectation that the next move is likely up from its policy meeting minutes?
I wouldn't necessarily draw conclusions from recent moves in the Ramsay share price. Disappointment always leads to delayed selling, in particular this time of the year when accountants are advising their clients to sell some shares in order to reduce tax liabilities. For a more positive view on the company, analysts such as those at CLSA and at Wilsons, point out the company is still profitable, and growing, and it is expected to do exactly that in the years ahead.
It's just that Ramsay's growth is no longer the same as it used to be, both in terms of pace and of quality. No matter what angle we take, this equals a less impeccable reputation, and thus a lower valuation. That's exactly what has happened over the past 18 months or so.
Keeping a positive view because plenty of stocks do not look expensive in Australia while earnings growth remains supportive, without being spectacular, Deutsche Bank strategists Tim Baker and David Jennings continue to see some 5% upside for the Australian share market over the next twelve months.
They also zoom in on the fact that the valuation gap between 'value' and 'growth' is now at an all-time high worldwide, not just in Australia, and this means risk-reward must now be in favour of cheaper 'value' stocks. It has to be pointed out, other than a theoretical higher adjustment in bond yields, neither of the two can come up with a concrete trigger for a de-rating of the much maligned, but oh so popular 'growth' stocks.
Both support a mild overweight position in Australian banks, predominantly because share prices look extremely cheap. Trading on 1.5x price/book ratios, Deutsche Bank points out sector valuations post 1995 have only been cheaper during the global recession.
They also make a currency call with the Aussie dollar expected to be stronger in the second half, which will benefit domestic earners over offshore earners. Plus they retain confidence in China's resilience.
Deutsche Bank's model portfolio has added CSR ((CSR)), AMP ((AMP)), Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)) while removing James Hardie ((JHX)), Star Entertainment ((SGR)), ResMed ((RMD)) and Healthscope ((HSO)).
Stockbroker Morgans has once again repeated its (by now rather small list) of Conviction Calls in the Australian share market: Cleanaway Waste Management ((CWY)), Suncorp ((SUN)), and Westpac ((WBC)) among ASX100 constituents, and CML Group ((CGR)) and PWR Holdings ((PWH)) outside of the ASX100.
Morgans sees little incentive from the federal government's budget, including tax cuts, to turn more excited about the local share market. Constrained expectations seem the key operative, and the fact that Conviction Calls currently remain limited to five stocks fits in perfectly with that narrative.
Global strategists at Morgan Stanley have been focusing on USD strength, and weakness in emerging markets as a result. Since they have adopted the view USD strength, while anti-trend, is likely to stay with us for longer, their view on emerging markets short term has soured.
Meanwhile, macro risks continue building, they keep repeating.
The key to Australia's attraction for EM investors, suggests Morgan Stanley, is the fact the Aussie dollar has already depreciated -9% from its year-high, which may suggest most of the downward adjustment has by now occurred.
The strategists also point out funds flowing into Australia from regional markets is likely to ignore the "not insubstantial" endogenous risks of the slowing housing market and broader consumer credit crunch. The advice for domestic investors is to not follow the lead from offshore and instead remain very much focused on these risks.
Morgan Stanley remains unconvinced that cheap looking Australian banks will prove to be an excellent buy given ongoing risks for revenues, volume and regulatory constraints for the sector in Australia.
Global asset allocation strategists Michael Birch and William Liu at Wilsons retain the view that the macroeconomic environment continues to be supportive of risk assets. Their portfolio positioning remains overweight international equities, US markets in particular. Wilsons portfolio has zero exposure to European markets.
Wilsons has also reduced its exposure to gold to zero with the funds being re-allocated to defensive assets. Here the strategists mostly prefer international corporate credit, inflation-linked bonds and cash.
Analysts at Morgan Stanley have further zoomed in on 'disruption' considered to be a key theme for investors trying to understand both the outlook for Australian companies and the domestic economy's current transition. A 81-page report advocates some of today's laggards should be considering self-disrupting their sector in order to come out on top.
Those who have already turned themselves into successful self-disruptors, according to the research, include AGL Energy ((AGL)), Aristocrat Leisure ((ALL)), ASX ((ASX)), CSL ((CSL)), and Domino's Pizza ((DMP)).
Those who have the potential to become successful self-disruptors include AMP, Coca-Cola Amatil ((CCL)), and Telstra ((TLS)). The analysts also believe private health insurance and retail banking are ideally positioned for self-disruption.
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 10.30am Skype-link to discuss broker calls
-Thursday, from midday until 2pm
-Friday, 11am, Skype-link to discuss broker calls
Rudi On Tour
-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
(This story was written on Monday 25th June 2018. It was published on the day in the form of an email to paying subscribers at FNArena.)
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