What Beyond The Rally?

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 | Nov 01 2018

In this week's Weekly Insights:

-What Beyond The Rally?
-Rudi Talks
-Rudi On Tour

What Beyond The Rally?

By Rudi Filapek-Vandyck, Editor FNArena

There is one specific reason as to why I would caution investors to have high expectations about the local share market post October carnage, and that is because of US government bond yields, in itself the trigger to global share market weakness over the past two months.

No doubt Fed Chair Jerome Powell thought he'd sooth market fears about the Federal Reserve tightening too fast when he declared in early October US interest rates were still a long way off from reaching neutral territory, but financial markets received the message in a "OMG!, there is a lot more tightening coming" way, and down went equity markets.

The irony is that since October 3, the yield on 10 year US Treasuries has declined from 3.23% to 3.08%, but one should interpret this as the self-correcting mechanism that exists because of short term refuge being sought in the traditional US safe haven. (When more money flows into bonds, prices rise and thus yield drops). After all, these are US government bonds, the safest among all safe assets in our life time (at least in the short term).

About one month later, global equities seem extremely oversold, which is what one would expect given how savage the sell-offs have been, so assuming bargain hunters will start moving in, and investor sentiment as a whole can relax a little, this "relaxing" will not only translate into recovering share market indices, it will also lead to short term safe haven seekers abandoning the US bond market again.

Can everyone see where I am going with this?

Global investors worrying about what US bonds might do next are not in a position to now forget about US inflation, the Federal Reserve, the risk-free rate and global yields. Equities remain at risk of being a permanent prisoner of the global bond market, at least until current dynamics shift decisively either way.

And this still could well become a matter of be careful what you wish for.

Let's assume inflation does fall, which -all else being equal- would make a lot of sense given global growth is still decelerating, and has been for a while, thus removing the need for bond yields to rise further. They might even trend lower then.

How do you think this will impact on equities?


Australian investors already have witnessed what investor doubt about future growth prospects can do to share prices. FlexiGroup ((FXL)) shares are down -35% over the past three months, including a brief respite rally during reporting season in August. Automotive Holdings ((AHG)) shares are down -33% over the same period, and -43% over the past twelve months. Shares in EclipX ((ECX)) have lost -23% and -41% over respective horizons.

The local housing market is weakening, and has been for a while, and now retailers have started noticing a real impact on their sales numbers from households tightening their purse as the bricks and mortar wealth effect is evaporating. On Tuesday, as I am writing this Weekly Insights, cheap bling retailer Lovisa's ((LOV)) share price is down in excess of -19% after yet another disappointing market update from the sector.

Investors are responding by pulling money away from companies that are directly linked to either housing or consumer spending, and that is a big chunk of the Australian share market (including the banks, of course).

This indiscriminate selling is opening up opportunities for savvy investors who know better than to use the same brush for all listed companies -- REA Group ((REA)) and Carsales ((CAR)) spring to mind, but also Bapcor ((BAP)) and GUD Holdings ((GUD)) -- but this also puts one big dent into the ruling mantra that "value" investing is now making a lasting come-back, and "growth" investing is out of fashion.

Which is why this week's warning by Tony Brennan and James Wang, equity strategists at Citi, seems a little bit off the mark, unless one continues to look into the future with a rose tinted pair of glasses. Growth stocks are still trading on elevated multiples, and at a noticeable premium versus "value" stocks, the Citi strategists observe.

This, in their view, implies growth stocks remain at risk of further share price weakness. Granted, issuing profit warnings is no longer the sole privilege for structurally challenged "value" companies or local retailers, now high PE companies such as Kogan ((KGN)) and BWX ((BWX)) have joined in, but should we really compare these companies with the likes of CSL ((CSL)), ResMed ((RMD)), REA Group, et cetera simply because they are all trading at a premium to the lower value end of the share market?

In the short term, no such distinction might become apparent. Savage sell-offs have significantly dented investor sentiment and many would be in the mood to sell first, then ask questions, and see their actions being vindicated because of falling share prices, seemingly without any distinction on the basis of past track record, idiosyncratic quality characteristics, or reasonable growth prospects; but such distinction will establish itself at some stage.

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