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Bonds Are Crying Wolf

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 | Mar 28 2019

In this week's Weekly Insights:

-Bonds Are Crying Wolf
-Conviction Calls
-CSL Challenge: The Real Challenge Is Inside Us
-Have Your Say – The CSL Challenge

Rudi On TV
Rudi On Tour

By Rudi Filapek-Vandyck, Editor FNArena

Bonds Are Crying Wolf

At risk of quoting the wrong investment legend, which is why I am sticking with anonymous, a smart cookie once observed that only after the infamous stock market crash of 1987 did investors the world around start worrying about the potential for a crash.

In similar vein, I'd like to put forward that selling risk assets because you might be worried about the world and the US economy sinking into recession looks well behind the curve at this stage. It is for this reason that commodities and equities sold off in the final four months of calendar 2018.

The world has seen a few dramatic changes since, and this has allowed for a quick V-shaped recovery. The first one is a significant policy change at the Federal Reserve, which not only has abandoned its intention for two more rate hikes medium term, Powell & Co have also decided that balance sheet reduction is no longer of the highest priority.

On top of this, the ECB is essentially back to being ready to re-start Quantitative Easing, while central bankers in New Zealand and Australia are watching further developments very closely in case domestic interest rates might need to be reduced. China already is stimulating its economy. The Japanese have shown no sign of ever quitting their perpetual QE policy.

The chart below has featured prominently in my on-stage presentations to investors this year. It shows why financial markets lost their nerve in the final quarter of calendar 2018; leading indicators for the US and for the global economy kept on weakening, and by the end of the year they were accelerating into negative territory.

The chart above shows one leading indicator for the US economy, but the situation was similar for the global economy as a whole.

There is an important similarity with two prior periods when leading indicators fell below the zero/neutral line. In early 2016 an imminent crisis was averted after the Federal Reserve, back then chaired by Janet Yellen, communicated to the market it would take a much more patient approach in normalising the cash rate back to neutral.

Back in 2011-2012 the crisis was all about Greece, and debt, and potential disintegration of the eurozone and it wasn't until Mario Draghi, president of the ECB, declared on July 26, 2012 he would do "whatever it takes" that worst case scenarios got buried and forgotten about.

Most importantly, and as shown on the graphic above, in each case economies recovered and so did risk assets. Until central bankers started "normalising" again, which in modern times means they reduced the virtual printing of money and even dared to start shrinking their bloated balance sheets.

Nobody really knows for how long this process can continue without creating the next financial crisis, if that is the inevitable end result of all this central banking Houdini-magic. But the impartial observation is that it has worked on both prior occasions, and it is likely to exert its magic again this time around.

The leading indicator that is shown on the graph above as falling steeply has already tentatively reversed course, posting a small rise in January. This, all else remaining equal, should in a while from now show up via improving economic data and indicators, feeding into market confidence that, yet again, worst case scenarios have been averted.


It is generally accepted that bond markets represent more wisdom and gravitas than equity markets where daily sentiment and other factors of lower quality and sustainability can more easily grab the upper hand, certainly in the short term.

There is therefore a general acceptance that if ever a conflicting message is provided by movements in bonds and equities, wise investors take guidance from the former over the latter.

I would fully back up that view. But no market is infallible. And bonds do at times interpret the world incorrectly. This time might be one such example.

Or maybe the bond markets are not wrong, but the humans trying to interpret their message and its consequences are too much relying on the past?

What if bond markets are anticipating more Quantitative Easing from central banks, starting with the ECB in Europe? In that case, bond yields need to go lower, and investors believing a recession is on the horizon might panic out of equities and commodities. But if central bankers succeed in their quest, that will prove to be the wrong decision.

A recent study of bond market behaviour by analysts at Macquarie supports this view. Bond markets, reports Macquarie, in 2011 and 2016 troughed some 3 months later than equity markets, whereas further back into the past, bonds used to lead risk assets, not lag.

The problem post 2011-2012 is, of course, that central banks are very much engaged and actively intervening. It is well possible that, for the time being, bonds have lost their accuracy and their leading role, not to mention their predictive powers. This time around, suggests Macquarie, the observed lag might get even longer as some investors anticipate not only rate cuts but also the return of QE in response to slowing economic growth.

With other indicators such as copper, iron ore, and, yes, global equity markets themselves suggesting things have actually started improving for the global economy, Macquarie analysts firmly suggest this time around investors should back those indicators instead of bonds.


None of the above means equity markets can never ever experience another sell off or meltdown. The last near abyss experience only ended less than four months ago. But it does appear that fears for the next recession are both late and premature.

The one scenario I am most worried about is that central bankers' race to the bottom might somehow feed into a much stronger US dollar, and this almost by definition will trigger money outflows for commodities, emerging markets and likely US equities as well.

Central bankers might feel like they're acting as the proverbial cavalry storming over the hill whenever things get hairy in the real world, but they do not meticulously control everything under all circumstances.

And yes, QE really has put those central bankers in a situation from which there simply is no easy escape. But that's a narrative for another time.

P.S. buy gold if you are really worried the end of this monetary experiment is nigh, and it won't be pretty.

P.P.S. Yield is in, not out. (But be wary of shopping mall owning REITs – see Premier Investments last week).

Conviction Calls

Morgan Stanley strategists have reiterated their view the Australian economy is due for a much longer slowdown than currently is being forecast by market consensus and the Reserve Bank of Australia.

With the Federal election and government budget upcoming, including hand-outs from a government keen to use all options to possibly avoid getting voted out, the RBA is likely to wait and see, and therefore poised to come to the stimulus party too late later in the year and in 2020.

The result is that earnings growth for corporate Australia will remain under pressure for longer. Morgan Stanley's modeling suggests investors should prepare for continued downward pressure as far out as late 2020, with possibility of a true blue earnings recession along the way.

The strategists have pulled back their year-end target for the ASX200 to 5800 from 6000. Industrials ex-financials with a domestic focus in particular have been singled out as the most likely victims on the Australian share market.

Morgan Stanley advises investors should remain focused on owning defensive industrials, preferably with an offshore bias, and resources stocks. The latter because the strategists continue to put their faith in the effectiveness of more China stimulus. Most preferred defensive industrials include healthcare stocks and insurers.


Stockbroker Baillieu (it's not clear what their exact name is these days) has used the February reporting season to put forward a number of Top Stock Picks in the small and mid-cap segment of the Australian share market.

Among the suggestions made are Village Roadshow ((VRL)) and Galaxy Resources ((GXY)), both essentially being selected on the basis of "the future can only look better", but also EML Payments ((EML)) and MNF Group ((MNF)).

Amongst all the excitement regarding Afterpay Touch ((APT)), Zip Co ((Z1P)) and Splitit ((SPT)), investors might have missed the new contract wins at online loyalty programs and payments facilitator EML Payments, which should translate into hefty growth numbers for the years ahead.

EML Payments mainly serves customers in the wagering and salary packaging industries, with locally William Hill using its infrastructure to facilitate bets and payments by and to Australian punters. Baillieu thinks the onus is to the upside in terms of growth. It rates the stock Buy with a price target of $2.40.

MNF Group already enjoys a small army of loyal shareholders among small cap specialists, including formerly Contango now Naos Asset Management, so Baillieu analyst Luke Macnab is certainly not alone with his lofty expectations.

Describing MNF as "effectively the fifth telco of Australia", Baillieu finds MNF is best aligned with the rapid digitisation of telco services both domestically and abroad. MNF predominantly provides wholesale services to other telcos and to businesses across Australia with its cloud based virtual switchboard a cheaper and more efficient solution for many.

The company bought its nearest competitor last year (wholesale operations from Inabox Group ((IAB)) and the synergies to be achieved should underpin the tech-telco's strong growth profile in the years ahead. Recurring revenues are increasinly becoming a dominant feature.

Baillieu has a Buy rating for MNF, with a price target of $5.43.

CSL Challenge: The Real Challenge Is Inside Us

Two weeks ago, for my regular appearance on the free-to-air Finance TV channel now known as Your Money (formerly Sky News Business), I got teamed up with Mark Moreland from Team Invest.

Mark and I usually engage in friendly and sarcastic banter, both knowing we agree on many things about investing and the share market, but there is lots we will disagree on into eternity.

At one point during the broadcast Mark confessed he once upon a time owned shares in CSL ((CSL)), but then he sold out when the share price had reached $55, and subsequently never managed to get back on board.

I am not having a go specifically at Mark (I am sure he has many more profitable examples of investments made) but I instantly understood this is a prime example as to why investing in the share market is so much of a personal journey.

I have little doubt Mark believed at that time CSL shares had become too expensive, and they were poised for a fall too big to continue holding them in his portfolio. Instead, as we know now, CSL shares multiplied by a factor 4x over the subsequent five years.

The point I think is worth highlighting here is how our human mind works, creating barriers that become mountains we are unable to overcome. Having sold at $55, Mark could have bought back in at $70, or at $92. He could have re-joined at $140, or even at $178. But he never did, and two weeks ago he blamed himself for it.

Selling CSL shares at $55 was a bad decision, even though Mark had made a profit. Never getting back in was even worse a decision.

For investors, Mark's story serves as a reminder of how we build pivot points in our mind, which become barriers, and we get sucked into the short term myopia, telling ourselves we should be focusing on the long term, but we are obsessed with the here and now, which impacts on our vision and the investment decisions we make.

The other point to make is that short term Price Earnings (PE) multiples, or other forms of valuation measurements, can be quite deceiving for the simple fact they are short term. I note similar dynamics have kept investors at bay for high quality, robust growth stories including Altium ((ALU)), TechnologyOne ((TNE)), NextDC ((NXT)), Xero ((XRO)), and Aristocrat Leisure ((ALL)), to name but a few names on my own radar.

It's worth pointing out that while most research and analysis focuses on macro, trends, valuations, forecasts, et cetera the real enemy is hiding mostly inside us, not inside day to day share market volatility. It's there that the real challenge lies.

Have Your Say – The CSL Challenge

It's probably one of my key achievements since starting FNArena in 2002; to get investors interested in owning shares in CSL ((CSL)) and similar robust, high quality, sustainable growth stories, in defiance of general perception that stocks trading on a high PE multiple can never be owned but for a short term momentum play.

Over the years I have received many supportive emails and vocal encouragement from FNArena subscribers and investors elsewhere. At the end of last week's presentation to ASA members in Sydney, one elderly investor approached me with the words "CSL is such a wonderful company, why would you ever sell it?"

I think time has arrived we started sharing some of those stories with investors who are new to the CSL Challenge. From investors to investors. I am hereby asking those who own CSL shares to write down their motivation, memories, experiences, et cetera in order to share them with other investors.

Make it as detailed/generalised and as long/short as you like. Send it to, preferably with reference "CSL Challenge".

You don't have to do it completely pro bono. An innocent hand at the FNArena office will pick at random three contributions that will receive one bottle of wine each. To be eligible, make sure you also indicate whether you prefer red, white or rose. We'll pick one winner for each choice.

I'd say we close this invitation by April 15th, but let's not procrastinate too long. Get onto it right away! We take care of the wine selection.

Rudi On TV

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

Rudi On Tour In 2019

-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 26th March 2019. It was published on the day in the form of an email to paying subscribers, and will be 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).



Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
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Subscriptions cost $420 (incl GST) for twelve months or $235 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible):

(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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