Rudi's View | Mar 21 2019
In this week's Weekly Insights (published in two parts):
–Central Banks Keep The Worries Away
-BC *Extra* Puts Small Caps In Focus
–Changing Climate Has RBA's Attention
-February Reporting Season: Final Observations
–Rudi On TV
–Rudi On Tour
[Non-highlighted parts will appear in Part Two on Friday]
By Rudi Filapek-Vandyck, Editor FNArena
Central Banks Keep The Worries Away
One of the curious characteristics of the 2019 rally in global equities is that while most commentators have been zooming in on the AbFab V-shaped performance against all odds, in the background investors have been withdrawing their money, leading to quite large net outflows which tend to indicate widespread unease and discomfort rather than the bullish view and optimism one might infer from face value index performances.
This observation has led to at least one strategist (Citi's Robert Buckland) to conclude "Buybacks, not investor inflows, now drive the US market".
While part of the global money flows can be explained by investors preferencing passive ETFs over active fund managers (unsurprisingly given many of the latter's dismal performances in 2018), outside of the US money continues to flow out of markets in Japan, China and the rest of Asia, as well as away from equities in the UK and Europe.
Bonds are the biggest beneficiaries, believe it or not. So much for the Armageddon predictions by all too eager inflation hunters and otherwise end-of-bond-bull-market doomsayers. More stimulus from central bankers ("expectations of") means bond yields go down, thus bond prices move up.
Whereas 2018 proved a rather difficult year for global bonds, at least as far as money flows are concerned, net inflows for global bonds have been positive in each of the first three months thus far in 2019.
So where does this leave us regarding prospects for equity markets?
If we take a negative view, we could interpret the latest global industry data as a firm warning signal; investors, clearly, are sceptical about whether equity indices should be at current levels. Global economic growth is still decelerating, and Trump's USA is no longer the exception.
In Australia, it's easy to get excited by a recovery in banks share prices and ongoing strong gains by large mining stocks, but investors should not lose sight of the fact the February reporting season, underneath the apparent share price responses, wasn't good; it wasn't good at all. If anything, February exposed more headwinds and weaknesses than most of us were expecting.
However, there is also the opposite view, in that if investors now have a large chunk of their cash outside of equity markets, this can potentially provide a big boost to markets if some or most of that cash starts flowing back in.
I am rather sceptical whether a trade deal between the Trump administration and China will be the catalyst for such a move. But an unexpectedly stronger performance from major economies certainly can. To borrow from US Fed communiques since 2016: markets remain data dependent.
It is mostly a mug's game trying to predict short term directions of equity markets, but I haven't been too worried thus far in 2019. Yes, the V-shape recovery has come very quickly, and there are more than just a few reasonable question marks behind it all, but central bank support has proved such a powerful instrument in the post-GFC environment, it is almost an art not to let complacency take over in full.
The reasoning that is currently supporting equities globally is that economic data might still be looking ugly for the time being, central bankers in China, the US, Japan, the UK, and in Europe are ready, or have already started to reverse course and offer support to economies and equities.
In Australia, as we all know now, most economists with egg on their face having predicted interest rate hikes post 2016 are now forecasting one or two cuts later this year or in 2020.
Not everyone is convinced this will stop the downtrend in low quality apartments and consumer spending, but the share market is prepared to take a rose-tinted view towards the second half of the year, and this is why bad news and a less than stellar local reporting season have nevertheless allowed the ASX200 to surge near the post-GFC high from August last year, and not sell-off in a hurry since.
In the US, there seems to be an iron-clad conviction that profit growth for American companies will accelerate again later in 2019. As long as conviction in these projections remains intact, we can but wonder how much downside risk is there in the absence of adverse developments and left-field surprises?
A while ago, analysts at Citi devised a Bear Market Checklist for global equities, which is largely based upon the experiences from the early 1990s, 2000-2003 and 2007-2009, and we should all know history might rhyme but it never repeats in exact the same fashion. Nevertheless, updates to the Checklist are usually widely copied, republished and distributed by investors who like to add some substance to their own share market optimism.
This month Citi has launched a similar Bear Market Checklist specifically for US equities. I think we can all agree on the fact that the outlook for the local share market is very much dependent on what happens in the USA, hence the importance of this new indicator.
As it turns out, the new Bear Market indicator seems to suggest conditions are nowhere near dire enough to worry about the next bear market for US equities.
The signals from all 20 variables in this new US Equity Bear Market Checklist as at 7 March 2019 are shown in the table below. There are no variables in the Danger zone and four in the Caution zone. The total score is not even close to worrisome levels. In 1990, 69% of the factors were highlighting risk, while in 2000, the number reached 89%. In 2007, it was 55%. The current reading (4 Caution signals out of 20 variables) is only 20%.
Nothing here suggests we can take this indicator at face value and simply forget about what happens next or in the rest of the world. What has Citi strategists worried, a little at this stage, is the fact that the Fed's latest Senior Loan Officers' Survey was disappointing. If this is now setting a new trend, less availability of credit might indicate the forthcoming economic performance for the US is more likely to disappoint, irrespective of the Federal Reserve deciding to sit on its hands and stop shrinking its ginormous balance sheet.
This would place one big question mark over those optimistic projections for US corporate profits in the second half, and probably -all else remaining equal- put downward pressure on equity prices.
But we're not there yet. Far from it.
Changing Climate Has RBA's Attention
Central bankers like to operate on a low public profile. They in particular don't like to be pulled into the messy processes of domestic politics, which is why last week's public speech by Guy Debelle, Deputy Governor at the RBA, should have every investor's attention.
The speech is titled "Climate Change and the Economy". Given everybody inside and around the RBA would have been well aware of the potential for becoming implicated in local politics, with NSW elections this coming weekend and Federal elections not far off after, the brazen and candid manner in which this "hot topic" has been addressed by the number two at the most important financial institution in the country…, well, need I really spell it out?
The RBA is sending a clear and powerful message to everybody who is paying attention.
I hope this includes you too.
For good measure: the RBA is not playing local politics, and neither should Australian investors (not when it concerns their investment portfolio). This is not about whether you are a conservative, a hardliner, somewhere in the middle, or at the extreme left. This is about taking responsibility in the management of your investment portfolio by acknowledging there is a new type of risk, and you need to address it.
In the words spoken by Guy Debelle, what we are dealing with today can no longer be viewed as "cyclical"; long term trends are changing. This means any impact can no longer be interpreted as "temporary". Instead, investors have to start thinking in terms of long term impacts, if not permanent changes.
The implications are broad and varied, affecting the way businesses structure and run their operations, to how investors treat and value these businesses, to how governments prepare and respond, and to how central banks set interest rates and inflation/unemployment targets.
Ultimately, Debelle's speech makes it very clear, this is no longer a problem specifically for grape growers and milk farms and other types of agricultural companies and their suppliers and insurers; this is now a major change affecting whole economies and everybody who lives and works and operates in it.
Be smart. Deal with it.
The RBA is far from a front runner when it comes to putting the changing climate on its policy and analysis radar. Put APRA and climate in Google search and you'll find the local regulator for the financial sector has been addressing the topic for at least two years now, and with multiple repeats.
Debelle's speech can be downloaded from the RBA website:
I highly recommend you do. Read it multiple times. Observe the implications of the chart on page eight. China is less and less reliant on coal for its energy usage, and more and more on renewables. To borrow from the RBA's core message: while these are long-winded processes, this is not cyclical. This is a long term trend changing.
FNArena started its own ESG Focus section on the website in 2018:
If you are truly interested in what is happening in the world of coal, I highly recommend reading the stories FNArena has published thus far (including one on Tuesday morning). I cannot speak highly enough of the research and analysis done by journalist Sarah Mills, with more follow-ups in the offing. I think Sarah is doing a fan-tas-tic job.
Ultimately, for investors, this is not about making a political statement. This is about adapting to a rapidly changing world. FNArena, the RBA, and APRA, are merely providing tools and a framework. The rest is up to you.
Rudi On TV
My weekly appearance on Your Money is now on Mondays, midday-2pm.
Rudi On Tour In 2019
-ASA Sydney Investor Hour, March 21
-ASA Melbourne, May 1
-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 19th March 2019. Part One 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. Part Two will be published as a story on the website on Friday).
(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: firstname.lastname@example.org 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.)