Rudi’s View: Good News, How To Use PE Ratios & Conviction Calls

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 29 2022

In this week's Weekly Insights:

-Good News
-PEs - The Tool That Both Enlightens And Confuses
-Conviction Calls
-Research To Download
-FNArena Talks (3x)

By Rudi Filapek-Vandyck, Editor

Good News

A brutal September has pushed the market indicator that used to be known as Citi's Panic/Euphoria Index into Panic mode territory.

The good news is history suggests every time this happens equities are offering attractive entry points for investors who have the stomach to look beyond the short-term.

On Citi's own data assessment, US equities now offer a 91% probability of a positive outcome over the next twelve months.

The rebranded Levkovich Index, in honour of the late last year deceased market strategist, thus falls in line with readings elsewhere of equity markets being over-sold.

The not so great news is that analysis by Macquarie suggests any recovery swing upwards from here is unlikely to prove anything but the next bear market rally.

Having analysed 23 bear markets since 1901, Macquarie analysts believe all rallies will prove nothing but bear market rallies until central banks shift their policies from tightening to loosening, i.e. no more rate hikes and rate cuts instead.

Before that happens, equity markets are likely to see fresh lows with Macquarie retaining the view earnings forecasts are still too high for the recessions that are forthcoming next year.

PEs - The Tool That Both Enlightens And Confuses

It must be the ultimate irony that one of the most quoted and used investment tools available, the Price-Earnings (PE) ratio, causes so much confusion among investors who like to treat it as a one size fits all instrument to find "value" in the share market.

But, of course, there is no such thing as a simple universal measure to decide which stocks represent attractive "value" and which ones are "overvalued".

Growth stocks do not trade on a low PE, assuming there is a positive 'P' (profits), unless there is something fundamentally wrong with the business.

Infrastructure assets are valued against bond yields, so whatever calculation is available for a PE plays no role whatsoever.

Then there is your typical commodities producer -highly leveraged to the swings in prices through different stages of the cycle- that turns the whole concept of buying low and selling high on its head.

Every share market veteran knows commodity stocks represent the best value when PEs are sky-high while they are the most risky when PEs are low (as they are now).

It was only in April this year I was being challenged by investors on Twitter who'd assure me BlueScope Steel ((BSL)) shares looked many times over superior to CSL ((CSL)) because the respective PEs were 3x versus 40x.

Fast forward five months and BlueScope shares have since lost -32% while CSL shares have actually booked a small net gain. Incidentally, both PEs have now changed to 6x and 33.5x respectively (one year forward).

Needless to say, a lot more context is required to properly read and use PE ratios in the share market.

I can equally confirm the global analyst community has become a lot more sophisticated than when Benjamin Graham wrote The Intelligent Investor, and questioned the value of paying attention to Wall Street analysts' research.

For those investors who'd like a great update, and have no fear of being overwhelmed by numbers and calculations and plenty of particularities, The Little Book of Valuation by Professor of Finance at New York University's Leonard N Stern School of Business, Aswath Damodaran offers an excellent modern day curriculum.


PE ratios are also often used to conduct macro analyses and draw comparisons between sectors and historically distinctive periods. Again: this can be very useful for the average investor if the proper context is included.

A recent historical analysis of macro PE ratios by analysts at JP Morgan offers plenty of insights that could prove useful in the year(s) ahead, starting with the identification of four distinctive periods throughout the past thirty years.

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