article 3 months old

Out With The Garbage

rudi-views
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 | Oct 17 2018

In this week's Weekly Insights (published in two parts):

-Out With The Garbage
-Change: Rudi On TV
-Zimbabwe on Top Of The World
-Conviction Calls
-UBS On Inflation
-Rudi Talks
-Rudi On Tour

[Non-highlighted parts will appear in Part Two on Thursday]

Out With The Garbage

By Rudi Filapek-Vandyck, Editor FNArena

After what seems like an eternity of more selling than buying, the Australian share market is now heavily over-sold. Market indices have given up all gains accumulated earlier throughout the running calendar year, plus some. And it all went in a heart beat or two.

If markets follow the standard blueprint, we should see a relief rally, followed by yet another move to the downside. Only then will there be stabilisation, which can develop into a platform for the next rally upwards. Or not.

While it is fashionable to now reel out all kinds of statistics about how many -5%-plus market down drafts have occurred since the second week of March 2009, when the last bear market of late 2007-Q1 2009 was put in a coffin and buried, the objective observation is  this bull market is getting more mature by the day, economic momentum inside and outside the USA might be peaking, the Federal Reserve is a lot further into its tightening process and global bond markets seem a bit restless.

In such context, bad things can, and usually do, happen. Quod erat demonstrandum. Forecasters including myself had been building the case that 2019 would likely be a lot tougher for global equity markets, but it now increasingly looks like "tougher" has arrived much earlier.

For good measure: there is no evidence whatsoever to suggest the forward trend is now irrevocably south. But there is a real possibility that equity indices might have peaked, at least for the time being, and a more cautious approach seems but appropriate.

Most experts elsewhere are now telling investors they should grab this opportunity because this October market sell-off has created bargains everywhere. I have a different proposition. I agree share market weakness creates opportunity, but, as always, investors need context to assess what type of opportunity.

Irrespective of what happens to share prices tomorrow or the day after, there's no denying risks have been building throughout calendar 2018. Investors have largely ignored these risks, until the past two weeks. For long term oriented investors, the best strategy is now to de-risk portfolios and to try to avoid that one risk event can completely erase all the positive achievements from the years past.

Conclusion number one: cash is now a valuable asset.

Many a professional funds manager had been increasing cash levels earlier in the year, and so did the FNArena/Vested Equities All-Weather Model Portfolio. You might have done the same, if you'd read my Weekly Insights and had acted accordingly. If not, it never is too late to make changes to one's strategy and/or portfolio.

More importantly: share markets might look over-sold in the short term, this means nothing for the risks that have been building. Hence why I believe the best strategy is to look forward 1-2 years and consider the many risks that may or may not impact over that time span.

On international level, we have US bond yields that might surge a lot higher, the US dollar can rally a lot higher too, which means the Aussie dollar might crash, while crude oil prices can still rally higher too, while growth globally is slowing, US equities can have a much deeper correction (-10-15% is possible), Emerging Markets can throw up a tantrum, and the tension between the Trump administration and China can turn genuinely nasty, with Australia finding itself on the "wrong" side (from China's perspective).

Not to be forgotten: there is debt everywhere.

Domestically, we have banks and the Royal Commission, a housing market that is now correcting, household budgets further under pressure and a political cycle that is not favouring the incumbents.

All this seems a lot to take into account, which is why my preference lies with high quality, resilient businesses, that have a robust growth outlook, with as little risk attached as possible.

Some of such businesses have been communicating with investors recently. I note, for example, Amcor ((AMC)) has used its AGM to reiterate guidance for the year. Company management has a positive track record. This in itself is a de-risking event. The same can be said about Corporate Travel ((CTD)). The latter's management used a conference last week to communicate the new financial year has started strongly, while integrating the Lotus acquisition is progressing well.

Note also that, prior to the share market melting down, Carsales ((CAR)) had received three stockbroker upgrades to Buy in quick succession. Brian Johnson at CLSA and TS Lim at Bell Potter reiterated on Monday they think weakness in Macquarie Group ((MQG)) shares is creating an opportunity for investors who dare look past share market gyrations. Both would say bank shares in general look "cheap", but Macquarie remains the sector favourite.

Note that I don't think investors should be focusing on "value" but on "quality" and "risks" instead. Personally, I'm still not keen on banking shares, but I am a big fan of Macquarie (and so should you be). To prove my point about focusing too much on "value": Fairfax Media ((FXJ)) and Domain Holdings ((DHG)) unexpectedly issued a profit warning, also dragging down groom-to-be Nine Entertainment ((NEC)) and market leading competitor (and of incredibly better quality and resilience) REA Group ((REA)).

To put this in another way: shares have been falling significantly across the board. Why would you now risk being caught inside a yield- or value-trap? Surely the most devastating experience would be to survive this stomach-churning share market volatility only to be caught out in better times because one is still holding multiple stocks of the lesser quality/higher risk type?

Investors who really want to maximise this month's opportunity should, in my view, start cleansing the slate (to mix a few metaphors) and build a robust portfolio for the risks and challenges ahead.

Let's be brutally honest to ourselves: we all have a few. Stocks that seemed like a good idea at the time, but it simply hasn't worked out well. Time to ignore purchase prices and emotional attachment and ask some very apposite questions instead: would you still buy those stocks today (without looking at the share price)? Do you still think this is the ideal stock to own given the challenges ahead?

If not, you know what to do. It's time to get rid of all the garbage and add some real robust quality instead. Share prices have fallen across the board. Don't stick with a pair of brown pebbles whose gloss has worn off while you now can own a selection of true diamonds at much cheaper prices than only one month ago.

The FNArena/Vested Equities All-Weather Portfolio has done exactly this over the past week or so. We got rid of shares in companies like InvoCare ((IVC)) and Pact Holdings ((PGH)), disappointing investments that should have been abandoned earlier, but hey, we are all human. Instead we are looking at, or have been buying, shares in ARB Corp ((ARB)), GUD Holdings ((GUD)), ResMed ((RMD)), Goodman Group ((GMG)), Reliance Worldwide ((RWC)), and the likes.

At the same time, we have increased our cash position, which gives us double comfort in that we can look to deploy more, while also reducing our exposure overall to a share market climate that is volatile at best, and toxic at worst.

A few other things to take into consideration while portfolio re-calibration is in process:

-smaller cap stocks are more vulnerable during risk-off events
-stocks on higher PE ratios might sell-off more because of the perceived "richer" valuation, plus the knee-jerk response of profit taking implies past winners are sold more, and easier, than past losers (it's a human reflex thing, not necessarily useful beyond the short term)
-stocks in companies with no profits and no dividends might fall further (there is no natural support)
-investors should in particular be careful with smaller cap stocks that carry a lot of debt and whose operations might come under pressure
-local technology stocks are essentially beholden to whatever happens with Nasdaq in the US

For example: I would not be left with owning shares in Speedcast International ((SDA)) right now. The company severely disappointed in August and is carrying a mountain of debt, having acquired a multiple of companies since listing. Too much risk for my liking. In similar fashion, I did cast an eye over Ansell ((ANN)) shares, but there still is the possibility that gloves might be affected by Trump's trade tariffs.

A cheaper share price does not tell the full story. Investors should always make sure they try to gauge to the best of their ability the risks involved, so they can make (hopefully) a well-informed decision whether they want exposure, or rather not.

As has been our investment strategy since inception of the All-Weather Portfolio, the focus remains firmly on the various categories shown on the dedicated All-Weather Performers section on the FNArena website (sorry, available to paying subscribers only). To reduce risk and increase our cash position, the Portfolio has dialled back overall exposure to mid- and smaller cap stocks, and to the technology sector.

On a net-net basis, we have noticeably increased the Portfolio's cash position, which should provide both comfort and the optionality of responding to further developments.

Investors who'd like to include the August Reporting Season Monitor in their research/target selection can do so via the following story:

https://www.fnarena.com/index.php/2018/09/12/august-2018-reporting-season-wrap/

The Monitor itself is attached to the story (see top). Plus, of course, we are running a Monitor for post-August results live on the website (soon to be updated with the banks and others).

Change: Rudi On TV

As of this week, I will no longer appear on Your Money (the renamed Sky News Business) on Thursdays, but weekly on Mondays instead (1-2pm). This is likely to also impact on when I manage to write and send out Weekly Insights, in particular when a lot of reading, researching and thinking might be involved.

Hence from now onwards Weekly Insights might become more of a Tuesday event rather than the Monday evening, as has been the rhythm for quite some time. Whenever this happens, Part Two (if there is one) will be published on the website on Friday morning instead of on the following Thursday.

This week, as you might have guessed, everything will remain the same as always.

Rudi Talks

Audio interview from last week in which I advocate investors raise more cash and keep a list of stocks they do not own, but would like to:

http://boardroom.media/broadcast/?eid=5bbd2c4b7410a23524811618

Rudi On Tour

-Presentation to ATAA members and guests Sydney, on 18 October
-AIA Celebrity Lunch, Brisbane, on November 3

(This story was written on Monday 15th October 2018. It was published on the Monday in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part Two shall be published 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: info@fnarena.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 $420 (incl GST) for twelve months or $235 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

(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.) 

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

AMC ANN ARB CAR CTD DHG FXJ GMG GUD IVC MQG NEC PGH REA RMD RWC SDA