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February Reports: Is Not As Bad Good?

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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 27 2019

In this week's Weekly Insights:

-Share Market Momentum: 2x Indicators
-February Reports: Is Not As Bad Good?
-Yield: The Silent Performer
-Rudi On TV
-Rudi On Tour

By Rudi Filapek-Vandyck, Editor

Share Market Momentum: 2x Indicators

Two graphs included this week (see below) summarise, in my opinion, the background for today's equity markets.

The first graph concerns the leading indicator for the US economy, still the largest on this planet, as composed and published by the Conference Board, an independent research organisation with activities in 60 different countries.

As anyone can clearly see on that chart (which is updated until December), forward indicators for the US economic growth momentum pretty much fell off a cliff late last year, which easily explains as to why share prices went into a negative maelstrom at that time, fully exacerbating two full months of downward moving trend lines.

The graph specifically shows the leading indicator for the US, but the LEI for the rest of the world looks exactly the same. This feeds into the idea that a strong US economy can only withstand weakness in the rest of the world for so long. Eventually, and certainly history would back this conclusion, the US too will feel the impact from a slowing global economy.

The one caveat for all of this is that several input data for this indicator have remained missing due to the temporary US government shut down in December. The Conference Board might operate as an independent research entity, its indicators still rely on input data collected and published by departments of the US government. Since December, some of such data have not yet been released.

Also, as indicated (red arrows), the US LEI falling below the zero line historically always coincides with turmoil for global assets. In 2011 and 2012 the problem stemmed from a weakened and unstable Europe, by early 2016 investor doubt was focused on China with global momentum continuing to decelerate, and by late last year the culprit was more than likely a somewhat delusional Federal Reserve who somehow thought it could simply continue hiking the official cash rate, while running down the massive debt mountain on the central bank's balance sheet.

The world's most powerful central bankers have understood the market's message loud and clear since, and are now officially in pause mode.

This has facilitated strong rallies for beaten down equities the world around since. Which brings us to the second graph accompanying this story; CNN's Fear & Greed measure, observed by many across the globe who want a less technical indicator for where investor sentiment is at.

[With thanks to the Gartman Letter]

As clearly shown above, the indicator has ventured back into "extreme greed" territory, which is another way for saying shares have been egregiously overbought for the time being, or that market bullishness has once again reached elevated levels. None of this indicates a share market correction needs to follow immediately, but it does show the need for ongoing positive news flow to keep the upward momentum going, and probably shows a pull back, at the very least, needs to follow at some point, if only to let some steam escape from current share prices.

Investors might also take note that according to some technical analysts, like Gary Burton at FPMarkets, equity markets globally remain in a bear market. Viewed from this angle, the swift rally post Christmas into late February fits in the mould of sharp rallies that are typical under bear market conditions.

To throw off the mantle of the bear, the local ASX200 index needs to rally past the previous high, achieved in Q3 last year at 6373. I don't want to sound too pessimistic, but I don't see that happening in the foreseeable future. (though, admittedly, stranger things have happened in financial markets). But there is plenty of grey to play with.

Burton's latest market update suggests what equities need right now is a pullback of -5%, and then a resumption of this rally. Were this scenario to unfold in the weeks ahead, Burton would be prepared to once again call equities as being in an uptrend.

February Reports: Is Not As Bad Good?

One of the key events this reporting season occurred on the final day of the opening week, Friday the 8th of February. Local real estate platform REA Group ((REA)) alongside parent News Corp released interim financials, and while the operational numbers looked robust and resilient, management's guidance for a more subdued, elections impacted second half period was instantly interpreted as an invitation to sell down the stock.

Flash forward two weeks, and today the share price sits well above the levels both prior to and after the release of interim financials.

This is not standard practice. Usually, and I am learning on experience from many years of observing and analysing corporate reporting seasons in Australia, following a disappointing market update, and subsequent public flogging, share prices of stocks such as REA Group remain in the doghouse for a while longer.

In a world that is increasingly short-term focused, all investors need to know during and immediately after reporting season, apparently, is whether the result beat expectations, or whether it was a disappointment. In case of the latter, investor interest may well remain lukewarm for a number of months, depending on the magnitude of it all, and whether there are ample opportunities available elsewhere.

In REA's case, history shows that when the company disappointed in August 2016, the share price didn't bottom out until the calendar read November, after which the prior uptrend in the share price resumed. By April the following year -eight months after the results related sell-down- REA's share price was back at pre-August release levels, and continued trending higher.

This time around the immediate "loss" suffered by loyal shareholders (such as myself) only lasted for about one week, give or take. And REA Group shares are far from the only ones to swiftly recover from earnings update inspired weakness. Take a look at Carsales ((CAR)) -same pattern- or Link Administration ((LNK)) -again, same pattern. Idem for GUD Holdings ((GUD)).

In contrast, when Insurance Australia Group ((IAG)) updated on the 6th of February, the release was labelled a "beat" by all and sundry, and the share price rallied on the day. But there never was any follow-through. In the three weeks post the IAG market update the share price has bit by bit given up on the share price gains booked on the day of release, to ultimately end up lower than on the days prior to the market update.

So who are the real winners and losers in this February reporting season? The distinction between the two has, according to my memory, never been this blurred.

Reporting season in February still has a few more days to run, but already it has become clear total "beats" and total "misses" are in a tight contest to grab the largest percentage of the season's corporate reports. FNArena has been closely monitoring local reporting seasons since August 2013, but never have we witnessed such a tight race between "beats" and "misses", i.e. between "positive surprises" and "negative disappointments".

Underlying, earnings estimates are trending south, outside resources, but probably at a slower pace than predicted pre-February. Valuations and price targets are struggling to stay positive, for the season as a whole. If the end result ends up negative, this too will be a first since August 2013 (Either way, it seems the end result is on its way to become the least favourable outcome in the series to date).

None of this should surprise, given the background of overwhelmingly soft looking economic indicators, that are -equally important- pointing towards more weakness, not improvement in the weeks and months ahead. Some sectors have revealed their vulnerability this month, starting with car-related businesses (virtually all disappointed), with building materials and construction, and even both supermarket operators unable to shake off operational headwinds.

Some retailers managed to stand above the crowd; many others, however, did not. All aged care providers disappointed on a genuine downturn for the sector, despite increased government funding. Regional banks were weak. Outdoor media, clearly, is doing it tough too, as are wealth managers with exception of you know who.

Popular, High PE super-performers who yet again proved their mettle, confounding the many critics on the sideline for the umpteenth time, include a2 Milk ((A2M)), Altium ((ALU)), Appen ((APX)), and Nanosonics ((NAN)). They join the list I pointed out last week, see:

https://www.fnarena.com/index.php/2019/02/21/february-reports-early-resilience-big-disappointments/

Others, including Blackmores ((BKL)), Domino's Pizza ((DMP)), Flight Centre ((FLT)), Hub24 ((HUB)), and Praemium ((PPS)) simply couldn't live up to market expectations.

Equally noteworthy, in the shadow of mostly robust performances from large resources stalwarts, including BHP Group ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Woodside Petroleum ((WPL)), the contractors and engineers are awaiting their moment in the limelight. Investors should keep in mind, nevertheless, this is a sector that traditionally combines outsized investment returns with dismal failures. It wasn't that long ago RCR Tomlinson went bankrupt, just like that, and Lendlease is now looking to divest its own (troubled) engineering division.

This month, services providers including Ausdrill ((ASL)), Alliance Aviation ((AQZ)), Monadelphous ((MND)), and NRW Holdings ((NWH)), among numerous others, provided plenty of confirmation and indications there should be plenty of fresh contracts awaiting in the near term.

On the flipside, companies including iSentia ((ISD)), Ardent Leisure ((ALG)), Asaleo Care ((AHY)), Class ((CL1)), Coca Cola Amatil ((CCL)), Event Hospitality and Entertainment ((EVT)), Fletcher Building ((FBU)), Freelancer ((FLN)), Healius ((HLS)), Mayne Pharma ((MYX)), Pact Group ((PGH)), and many others, once again provided plenty of evidence it is not easy to successfully turnaround a business stuck in struggle street.

On occasion, one such perennial disappointer refinds its mojo, and triggers a successful recovery in the beaten down share price, to the grand delight of long suffering loyal shareholders. This month's turnaround story may well be named QBE Insurance, but we won't know for certain until after the next season in August, if not until after February next year.

All in all, it looks like the end of February will leave investors with a general feeling corporate health and performances in Australia are not mirroring worst case scenarios, but being not as bad, is this good enough to sustain current share price levels?

Ironically, the answer is likely to depend on what happens at the macro level.

FNArena keeps track of corporate results the year-around. Our February assessments can be tracked through daily updates via a dedicated section on the website:

https://www.fnarena.com/index.php/reporting_season/

Yield: The Silent Performer

If there is one forecast that many experts have called wrongly in the share market over the past few years, it is the direction of government bond yields.

Gone are the predictions that pinned bond yields at 4%, and possibly higher. Whoever sold their high yielding shares in the local share market on the basis of such predictions has been left severely disappointed since. Share prices for yield stalwarts such as Transurban ((TCL)) and Sydney Airport ((SYD)) have not crashed to all-time lows, but surged to near all-time highs instead. And the same applies to smaller brethren equally offering juicy yields, such as Viva Energy REIT ((VVR)) and Atlas Arteria ((ALX)), to name but two.

And what to make of the stand-out performances of the new growth stocks in the local yield sector, Goodman Group ((GMG)) and Charter Hall ((CHC))? The former's forward looking dividend yield at the present share price and on freshly updated consensus forecasts is currently… wait for it… 2.4%!

This is an indicating of how strong the performance of Goodman Group shares has been in recent years. Surely, I am not the only one who can still remember when shareholders in Goodman Group could expect a similar income/yield from dividends as their peers holding Transurban or Atlas Arteria?

There is an old saying that financial markets are there, above anything else, to keep investors humble, and humbled many have been. Not just by diverging trends over the past five years, or by last year's sudden bear market black hole, but most certainly by how difficult it has been to retain even a modest level of economic growth the world around, and by the persistent absence of that what many fear most; tangible price inflation.

Slow(ing) growth with no inflation (to speak of) equals lower bond yields and ten year US Treasuries are currently yielding less than 2.70% – a long way off from the 3%-plus the world witnessed in Q3 last year, and certainly nowhere near the occasional 4% or 5-6-7% we might have heard mentioning by very intelligent looking, highly eloquent men in suits on financial television.

Lower bond yields are, of course, one of the factors that have supported a recovery in equity markets. While the underlying reason as to why bond yields are again trending lower is a clear negative for risk assets, the immediate impact is one of providing support. See the yield stocks mentioned earlier (and their peers), but also share markets in general.

The Federal Reserve is now officially taking a breather. To some experts looking back at historical precedents, this most likely means the next step will be a rate cut, but probably not anytime soon. The complicating matter here is that quantitative tightening really has only just started.

No matter what scenario lays ahead, quantitative tightening remains far from done, or even remotely near the level the Federal Reserve had been targeting until recently. So investors should not be surprised if -but that's still pure and plain speculation at this stage- quantitative easing and negative interest rates are to remain much longer on central bankers' To Do list.

Potentially much, much longer.

Can you hear that noise in the background? That's from all those investors having gone short Goodman Group, or from advisors telling their customers to sell. Yet, if global bond yields are continuing to trend lower, it is not very likely we will have the chance any time soon to see Goodman Group shares trading at "cheap" levels.

One thing that may well be on the Fed's menu, and soon too, is a general reset for the so-called dot plots. This is the level at which each individual FOMC member (those who decide upon the official cash rate) indicates where he/she sees the cash rate into the future.

Now that the Federal Reserve has acknowledged the December hike might have been one step too far already, it is not inconceivable a number of FOMC dot plotters will reset their expectations, and the median from all dot plots should thus fall at the next update in March.

Spoiler alert: bond traders and fixed income investors pay close attention to such signals. We might yet see US treasuries take another rally-step higher, meaning bond yields can still move to a lower level, even though they already are low within historical context.

I wouldn't be selling any Goodman Group shares just yet. (The FNArena/Vested Equities owns Goodman Group shares, as well as Viva Energy REIT and Atlas Arteria and we haven't even thought about selling for one millisecond in weeks past).

All else being equal, rallying bond prices and falling bond yields should equally benefit Australian banks' share prices, but ever since that strong rally leading into May 2015, the case to own Australian banks/witness them benefiting from lower bond yields has not been as simple and straightforward as it usually is.

I feel a separate story on the risks that still surround Australian banks is necessary. Watch this space.

Rudi On TV

My weekly appearance on Your Money is now on Mondays, midday-2pm, but due to the February reporting season I shall remain absent both on Monday, 18th February and on 25th February. I'll resume on Monday, 4th March.

I should also appear on Wednesday, March 6, 2pm to discuss the February reporting season.

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 Monday and Tuesday 25-26 February 2019. It was published on the Tuesday 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: info@fnarena.com or via the direct messaging system on the website).

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(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.) 

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