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Rudi’s View: Citadel, Stockland & Expert Warnings

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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 | May 31 2019

In this week's Weekly Insights (this is Part Two):

Conviction Calls, Part I
-In Quality We Trust
Conviction Calls, Part II
-Rudi Talks

-Rudi On Tour

[Non-highlighted parts appeared in Part One on Thursday]

By Rudi Filapek-Vandyck, Editor FNArena

Conviction Calls, Part I

Asset managers at AXA Investment Managers are touring Australia this week and their central message is that, maybe, investors should start preparing for more volatile, tougher times ahead.

AXA IM itself, which manages some EUR750bn globally both for the French headquartered insurer and for institutional and retail investors (institutions only in Australia), has adopted the view that the current economic expansion in the USA and elsewhere is getting long in the tooth. AXA suggests it's time to start positioning for a different context for equities globally.

While acknowledging the past years have been fairly atypical with bond yields at all-time lows (if not negative) and with central bankers actively supporting risk assets, AXA managers still maintain attention should be paid to the historical cycle for corporate earnings. The typical cycle framework below was presented during a briefing with the local press on Monday.

It suggests that "value" investors might have to wait a whole lot longer until "low volatility", "positive momentum" and "quality" hand over the baton for leading performances in shares.

If AXA's assessment is correct, we are currently at an undefined point in the Late Cycle phase, implying at some point the economic cycle will turn for the worse, forcing investors to hide in stocks that look safer, carry less risks, are more reliable and robust, and less vulnerable to loss in economic momentum.

Interestingly, when asked about the observation that it might not have happened before that stocks of high quality are also trading on higher than usual valuations, Kathryn McDonald, Head of Sustainable Investing at AXA IM Rosenberg Equities, responded she still believes the underlying dynamics as represented on the stylised cycle overview should still prove valid.

If one looks closer into what is happening inside most of the world's quality companies, McDonald explained, one finds they are mostly not as expensive as they appear at face value. Even so, cheaper "value" stocks should prove more vulnerable when darker economic clouds announce themselves, so there's little use in trying to hide in cheaper valuation just for the sake of it.

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AXA IM is not the type of manager who tries to put a precise timing on the next turn in the cycle, unlike strategists at investment bank Morgan Stanley whose view about the outlook for equities can be summarised as: see AXA IM's cycle assessment with exact timing being: now!

Two concerning observations stand out from the US strategy team's latest update: the Federal Reserve already has tightened a lot more than the average analyst/investor appreciates, and Morgan Stanley's proprietary, adjusted for QE and QT, US bonds yield curve implies the curve has been negative since November last year, and remains deep in the negative today.

Investors will be hoping the internal modeling at Morgan Stanley is not quite correct because history shows an inverted yield curve that stays inverted for this long is always followed by an economic recession. Which is why Morgan Stanley strategists warned their clientele this week not to get carried away by trade war hopes, Trump tweets, Q1 better-than-feared corporate profits and a Federal Reserve that has pressed the pause button in response to share market turmoil.

[Special note: since publication of Morgan Stanley's research note the US bond market has moved into an inverted yield curve without adjusting for QE/QT]

We are now officially on "recession watch", the strategists declared, explaining underlying momentum for the US economy had been weakening even before the current trade conflict with China captured newspaper headlines. One forecast stands tall: volatility is about to rise significantly. In addition: the next move from the Fed will be to cut interest rates, as implied by the bond market.

Economic data will get weaker. Corporate profits are poised to disappoint in the quarters ahead. Morgan Stanley's proprietary US Cycle Indicator is now, for the first time since late 2007, signalling a new downturn is emerging.


The strategists point out the early downturn assessment occurred on input data from April, which is before the Trump-China trade talks broke down. They add the OECD leading indicator has now fallen to its lowest level since the last recession. In addition, recent Market PMIs for the US are the lowest readings since the Great Recession.

A whole lot of confidence in the US is based on a general prediction the US economy and corporate profit growth should look a lot better in the second half of the calendar year. Morgan Stanley strategists believe this market confidence is about to be hit by a cold hard reality check.

Coincidentally, Emerging Markets analysts at Citi this week reversed their view now favouring risk to the downside on noted loss in economic momentum. A resolution in the trade spat between US and China can reverse this, as it would translate into a weaker USD, say the analysts.

Economic modeling by Morgan Stanley suggests continuation of US trade tariffs will pull both the economies in the USA and China on the verge of recession late in 2019. They also are concerned that it will take economic signalling, followed up by financial markets, to reignite negotiations with a stronger incentive to actually reach a concrete agreement between the two protagonist countries.

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Fund managers at Wilsons Advisory and Stockbroking recently moved to reduce risk in respective model portfolios. Portfolio positioning is now underweight US equities, neutral Emerging Markets equities, underweight European equities, and with overweight positions in cash and fixed income (bonds).

Notably, Wilsons made no changes in positioning towards Australian equities, expecting the Australian share market from here onwards to perform better than offshore peers with a preference for domestic oriented business models.

The prime reason behind this change in preference is, of course, the fact that RBA and APRA are now in coordinated stimulus to stop the slide in the domestic housing market, while the freshly re-elected government should (at some point) join in with fiscal stimulus for low-to-middle income groups.

"Australia", notes Wilsons, "is in a fortunate position in that we have room to stimulate the economy through fiscal policy. Among the developed economies in the G20, Australia's fiscal balance as a percentage of GDP is the second best, beaten in our frugalness only by Germany."

Higher for longer iron ore prices are boosting the federal government's coffers, creating a rather large windfall that provides options for ScoMo's team in Canberra to ease the tax burden on income earners. On my observation, it has been a long while since asset managers preferenced Australian shares over international equities.

Investors would have noticed the Australian share market has outperformed overseas markets since that surprise outcome from the federal election.

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Similar considerations are behind the decision by Australian strategists at Citi to raise their year-end target for the ASX200 to 6700, from 6500 previously, and to 6850 for mid next year. Citi's revised targets imply the ASX200 will finally break through the GFC high from late 2007. It will have been, by then, more than 12 years, and that's assuming Citi's projections will materialise.

Shorter term, Shaw Stockbroking chief investment officer Martin Crabb observes both US and Australian equities have outperformed the world index over the past twelve months with returns of 5.63% and 2.32% respectively. In comparison, Japan is down -11.5% over the period, while Europe ex-UK is down -4% and Emerging Markets have clocked losses of -9.4%.

Crabb highlights Australia's performance has not been backed by commensurate increases in earnings estimates, with iron ore producers pretty much the sole segment continuing to enjoy upgrades to forecasts. This makes the Australian share market "really expensive" on a global basis, suggests Crabb.

On a 12 month forward PE comparison Crabb believes Australian shares are now trading at an 8% premium vis a vis international equities. He thinks this is a time and context to be rather cautious.

Conviction Calls, Part II

Analysts at Wilsons don't like companies that issue profit warnings; in particular not when the company has been selected as a Conviction Buy for the year ahead.

And thus the only logical decision to make when Citadel Group ((CGL)) issued its surprise profit warning earlier in May was to downgrade its rating for the stock, while also removing it from its core model portfolio. The downgrade to Hold with a reduced price target of $4.50 implied the stock could not be maintained on Wilsons' Conviction Calls list either.

What irked Wilsons analysts most is they had been in contact with management recently, and guidance for the current year had been all but confirmed at an investor conference at the start of the month. The company's fall from grace comes with a stern warning there are now enough question marks to keep buyers at bay, putting the shares at risk of further de-rating.

In Wilsons' lingo this reads as follows: "We have seen this across the technology sector where surprise downgrades cause the stock to drift lower/underperform the market for multiple quarters post initial the downgrade." (sic)

Citadel Group had also been added to my personal selection of potential future All-Weather Performers. It has equally lost that spot too.

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Portfolio managers at Macquarie have made several changes post Coalition re-election in anticipation of an improving housing market. They added Stockland ((SGP)) but removed Mirvac ((MGR)) while focusing the exposure to local banks on National Australia Bank ((NAB)) and Westpac ((WBC)).

Investment returns from the construction materials sector have been the worst in decades, notes Macquarie, but with RBA rate cuts on the agenda it is time to increase exposure. Macquarie has added CSR ((CSR)) on top of its existing position in James Hardie ((JHX)).

Macquarie also decided to take profits in (reduce exposure to) Aristocrat Leisure ((ALL)), BHP Group ((BHP)) and Rio Tinto ((RIO)).

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Over at Citi, the surprise federal election result has encouraged recommended portfolio managers to increase the overweight position in banks, while also adding Harvey Norman ((HVN)) and Boral ((BLD)).

Citi also increased its exposure to Downer EDI ((DOW)) which just goes to show not everything can be foreseen and contractors in general remain a fickle industry to invest in. Downer shares tanked more than -9% on Wednesday after the company flagged it might be financially responsible for the Murra Warra windfarm project, now its German partner in the project has called in the administrators.

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Brian Johnson and Christopher Kightley, banking analysts at CLSA, refuse to budge from their Underweight sector recommendation irrespective of a number of positives occurring that have triggered a rally in bank share prices in the second half of May.

Both analysts maintain, despite the positives from RBA, APRA and Coalition government, operating profits across the sector are growing at insipid pace at best, which means share prices will at some point probably trade weaker too.

Banking sector analysts at stockbroker Morgans is of a similar view, arguing one month ago or so Australian banks seemed to offer good value, but now that underlying dynamics have received a boost, and post share prices rallying, the sector looks a lot closer to fully valued, suggest Morgans' analysts.

Morgans likes Westpac ((WBC)) the most, and National Australia Bank ((NAB)) the least.

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However, not everybody is singing from the same hymn sheet when it involves Australian banks, or even the Australian share market in general.

Market strategists at Deutsche Bank are keeping a bullish outlook and their suggestion to investors is to "let it run hot". Against a darkening international backdrop, stimulatory measurements locally will translate into outperformance for domestic companies and shares, Tim Baker and David Jennings predict.

Their recommendation is to stay Overweight Australian banks, as more RBA cuts will keep bad debts low, as well as Overweight offshore cyclicals as the weakening AUD should further support them, while Aussie yield continues to look attractive on a global scale.

Having said so, Deutsche Bank does believe the Australian share market has overdone it in the short term, so as a whole Baker and Jennings believe the major indices are probably looking at lower levels in the months ahead.

Deutsche Bank's model portfolio is Underweight resources. Recent changes made include adding Atlas Arteria ((ALX)), Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Medibank Private ((MPL)), Evolution Mining ((EVN)), and ResMed ((RMD)).

Stocks that have been removed from the model portfolio include Insurance Australia Group ((IAG)), Oil Search ((OSH)), Flight Centre ((FLT)), Downer EDI, Incitec Pivot ((IPL)), and Ansell ((ANN)).

The combination of APRA-RBA stimulus and a general reversal in sentiment throughout the general populace in Australia, with soon a stabilisation in property prices to follow, is making the managers at the Auscap Long Short Australian Equities Fund equally positive.

As a matter of fact, having attended Auscap's annual roadshow meetings for quite a while, this week's presentation in Sydney was by far the most bullish in the history of Auscap roadshow presentations on both my observation and on the manager's own admission.

Auscap is so bullish on the Australian economy, it doesn't understand why the RBA is cutting interest rates! (But they will).

The fund's current top ten holdings are Adelaide Brighton ((ABC)), Blackmores ((BKL)), Centuria Metropolitan REIT ((CMA)), CYBG ((CYB)), GDI Property Group ((GDI)), JB Hi-Fi, Mineral Resources ((MIN)), Nine Entertainment ((NEC)), Super Retail Group ((SUL)), and Unibail-Rodamco-Westfield ((URW)).

Auscap has this month been buying bank shares, for the first time in years, with Westpac shortly to enter the fund's top ten holdings.

Being a typical value-oriented investor, Auscap sees most opportunities among domestic oriented old economy stocks that are trading near post-GFC lows in terms of valuations, with the added requirement these companies are adjusting to the threat of modern interruptive technology-driven competitors.

Contrary to rising cash levels elsewhere, Auscap co-founder, principal and portfolio manager Tim Carleton gleefully declared the fund is fully invested (zero in cash), being indicative of how "genuinely excited" Auscap is about the outlook.

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Adding a final twist to the domestic investment story: on Friday, banking analysts at Deutsche Bank (not the same guys as those manning the market strategy desk) reiterated to Deutsche Bank clientele lower interest rates domestically are not helpful for the banks. They are creating more powerful headwinds for the sector.

Brian Johnson & Co would say "told you".

Rudi Talks 

Audio interview about investing in high quality stocks in the Australian share market:

https://www.youtube.com/watch?v=f9pTAV4TPJA&t=16s  

Rudi On Tour In 2019

-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 and Wednesday 28th & 29th May 2019. Part One was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two appears 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: 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.) 

(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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