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FOFO In February

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 | Feb 14 2019

In this week's Weekly Insights:

-FOFO In February
-February Previews: Miners & Energy
-Index Changes Afoot
-Conviction Calls
-Rudi On TV
-Rudi On Tour

FOFO In February

By Rudi Filapek-Vandyck, Editor FNArena

Something peculiar happened last week.

The FNArena/Vested Equities All-Weather Portfolio, which up until February had been outperforming the ASX200 Accumulation Index (including dividends), experienced first hand the potential consequences if one's portfolio does not include miners and energy stocks or major banks. In one swift move whatever was there in relative outperformance disappeared and was replaced by relative underperformance.

I am referring to the Big Four Banks and their share price moves following the release of what is generally accepted was a rather forgiving slap on the wrist, and not much more, for a sector whose shenanigans and embarrassing client-unfriendly corporate culture had dominated newsflow and headlines throughout most of 2018.

And so the avoidance of much worse scenarios triggered a fierce rally in banks' share prices, usually reserved for tiny little tiddlers in the margin of the share market. In the context of Australia's Big Four banks representing more than 20% of the ASX200, with CommBank ((CBA)) alone weighing some 7.2%, this is a major event.

In particular if you happen to be a professional funds manager and your performance already has been on the lighter side, a position many of domestic fundies have found themselves in for the past five years.

Now consider the fact that banks have been underperforming since early 2013, but in particular post May 2015, and that large swathes of the professionals had simply gone underweight the sector in response, and you instantly understand what I am talking about.

That Big Rally we witnessed last week was not all about a softer than feared slap on the wrist by Commissioner Hayne; it was as much about fund managers scrambling to secure their job. If your performance already is hardly keeping up with the market, you are underweight that particular sector and then banks' share prices start rallying, you literally see your future running away from you.


Australian equity strategists at JP Morgan, Jason Steed and Radhika Wadhwa, introduced a new acronym to describe what happened last week: FOFO – a fear of financials outperforming.

JP Morgan keeps a regular tab on domestic funds managers and on its own sets of data, nearly 75% of managers locally had been running their portfolio allocations at a deep underweight position for the banks. Wait, this story is yet to become a lot more interesting.

On JP Morgan's data, the aggregate underweight position of local fund managers is circa $30bn across the four majors. Were these managers to conclude that the outlook for CommBank & Co is about to improve materially, and they need to move to market-weight by fully erasing their relative underweight positions, this would translate into the equivalent of two months' of daily trading volumes for each of the Big Four.

Yes, this is a major insight. You can read that last sentence again if you like.

For those who like more detail, consider the following: according to JP Morgan, two-thirds of funds managers were running portfolios pre-Hayne report on average -600bp underweight the banks' weighting in the ASX200. Each 100bp narrowing would amount to an estimated nine days of volume, individually, based on the three months average traded value by stock.

Of course, these numbers, while impressive, tell us nothing more than what we already knew. The professionals are not too keen on the banks, still. But watch out when the tide really turns. We could be witnessing a sector turnaround that lasts for many months, not just a week or so.

On my scattered observations, stockbroker Morgans has been among the professionals increasing their relatively lightweight exposure to the banks, while Morgan Stanley showed no appetite at all. JP Morgan itself is with Morgan Stanley. No appetite to change that underweight positioning.

Another observation made by Steed and Wadhwa is that fundies are scaling back their overweight positioning towards resources stocks. At least they were up until December when the latest data had been gathered and analysed.


Meanwhile, sharply higher share prices and a big drop in day-to-day volatility might lure investors into the comforting impression that everything is going to be just fine this year; late 2018 was simply a big, misguided scare, and nothing more.

Well, the Federal Reserve has lent its ear to market concerns, and responded, which is what is currently supporting this phase of the recovery rally. But how long before the market's attention will shift towards the reason that share prices sold off last year?

That reason might not be about an economic recession on the horizon, but downward pressure on US corporate earnings is genuine and real. Morgan Stanley's market strategists in the US have lowered their base case S&P500 EPS growth prediction to 1% only.

This is still positive, for sure, but it is lower than current market optimism, and certainly lower than what is priced into today's equities in the US. You should not be surprised the in-house view is now that bond yields will also be lower by year-end. The year-end target of 2750 for the S&P500 (currently above 2700) suggests not a lot of positive return in store for the remainder of 2019, on a net basis.

For good measure: not everybody agrees with such assessment, otherwise share prices probably wouldn't be where they are right now, but a number of less pessimistic market analysts agrees with Morgan Stanley the underlying signals from the Q2 reporting season in the US, now in its final chapter, are negative.

On Citi's numbers, for example, the downward revisions to analysts' forecasts, predominantly on the basis of companies providing downbeat guidance, is the worst since the GFC. As Citi analysts point out, back then the world was experiencing a true global financial crisis, which is unlikely on the menu this calendar year, so hopefully things may not turn out as badly as is the current trend.

Do keep in mind, market forecasts in the US now are heavily biased towards a pick up in earnings growth in the second half of the year. Even Citi itself acknowledges this can potentially prove too optimistic, though we probably won't know for certain until later in the year.

Locally, the reporting season is still young, but early signs are Australian companies are not significantly outperfoming rather mediocre growth forecasts. Make sure you have plenty of exposure to strong and healthy businesses, instead of solely focusing on cheap looking valuations.

Only A few days ago, Bendido and Adelaide Bank ((BEN)) shares were trading above $11.30. Now, after the release of disappointing interim financials, the shares have fallen to just above $10. This regional bank hasn't achieved "growth" for a number of years now, and it doesn't look like that is about to change.

GUD Holdings ((GUD)), on the other hand, saw its share price fall post the release of interim financials, but the share price had recovered in full by the time the shares went ex-dividend, which was today.

I also note ResMed ((RMD)) shares are gradually climbing their way back after being punished for failing market expectations in late January. And REA Group ((REA)) shares put in a great performance today, having experienced more sellers than supporters after management guided for less revenue growth in the second half.

I don't think suffering shareholders in Bendalaide Bank can expect a similar pattern, and that, as they say, is one of the key differences that will be on display this February reporting season.

February Previews: Miners & Energy

Commodity prices have remained persistently high, but costs have been rising too and resources analysts at UBS, for one, believe one factor will be found to have largely cancelled out the other factor throughout the February reporting season in Australia.

UBS analysts see their confidence in both dynamics growing having paid attention to what companies have been communicating and reporting in overseas markets. If the offshore pattern is to be repeated here in Australia, companies exposed to aluminium in particular might be prone to disappointment because of higher-than-forecast costs.

Nevertheless, conservative balance sheets are still offering further room for capital management, including sizable cash returns to shareholders. UBS has nominated Rio Tinto ((RIO)) as primes inter pares when it comes to having the ability to return cash -lots of it- to eager shareholders.

Numerous asset sales plus healthy operational margins on the back of a higher-for-longer iron ore price may well translate into the Rio Tinto board expanding the current share buyback to US$3.6bn, while also announcing a special dividend in excess of US$1bn, while still paying out a large ordinary dividend. There's no end to the cash boom times this time around!

More cash back surprises could stem from Alumina ltd ((AWC)) and from ex-BHP's South32 ((S32)), with gold miner Evolution Mining ((EVN)) potentially joining the sector's cash splash later in the year. Newcrest Mining ((NCM)) could also join in, but the board at Australia's largest gold miner needs to keep an eye on capex requirements for Golpu, UBS explains.

Macquarie, on the other hand, predicts investors will have a harder-than-usual task in assessing financial performances from oil and gas producers this season, and accountancy adjustments and forthcoming changes to the petroleum resource rent tax (PRRT) are to blame.

First off, the introduction of AASB16 as of January 1st this calendar year affects the way leasing arrangements are being accounted for, now turning into financing costs from depreciated assets and liabilities previously. It sounds complicated, and it probably is too much detail already for many of us, but the change in accountancy will disturb analysts' neatly kept excel file data in a meaningful way, says Macquarie.

The Coalition government has already expressed the intention of moving into a new PRRT regime by July 1, 2019.

Macquarie thinks Woodside Petroleum ((WPL)) stands to be most affected by both impacts, and is therefore preaching caution ahead of its financial result this month. Santos ((STO)) remains the broker's top pick, also because cost cutting, drilling and acquiring the Quadrant asset all seem to have gone smoothly thus far, virtually guaranteeing positive karma and share price momentum.

All of the above should bode well for engineers, contractors and whoever provides services to resources companies. It therefore cannot be a surprise that analysts are anticipating some stellar results from this particular segment this month. Wilsons' three sector favourites are Ausdrill ((ASL)), Austin Engineering ((ANG)), and NRW Holdings ((NWH)).

Two other Buy-rated sector peers are Monadelphous ((MND)) and Mastermyne ((MYE)). Analysts at Wilsons are expecting guidance to be at least maintained across the sector, if not supported by signals the outlook overall for these services providers is steadily improving.

Macquarie likes Beach Energy ((BPT)) as well.

Energy companies across the board are expected to start talking up their growth aspirations by 2025, predict the analysts, pointing out this in itself will mark a major shift from recent years when stabilisation was the sector's prime focus.

See also last week's February Reporting Season Preview:

Index Changes Afoot

We're still a few weeks away from the next announcement by Standard&Poor's about fresh inclusions and drop-outs from key local share market indices, but analysts at Wilsons have already put forward their predictions, which contain a few interesting changes, if proven correct.

The potentially largest favourable impacts are (this time) reserved for small resources stocks with all of Coronado Global Resource ((CRN)), Carnarvon Petroleum ((CVN)), Mt Gibson Iron ((MGX)), and Paladin Energy ((PDN)) awaiting probable inclusion in both the ASX300 and the Small Ordinaries indices. It means these highly volatile, cyclical small cap stocks might become "investment grade" for a number of institutional funds managers.

One small cap stock that has attracted a lot more attention than it used to, Jumbo Interactive ((JIN)), might also enjoy ongoing favourable consequences from the next S&P Indices update; it too might be cum inclusion for the ASX300 and Small Ordinaries.

Washington H Soul Pattinson ((SOL)) could be upgraded (so to speak) to large cap status, with Wilsons flagging possible inclusion in the ASX100, which can be a short term negative when small cap managers have to sell and large cap managers see no need to hurry in. Servcorp ((SRV)) might be booted out of the ASX300 and Small Ordinaries, with negative consequences.

Other changes considered possible are swapping Coles ((COL)) for Goodman Group ((GMG)) in the ASX20, replacing Orica ((ORI)) with Tabcorp Holdings ((TAH)) for the ASX50, and replacing Janus Henderson ((JHG)), IOOF ((IFL)) and Pendal Group ((PDL)) in the ASX100 with said Soul Pattinson, Beach Petroleum ((BPT)) and Altium ((ALU)).

What applies to Soul Pattinson can of course equally apply to Altium given this high growth market darling tends to trade on stiff market premia, even during the worst of times.

All of a sudden, suggested changes to the ASX200 seem small, benign and inconsequential. Wilsons is not sure, but thinks there could be two swaps upcoming whereby Automotive Holdings ((AHG)) and Infigen Energy ((IFN)) get booted out, and replaced by Clinuvel Pharmaceuticals ((CUV)) and Hub24 ((HUB)).

Suggested changes for the much broader ASX300, traditionally the home of many small caps due to the overall size of the Australian market, come in larger numbers with Wilsons pre-assessment pointing at 13 stocks that could possibly lose their spot: Blue Sky Alternative Investments ((BLA)), Servcorp, Class ((CL1)), Monash IVF Group ((MVF)), WPP AUNZ ((WPP)), Villaworld ((VLW)), and, on a lesser probability, Karoon Gas ((KAR)), Amaysim ((AYS)), Altura Mining ((AJM)), ARQ Group ((ARQ)), Integrated Research ((IRI)), Clean Teq Holdings ((CLQ)) and Kogan ((KGN)).

Stocks considered possible additions when the announcement is made on March 8, are Coronado Global Resources, Redcape Hotel Group ((RDC)), Carnarvon Petroleum, Sundance Energy Australia ((SEA)), Mt Gibson Iron, Jumbo Interactive, Paladin Energy, and, with ascribed lesser probability, Reece Australia ((REH)), Codan ((CDA)), Ramelius Resources ((RMS)), Baby Bunting ((BBN)), Alacer Gold ((AQG)), Zip Co ((Z1P)), and Pacific Current Group ((PAC)).

As per always, some impact might reveal itself in some of these share prices in the lead up to the announcement, scheduled for March 8, 2019.

Conviction Calls

Last week I caught up on Morningstar's selection of Best Stock Ideas for 2019. It wasn't long before Morningstar announced its analysts had made a few changes.

Have been added to the list are Carsales ((CAR)) and Crown Resorts ((CWN)), while G8 Education ((GEM)) and a2 Milk ((A2M)) have been removed, both following recent outperformance.

Other stocks included in the selection are Aveo Group ((AOG)), InvoCare ((IVC)), James Hardie ((JHX)), Link Administration ((LNK)), Macquarie Group ((MQG)), Pendal Group ((PDL)), Telstra ((TLS)), Westpac ((WBC)), and Woodside Petroleum ((WPL)).


Over at Stockbroker Morgans, Model Portfolios have been trimming exposure to BHP Group ((BHP)) and Rio Tinto ((RIO)), while buying additional shares in Wesfarmers ((WES)) and Sydney Airport ((SYD)). In addition, the prior tactical underweight position towards local banks has been corrected in the aftermath of the public release of the Hayne report recommendations.

The Growth Model Portfolio has sold out of ALS ltd ((ALQ)) and bought ResMed ((RMD)), still considered a High Conviction stock inside the local healthcare sector.


Elsewhere, at Morgan Stanley, market strategists are calling for a more defensive positioning, even more as their Model Portfolio had already adopted a defensive bias. As such, Morgan Stanley's Model Portfolio has been selling resources exposure, including the full removal of gold.

In another interesting move, the strategists added Spark New Zealand ((SPK)) on the belief this represents a less risky telecom exposure in comparison with peers in Australia. China stimulus anticipation has led to the inclusion of zircon through Iluka Resources ((ILU)).

Healthcare and consumer staples are the two largest sector exposures, followed by insurance, metals & mining, and energy. On "Super-sector positioning", this leaves the Model Portfolio with two big overweights to Defensive Industrials and Resources, and with two clear underweights to Cyclical Industrials and Financials.

Banks remain the largest underweight sector in the portfolio, with only National Australia Bank ((NAB)) owned above its index weight.

Instead, Morgan Stanley's Model Portfolio very much likes Insurance Australia Group ((IAG)), QBE Insurance ((QBE)) and Macquarie Group ((MQG)) among financials, while also owning overweight positions in Aristocrat Leisure ((ALL)), Domino's Pizza ((DMP)), Tabcorp ((TAH)), Treasury Wine Estates ((TWE)) and all three of CSL ((CSL)), Cochlear ((COH)) and ResMed ((RMD)), which explains the largest sector exposure to local healthcare.

Rudi On TV

My weekly appearance on Your Money is now on Mondays, midday-2pm.

Rudi On Tour In 2019

-ASA Inner West chapter, Concord, Sydney, March 12
-ASA Sydney Investor Hour, March 21
-ASA Toowoomba, Qld, May 20
-U3A Investor Group Toowoomba, Qld, May 22
-AIA Adelaide, SA, June 11
-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1

(This story was written on Tuesday 12th February 2019. It was published on the day in the form of an email to paying subscribers at FNArena, and again on Thursday 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: or via the direct messaging system on the website).



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