Rudi’s View: The Market Has A Carrot

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 30 2021

In this week's Weekly Insights:

-The Market Has A Carrot
-No Weekly Insights Next Week
-Conviction Calls

By Rudi Filapek-Vandyck, Editor FNArena

The Market Has A Carrot

If the year past has shown investors one thing, it is that taking too bearish a view on the outlook for equities and bonds is seldom and only briefly rewarded.

Equity indices, including the ASX200 in Australia, might well be staring at their first negative monthly performance since... September last year!, but it's hardly looking like disaster-territory given the seasonal pattern and the potential worries that are on investors' minds.

Yet, it might equally be folly to assume this market will simply keep on powering on, and ignoring everything that could change the landscape dramatically; from slowing economic growth, to central banks moving in tightening mode, to the Evergrande fall-out, higher bond yields and the rising awareness of downward pressure on corporate profit margins.

Probably the most straightforward observation to make is that most economic insights and indicators, be they here in Australia, or offshore in China, the US, UK or Europe, are no longer surprising on the upside; they have a tendency to now fall short of market forecasts, and they have been doing so for a number of weeks.

The message here should be clear: global economic momentum is softening, and it is likely to soften further over the weeks and months ahead. The more optimistic forecasters see momentum recovering in the final quarter of this year, if one's less optimistic this could be the return to the low growth environment that persisted pre-covid.

What happens at the macro-level impacts the micro and company earnings estimates have stopped trending upwards in Australia.

As I reported a few weeks ago, the August reporting season in Australia broke the eleven month-long trend in Australia and earnings forecasts are now falling.

This process has accelerated in September as companies such as Clover ((CLV)), Kathmandu ((KMD)) and Sigma Healthcare ((SIG)) missed expectations with their FY21 performances, but most of all because of a sharp -50% fall in the price of iron ore.

Earnings estimates for US companies are now starting to trend downwards as well as analysts are looking forward to an unfavourable combination of rising costs and slowing sales.

Historically, such periods of negative earnings momentum tend to last about six months and, unsurprisingly, there's usually not much on offer in terms of net positive return as investors, understandably, tend to become more cautious during such times of greater uncertainty and greater potential for negative surprises.

Analysis by Morgan Stanley makes it very clear: the Australian share market's average return during periods of positive earnings revisions is circa 10%, but during periods of negative momentum the average net return reduces to -2%.

2021 Might Be Different

This year, however, the overall picture is a lot more blurred with most investors and analysts considering the virus and renewed lockdowns responsible for the negative impact on growth and forecasts.

Thus far, this has translated into far more lenience offered to those companies under the spell of the virus, as better times surely are but a matter of patience?

Look no further than the share price of travel agent Flight Centre ((FLT)) to back up that statement.

On my observation, share markets can remain stronger-for-longer as long as there is a carrot dangling in front of them. Think Trump tax cuts, for instance. This year and last, the prospect of a successful vaccine-rollout, leading to re-opening borders and economies with cashed-up consumers ready to unleash their wallets on travel, leisure and other services, is likely acting as one such giant carrot.

Regardless, the prospect of higher input prices against a background of tougher sales growth will put a number of businesses under pressure from here onwards and it is anyone's guess who will be issuing the first serious profit warning, and when?

The old saying is that no profit warning is ever fully priced-in. Investors might be reluctant to sell the market as a whole, at a time of growing nervousness and generally elevated valuations, I doubt whether individual profit warnings won't be punished in the good old fashioned manner: quickly, fiercely and without thinking twice about it.

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