Rudi’s View: The Trend Is Still Our Friend

rudi-views
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 | Jul 08 2021

In this week's Weekly Insights:

-The Trend Is Still Our Friend
-Conviction Calls
-Research To Download


The Trend Is Still Our Friend

By Rudi Filapek-Vandyck, Editor FNArena

The ASX200 Accumulation Index, which combines share price appreciation with dividends paid, closed off FY21 with a total return of 27.80%.

It wasn't the best performance ever, also because back in 2007 the average dividend yield was higher, but eleven months of the twelve posted a positive return and every market veteran will assure us: this had never happened before.

Indeed, past data analysis conducted by Bell Potter's Richard Coppleson revealed the best index performances in terms of number of positive monthly returns post 1993 had previously stopped at ten out of twelve. In the past 28 years only FY07 managed to post a better result, delivering 28.66% in total for investors.

As is standard practice, that formidable index performance was achieved amidst continuous calls for "too much investor exuberance", "excess liquidity and cheap money-inspired bubbles" and predictions the next Wile E Coyote experience surely must be around the corner. It's only a matter of time!

I have steadfastly believed such criticism to be misguided. Firstly, because financial markets look ahead and what they see is a sharp economic recovery, albeit not in a straight line, underpinned by supportive governments and central banks. Most importantly, however, is that share prices have been supported by strong, continuous upgrades to market forecasts.

For investors there is at least one valuable lesson to be learned from the experience of the twelve months past: never bet against a market that is supported by continuous upgrades to profit (and dividend) forecasts. In Finance, it's not necessarily the actual data point that is most important, but rather the direction of the trend.

And the trend in profit projections, both in Australia and elsewhere, has thus far remained positive for ten successive months.

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It goes without saying, forward economic projections and corporate profit forecasts are not the only factors that guide equity markets. The past has shown equities can deliver a positive return even when profit forecasts are negative, and vice versa, but when corporate outlooks are supported by ongoing positive revisions, the share price usually responds to the upside, and remains well-supported.

What goes for individual shares equally applies to markets as a whole. Rising forecasts, even if they prove misguided further-out, make present day share prices look cheaper. Thanks to the strength of this year's upgrades, the local share market became less expensive even as the ASX200 added 12.90% since the start of the new calendar year.

To prove my point, investors should consider that analysts have been lifting their FY21 profit projections by between 15-20% on average for most markets. Very few indices have gained more than seems justified by those numbers. The S&P500 gained 14.9%. The average gain for developed markets has been 14.5%, when measured in local currencies. Emerging Markets, on average, only advanced by 8.1%.

In Australia, the largest improvement in profit forecasts went to the energy and materials sectors, with financials a lagging third. No surprise thus, the ASX20 has beaten all other indices in Australia over the past six months with a gain of 16.13% ex-dividends. Equally noteworthy, on assessment of Morgan Stanley, the Small Ordinaries is no longer trading at a discount to the ASX100.

The direct result of all of the above combined is that the average Price-Earnings (PE) ratio for the ASX200 has fallen to 17.5x from 20x in January and late last year. It is true, markets can become cheaper even as they rise to fresh record highs. The one sector that stands out in terms of valuations becoming cheaper and cheaper, including on relative and historical comparisons, are resources companies; oil&gas, mining and mining services.



On the one hand, this reflects the unraveling -temporarily or otherwise- of the so-called reflation trade since mid-March as global bond yields are no longer rising. On the other hand, we should never underestimate the impact of investor sentiment. Doubts have crept in and weighed upon share prices for your typical cyclicals as investors worry about slowing growth in China, but equally whether 2022 might not be a straightforward extension of the economic recovery this year.

In this context, it remains remarkable that the price of iron ore has continued its upside surprise thus far in 2021, but equally that most sector analysts remain convinced prices will reset at lower levels in the year(s) ahead. Stockbroker Morgans issued a stern warning to investors recently: when prices start declining (not 'if'), it'll be the direction in the (new) trend that counts for more than the actual data. Morgan Stanley has suggested financial results and oversized dividends in August will mark the final Hurrah! for Australia's large cap iron ore miners.

Such forecasts might still be proven wrong, but they are preventing shares for the likes of BHP Group ((BHP)), Rio Tinto ((RIO)) and Fortescue Minerals ((FMG)) to reach full potential. FNArena's consensus targets are currently $50.50, $135.50 and $22.35 respectively (only Fortescue is trading slightly higher) but if we were to take guidance from the bulls in the market, Macquarie and Ord Minnett, these share prices could be 30% higher next year.


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