Rudi's View | Mar 13 2020
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Dear time-poor reader: as global equities are experiencing their toughest time since 1987, let's all hope this doesn't turn into a repeat of the 1930s
By Rudi Filapek-Vandyck, Editor FNArena
One week ago, Gerry Harvey, founder of retailer Harvey Norman, reportedly instructed his stockbroker to invest $15m in 15 ASX-listed stocks, including the Big Four banks, BHP Group, Rio Tinto, Woodside Petroleum, as well as the retail company he still runs in close cooperation with his wife.
Within a few days, the $15m investment was worth -$1.5m less, and it would be worth even less today. Like every other investor who makes a decision that turns out ill-timed amidst extreme share market turmoil, Gerry Harvey is seeking solace in the knowledge he doesn't need the money tomorrow, and he has a long-term view.
According to the most recent AFR Rich List, Harvey's net worth is about $1.9bn. Most of us don't have a spare $15m, and we certainly cannot stomach a quick loss of -$1.5m, and counting.
Which is why the savviest advice to investors during any Bear Market -brief or long, shallow or sharp- is to make sure you are comfortable enough with your portfolio so you can still sleep at night and are not at risk of blowing up your career or family fortune. Nobody needs to be 100% invested at all times, but sitting 100% in cash might not be suitable either.
The "can I sleep at night" factor should never be underestimated. On Monday, I wrote there have been four Bear Markets post-GFC and while none of the three before the present one came anywhere near the length and the severity of the 2008 carnage, they all had in common that on some days, at times on successive days, literally nothing is guaranteeing your capital won't shrink.
Not gold. Not government bonds. Certainly not bitcoin. Only cash. Cash generates no income and no return (to speak of) but at least it doesn't depreciate by double digit percentage in front of our eyes, triggering responses on social media and headlines through financial media that have the ability to significantly impact on the necessary good night's sleep.
In the midst of sharply falling share prices, it is extremely difficult not to be affected, and this applies even more when it is your own money that is at stake. So rule number one is to remain as comfortable as one can be given the circumstances. If this means you'll be joining others in selling parts of the portfolio, so be it.
The shortest of the three previous Bear Markets consisted of four months of relentless selling in late 2018. And while some might have forgotten the severity of the selling that occurred back then, it was no different from what is happening in global equities today. Again, on Monday I wrote these Bear Markets last for as long as until authorities find a solution to stop the downward spiral.
Investors around the globe had become accustomed to the fact that central banks had turned themselves into the cavalry that comes galloping over the hill whenever the financial or economic situation turns precarious, but that won't work this time around. This time we need to see governments use their clout and their influence to stop the world economy grinding to a halt.
Earlier this week, I have to admit, I was still relatively comfortable with what had been happening in global markets because it was clear the necessary governmental response was forthcoming, on top of the fact that central banks will not stop cutting interest rates, including here in Australia, where Quantitative Easing, or QE, is becoming inevitable, so it seems.
The alternative acronym for QE in Australia is YCC, which stands for yield curve control which is essentially what all and sundry predicts will be the next step in the RBA toolbox; communicating with the bond market where it would like to see bonds trade at.
I am by no means suggesting governments in Europe, the US and in Australia will solve this problem quickly and we can all forget about it and continue with our lives, but at the very least, I thought, it might stop the relentless selling. As long as investors can have a reasonable level of confidence that we can avert worst case scenarios, for now.
Unfortunately, as I am writing these sentences on Thursday, it is clear that disappointment has overtaken market sentiment once again. It would appear some politicians have a much better understanding about what needs to happen than others.
Australia Got The Message
Let's start with the positive news first. The Morrison government has detailed a financial stimulus package roughly of the size of the Rudd stimulus back in 2008 (step one, when measured against the respective sizes of the domestic economy back then and today) and it is aimed at those who need it most; small businesses in strife and vulnerable consumers in distress. If it works, it'll keep Australia's unemployment numbers from shooting up (see apprentices, etc), while assisting small businesses with staying in business (the ATO is in on the act too).
With a healthy dose of luck, it might yet prevent a second consecutive quarter of negative GDP growth. The latter is being described as a technical recession by economists. It's the one event that Australia hasn't experienced since 1991; 29 years ago.
Note how I wrote "a second consecutive quarter of negative growth". Just about everyone is convinced the current quarter will print negative growth in Australia.
The second positive characteristic about the Morrison government's initiative is that it will be complemented by state governments putting in their own, additional effort. The third positive factor is the RBA is not going to stop trying either. Fourthly, and probably the most important factor for investors is that this will only be step one in the federal government's "keep Australia in business" program. By mid-year, as the world has hopefully put premium anxiety about covid-19 behind it, there will most certainly be a step two program aimed at reinvigorating economy-wide spending.
In effect, the Australian government's plan of action has a lot in common with the coordinated policy-response announced less than 24 hours earlier in the UK where the Bank of England cut rates by -50bp to 0.25% while the British government launched a package that includes unlimited funds for the healthcare sector to deal with covid-19, alongside a dedicated credit scheme for small businesses (SMEs) and households.
The government led by Boris Johnson opted for a stronger response to the crisis with fiscal measures and increased liquidity estimated at 16.5% of UK GDP. According to economists, the program will probably prove growth neutral, but it will provide a significant buffer to the British economy, and that should, in return, help to sooth market anxiety. New Zealand did the right thing too, and early.
It is clear behind the scenes G7 countries are coordinating efforts in order to address the broadening global crisis. The European Central Bank is expected to be in on the act as well. As is China.
Unfortunately, the disappointment du jour came from the US where germaphobe and self-declared genius President Trump announced a rather lightweight response to the crisis, which might actually depress economic activity more as a result of the 30 days travel ban slapped on Europe ex-UK. Not what markets were hoping to hear, and unfortunately disappointment from the US is outweighing any potential positives from elsewhere.
The Situation Can Get A Lot Uglier
Irrespective of short-term tribulations, investors should not underestimate the shift in global sentiment that is happening this month. What started off as a panicked response to an emerging pandemic, with many having a laugh about supermarket crowds going nuts hoarding toilet paper and hand sanitisers, has now led to investors and analysts zooming in on the global economic impact.
The immediate result is that, all of a sudden, the word "recession" has made a sharp come back. A global recession (irrespective of the exact methodology behind the term) is now seen by many as a near certainty. For investors, the key thing to understand is that such a recession is not yet priced in equity markets and corporate credit.
Even so, a recession can still be quick and shallow, instead of long and nasty as we experienced back in 2008. I would argue a coordinated response from central banks and governments from key economies can tip the odds in favour of the first scenario, but as the Trump administration showed on Thursday, there is no such thing as a guarantee in life, let alone during a Bear Market for global equities.
Incidentally, global suspicion is growing the US administration is simply not well-prepared to deal with this pandemic, and this feeds into fear the situation in the world's largest economy might yet get a lot worse.
What equity investors are grappling with (apart from sheer panicked selling) is the uncertainty about corporate earnings, both locally and overseas. The February reporting season in Australia showed the majority of ASX-listed businesses are struggling to find momentum, in best cases, or barely keeping it together in most cases. Add covid-19 and what will we end up with?
The dilemma for Australian investors is not made any easier since many portfolios are stacked with high dividend paying stocks, which might be about to reveal their weakness during economic duress. Cue G8 Education. Cue Southern Cross Media. Cue Scentre Group. Cue the Big Four Banks.
It goes without saying, weaknesses and vulnerabilities inside corporate Australia are not solely confined to high yielding stocks. Small cap miners or energy companies, biotechs with no recurring revenues, balance sheets with lots of debt and no certainty about level of earnings, technology disruptors that won't be able to maintain their high rate of growth; the list of companies best to avoid is a lot longer than for the companies that most likely will turn out just fine
And this doesn't even take into account the fact that, on days of peak anxiety, the good stocks will go down as well, while many a smaller cap stock might just get clobbered, because it's a small cap, irrespective of the company's outlook, history or credentials.
Look no further than Wilsons Conviction Insights if you want any evidence of the latter. Usually, the selection of stocks with High Conviction by the analysts at Wilsons is responsible for above average investment returns. Since inception, total returns per annum are running at 14.67% but in February the Portfolio of Conviction stocks deflated by no less than -18.20%.
Stocks included are EML Payments ((EML)), ReadyTech ((RDY)), Whispir ((WSP)), ARB Corp ((ARB)), Collins Foods ((CKF)), Nuchev ((NUC)), Integral Diagnostics ((IDX)), ImpediMed ((IPD)), Pacific Smiles ((PSQ)), Telix Pharmaceuticals ((TLX)), Mosaic Brands ((MOZ)), Mastermyne ((MYE)), Perenti Global ((PRN)), and Whitehaven Coal ((WHC)).
With a potential recession looming for Australia, and a number of other countries, it is imperative investors weed out as many risks and obvious vulnerabilities as possible. Saudi Arabia is again targeting the fracking industry in the US. This means lower for longer for oil and gas prices. It also means a negative flow-on impact from cheaper LNG on thermal coal.
Businesses trying to establish a successful turnaround now even have a tougher challenge at hand, with less chance of success in the medium term. The market is closed for capital raisings. Bond yields will remain even lower for (much) longer. Don't assume it will be business as usual for tourism, leisure, and international travel.
Chapter One of the How Best To Survive A Bear Market guide starts by acknowledging the world has changed. Yesterday is now in the past. Today is about not owning stocks that are about to issue a profit warning, or for which the environment has changed so dramatically they can no longer be seen as an attractive proposition.
For those relying on research from analysts to make up their mind, or to find guidance, be mindful that many an analyst is now searching for answers as well. And those forecasts and valuations from yesterday won't be necessarily updated tomorrow.
If you are a paying subscriber, I'd still recommend you read The Australian Broker Call Report every day, while keeping in mind that no recession has been embedded in forecasts as yet, plus a price share that looks too cheap will attract Buy ratings, but it doesn't mean it's an investment you need anytime soon.
A few facts that attracted my attention this week:
-Medical app developer ResApp Health ((RAP)) received a 'no' from the US FDA and its share price target from stockbroker Morgans has now tanked to 8.6c. That's exactly where the share price is at, having been at 40c in October last year;
-Shares in Computershare ((CPU)) tanked from $18 to $10 and with the company issuing a profit warning, analysts revised price targets are essentially following the share price down;
-Shares in Webjet ((WEB)) lost an additional -19.65% on Thursday after the company issued a profit warning and with the US administration banning European travelers. Prior to that, the share price had lost -50% in less than one month;
-Amcor ((AMC)) shares have become the latest target of an offshore shorter, Spruce Point Capital
Equally noteworthy, I think, is the fact that analysts at Citi predict global earnings estimates have to come down to circa -10% year-on-year for 2020 (from neutral now for many countries).
The positive news is that those same analysts have revised targets for most share markets that indicate shares are offering positive returns between now and year-end. Having said so, Citi does not exclude entry levels can potentially go lower, still.
As one would expect, forecasts in cyclicals, especially Energy, Materials and Financials, look most at risk.
This week saw truly extraordinary market moves in Australia with local indices tanking in excess of -7% on both Monday and Thursday, on extraordinary high volumes too. While it may not seem to be making a difference on the day itself, investors who own High Quality performers that are unlikely to issue a profit warning next will be duly rewarded by the time the blind panic has run its course.
Unfortunately, there is no set timing for these processes, and in the meantime we can all distinguish investors that are less worried from others. The first group has a larger proportion of the portfolio sitting in cash.
This will become even more apparent after European markets and US equities had a true wash out the night after Trump's address to the US nation.
Paid subscribers have access to my research into All-Weather Performers via a dedicated section on the website: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/
-Bear Market Lessons And Observations https://www.fnarena.com/index.php/2020/03/12/bear-market-lessons-and-observations/
-Lose The Losers, Back The Winners https://www.fnarena.com/index.php/2020/03/05/lose-the-losers-back-the-winners/
On Thursday afternoon, UBS made a technical recession for Australia now its base case assumption. On UBS's projections, global GDP will sink to -1.9% annualised in the March quarter (Q1), with further downside risks seen if covid-19 does not stabilise over the next 4-6 weeks. If the latter proves to be the case, global GDP can jump back sharply to a decade high 4.5% in GDP in the June quarter.
For Australia, Q1 and Q2 are forecast to print negative GDP of respectively -0.5% and -0.2%. The latter would translate into 0.4% year-on-year which will be the weakest performance on record over the past 29 years. If the lucky country retains its label, growth can recover in H2. Otherwise, a slower recovery should be assumed.
Equally important is that UBS expects households will largely save the government stimulus initially, which means overall consumption will weaken further despite the government anticipating otherwise.
P.S. Now we have been reminded why your average real estate investor has a natural dislike for the share market
(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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