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.

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