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Bonds Add To Uncertainty

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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 | Sep 19 2019

Dear time-poor investor: an assessment whether the bond market induced momentum switch for equities spells more trouble ahead?

In this week's Weekly Insights:

Bonds Add To Uncertainty
-Dividend Cuts, They Are Coming
-Rudi Talks
-Rudi On Tour

Bonds Add To Uncertainty

By Rudi Filapek-Vandyck, Editor FNArena

Investors should draw an imaginary elastic band between share prices of, say, Goodman Group ((GMG)) and Scentre Group ((SCG)) as that will help them in understanding current dynamics in the local share market.

We've all heard and read it before: the share market is heavily bifurcated; general indices no longer tell the full story about what is going on in equities. What we are not often told about is that the gap between the Winners and Losers in the share market, between those shares that are fully participating in this year's bull market and those that are not, the laggards, that gap at times stretches out too far.

Hence why I think the comparison with an imaginary elastic band is but apposite. Whenever the gap stretches out too wide, next follows a snap back that closes the gap, somewhat, and up until this month only temporarily.

I picked Goodman Group versus Scentre Group because, to be honest, those were the two opposites that first came to mind. As the chart below shows, since January the share price of the laggard (Scentre Group, in orange) has weakened slightly while Goodman Group shares (blue line) torpedoed onwards and upwards to a gain, excluding dividends, of no less than 90% by the time FY19 results were released in August.

Maybe I should emphasise this gap between both share price performances captures no more than eight months. That's how pronounced the differences in relative performance have been between the Haves and the Have Nots in today's share market.

And here comes the ultimate surprise: according to the stockbroking analysts covering both stocks, one is currently representing good value, and the other is not. Post the pull back in recent weeks, it is Goodman Group that looks like excellent value with the shares now trading some -14.5% below FNArena's consensus price target whereas shares in Scentre Group, despite not having performed too well thus far in 2019, are trading ABOVE consensus target price.

In days gone, both stocks would have been treated as beneficiaries from falling yields on government bonds. These days, Goodman Group is seen as a leveraged beneficiary from growth in online retailing (it is a direct contractor to Amazon) as well as from investors' hunger for yield (through the company's funds management operations).

Scentre Group, on the other hand, is facing serious fall-out from smaller retailers falling victim to changing spending patterns and competition from online, while big box retailers including David Jones, Myer, Big W and Kmart are renegotiating better leasing terms, while also reducing their floor space inside shopping malls.

Property analysts at BIS Oxford Economics recently predicted owners of shopping centres might be facing a decade of intense pressure affecting their cash flows, profitability and asset valuations. Research likes that perfectly explains as to how the broader investor community currently views the diverging growth paths, and overall risk profiles, for opposites inside the broad property sector in Australia.

As said, there are clear Winners and Losers. Value investors should not automatically assume the latter represent the better investment opportunity, not even after the gigantic gap in performance as illustrated above.

Investors should note also, Goodman Group's story has been supported by higher growth and management upgrading forward guidance while Scentre Group's earnings per shares have been trending south and still analysts see no growth acceleration on the horizon.

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Quality bond proxies that have seen their growth accelerate, such as Goodman Group, but also including the likes of Charter Hall ((CHC)), Transurban ((TCL)), Atlas Arteria ((ALX)) and Viva Energy REIT ((VVR)), are not the only ones that have enjoyed the tailwind from falling bond yields in the share market.

Quality, reliable, structural growth achievers have equally been among the Winners. Investors only have to look up price charts for companies including CSL ((CSL)), ResMed ((RMD)), REA Group ((REA)) and Seek ((SEK)) to provide plenty of evidence, as have been emerging business models with a long-winded growth profile, including WiseTech Global ((WTC)), Jumbo Interactive ((JIN)), Altium ((ALU)) and Afterpay Touch ((APT)).

It can even be argued that reasonable dividend payers have been among the Winners, as long as they didn't carry too obvious problems or obstacles. Think Telstra ((TLS)) post TPG Telecom and NBN threats, and QBE Insurance ((QBE)), as well as Star Entertainment ((SGR)) post restructuring, and supermarket owners Woolworths ((WOW)) and Coles ((COL)).

In each case, our imaginary link with laggards such as Boral ((BLD)), Whitehaven Coal ((WHC)), Vicinity Centres ((VCX)), Unibail-Rodamco-Westfield ((URW)), Incitec Pivot ((IPL)), BlueScope Steel ((BSL)), Cimic ((CIM)), and many others had arguably stretched out too far.

This is why the August reporting season story has been disrupted in September. Usually, the Winners of the season continue enjoying the halo-effect for many weeks after releasing positive results. But those Winners of the season already were mostly trading at multi-year highs, at an oversized premium vis-a-vis the loser-laggards.

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What we are experiencing in the share market this month is a narrowing of the stretched out elastic band between Winners and Losers; call it a "correction" if you like. The last time something similar happened was in September last year, when more or less the same set-up was achieved during the preceding August reporting season.

That particular correction quickly morphed into a severe downwards maelstrom that pulled equity markets globally down by double digit percentages, and it didn't spare the Laggards, so investors will be just a tad nervous upon the repeat this year, looking out for any signs that share markets in general might possibly pull back much deeper in the days, weeks, or months ahead.

Value investors whose portfolios are filled with Laggards must be hoping for a repeat of late 2016 when a five-month long readjustment in market positioning pushed down share prices of CSL, REA Group, Goodman Group and the likes by -20% or more while pushing up share prices of Laggards by similar magnitude.

One observation that should concern us all is the rally in bank shares over the past weeks had pushed share prices for the Big Four in Australia above consensus targets, with CommBank's ((CBA)) valuation premium stretched out beyond 11%. I am well aware of the better signals coming from housing markets in Australia, and of consumer spending picking up a little, but I am not convinced there is a whole lotta improvement around the corner for Australian banks.

CommBank's consensus target declined a little in August. Just saying.

During times of less share market polarisation, I discovered one way to gauge whether investor sentiment had become too exuberant was through comparing share prices for all Big Four banks with respective consensus price targets. If they are all trading above target, it is time to adopt a more cautious approach.

This used to be an extremely accurate indicator pre-GFC. This time around, investors will be hoping any exuberance that has crept into bank share prices in Australia will only affect banks as a sector, and not the share market in general.

I know, valuations don't count for much when macro and geopolitical uncertainties dominate, but just as an observation, on Monday Rio Tinto ((RIO)) shares are still -7.5% below consensus target, CSL shares are -5% below target, and the earlier mentioned Charter Hall shares are by now more than -19% below target.

From a pure valuation perspective, it doesn't seem there is a lot of irrational exuberance priced into this share market, a few pockets here and there potentially being exempt from this generalised observation.

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Similar as last year and in 2016, the trigger for this month's correction in the relative valuation gap between share market Winners and Laggards is the US bond market. The yield on 10 year Treasuries had tumbled from 2.60% in April to 1.46% in August (meaning bonds have rallied strongly). That yield has now quickly risen back above 1.90%.

The Big Question now is whether this bond market "correction" has much further to play out, or not?

Short term further developments are anyone's best guess due to momentum trades, robotic execution, shorts and longs, and multiple factors impacting, including portfolio positioning. Medium to longer term, however, I'd still be expecting lower bond yields. This because central bankers are still loosening, there is no sign of governments joining in with fiscal stimulus, and inflation should not be an imminent problem either.

An economic recession might not necessarily be on the horizon, but the global economy is slowing. A sudden spike in oil prices, irrespective of how long it may last, is hardly a positive in this context.

Arguably, bond investors/traders had pushed the theme of global deceleration and monetary loosening too far too quickly, and that is now being corrected.

For what it's worth, Amundi, Europe's largest asset manager operating from France, recently tried to define a range for ten year US Treasuries for the year ahead. On Amundi's assessment, the US ten year yield should range between 1.60% and 1.80% by this time next year. If even remotely correct, this suggests the August-September US bond market correction might already have gone too far.

Amundi did have one stern warning for investors in equities: watch those corporate earnings. If they fall, equities are likely to follow (in particular if, for whatever reason, bond yields are rising at the same time).

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For investors the message is clear: it might be best to stay cautious and not too risk-exposed, but don't see the current switch in relative momentum as a lasting new trend. Share prices that are falling today can easily land back in buyers' favour tomorrow, or next week.

Meanwhile, the risk for a general risk-off pull back is always present. In particular with so many uncertainties yet to be resolved, including the risk for further deterioration in economic data and corporate earnings.

The August reporting season has clearly spelled it out for investors: large parts of corporate Australia are under intense pressure. This creates tangible and elevated risk. August hasn't been labelled the worst reporting season post-GFC for nothing.

Fittingly, perhaps, Sims Metal Management ((SGM)) issued a profit warning on Monday, with its share price subsequently squandering most of the gains booked on the back of a less-bad-than-feared result update in August.

Make sure you read Part Two of this week's Weekly Insights: "Dividend Cuts, They Are Coming", to be published on the website on Friday morning.

Rudi Talks

Audio interview about the share market last week:

https://www.youtube.com/watch?v=bdF_Ygh_nxc

Last week's video interview with Peter Switzer:

https://www.youtube.com/watch?v=tu3tE08bL2c

(I appear around minute 11 for circa 12 minutes)

Rudi On Tour In 2019

-AIA and ASA, Perth, WA, October 1

In 2020:

-ASA Hunter Region, near Newcastle, May 25

(This story was written on Monday, 16th September 2019. It was published on the Monday in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two this week will be written on 18 September and published 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.) 

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