Rudi's View | Apr 11 2018
In this week's Weekly Insights (published in two separate parts):
–Looking For Answers
-Conviction Calls
–Rudi On TV
–Rudi On Tour
[Note the non-highlighted items appear in part two on the website on Thursday]
Looking For Answers
By Rudi Filapek-Vandyck, Editor
After what turned out to be an unusually low volatility and robust uptrend in 2017, at least for US equities, the outlook for calendar 2018 was always going to be less predictable, and potentially a lot tougher. But only a few would have predicted things were about to dramatically change this early into the new calendar year.
Wall Street still had a few more weeks of unabated continuation of last year's market exuberance before anti-vol derivatives and the ugly side of bond market moves announced themselves. In Australia, the ASX200 has barely had a peek into what year-to-date positive performance looks like. And now US President Donald Trump is prepared to play all-or-nothing in a public game of political poker, or so it seems.
The result to date, apart from a significant spike in day-to-day volatility which the local share market tries its best not to follow blindly nor willingly, is a negative performance for Australian shares for the first three months of the new calendar year – a rather rare occurrence outside the bear markets of 2000-2003 and late 2007-early 2009.
Making this rare event even more exceptional is the fact Australian shares booked a negative performance for each of the three months that make up the first quarter. So much for the seasonal pattern that usually implies the best share market gains are generated between mid-October and late April (i.e. right now).
The two big questions on investors minds, no doubt, are:
-What does this mean for the rest of the year?
-And is this the end of the nine year long bull market?
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Let me first follow up by stating that on my observation there is no such thing as a 100% reliable blueprint guide from the past. Just like you, I regularly see "analysis" (note the quotation marks) and predictions based upon copy and paste charts from 1987, or from the sixties and thirties, and given such predictions have constantly been proved blatantly inaccurate, I am quite amazed such comparisons keep on popping up, irrespective.
If this truly is the start of something more sinister, like the next bear market or US recession in 2019, events will unfold at their own speed and in their own way rather than to copy any pre-defined pattern from the past. But, to be honest, the past is readily available and there are occasions when valuable insights can be derived from it.
As such, the first conclusion is that calendar 2018 might not be a good year for the local share market.
According to data analysis conducted by Bell Potter Director of Institutional Sales and Trading, Richard Coppleson, the past 79 years have only seen the March quarter in negative performance territory, with all three months contributing negatively, a total of five times. This didn't even happen during the past two bear markets mentioned above.
On Coppleson's data research, it happened in 1982, in 1965, in 1952, and in 1939. Only in the latter case the bad start to the new calendar year was not an omen for an overall very bad year for the share market, with double digit negative annual returns following the three more recent occurrences.
However, given this never happened during the past two bear markets, and the fact US equities only had two bad months out of the three, it's probably more helpful to look at negative March quarters without the requirement of three negative months. After all, both January and February only recorded minor losses.
Negative-returning first quarter performances are still relative rare, but they do occur more regularly: nine times in the past 25 years, including 2018. Six of those occurrences are linked to the two noted bear markets: 2000-2003 and 2008-2010.
Investors with a good memory will remember that share markets fared well in 2009, after a dreadful opening to the new year, and the same happened again in 2010. The last time a negative Q1 quarter happened was in 2016 and by the end of the year indices were clocking off on double digit percentage gains.
Making matters even more complicated, US equities often ended the above mentioned years with sizable gains.
Within this context I'd like to remind everyone about comparable data analysis conducted by the team of quant analysts at Macquarie in 2016. That piece of analysis was limited to a negative return for the month of January, but its underlying conclusion is likely to apply regardless.
Macquarie's data analysis seems to suggest that a calendar year starting on the back foot is no guarantee for a negative performance for the full year overall; it just makes it more likely the full year won't be a fantastic experience for investors. This may well be a case of simple mathematics. Including dividends, the ASX200 Accumulation index from here onwards carries a negative circa -3.5% for the remaining nine months.
Another way of looking at Macquarie's research is: a smidgen less than half of all negative January performances have proven to be a bad omen for the remainder of the year. This means more than half of all cases turns out to be a disappointing start, and nothing more.
I'd say the underlying conclusion is thus: clearly, a negative start to the new year indicates there are problems. Both the duration and the severity of these problems will determine the outlook for equities for the remainder of the year.
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One reason for short term optimism is that we now have entered April, which not only is the fourth month on the calendar, but historically the strongest month out of the twelve in terms of average share market performance, with December a close second. Also, think about it: if three consecutive negative months for Q1 are extremely rare, what are the odds the share market adds a fourth negative performance?
On my observation a number of market strategists (at Shaw and Partners, Ord Minnett, Morgans,..) are predicting a swift rebound soon as valuations for index heavyweights the Big Four Banks have now fallen near the bottom of historical valuation ranges, while a similar observation applies also to a number of other blue chip stocks.
In terms of average Price Earnings (PE) ratio for the local market overall, weakness throughout the first quarter has now pushed the number down to 14.8x (December). The average dividend yield for the ASX200 is now 4.6%. Both are near long term averages implying the share market can no longer be labeled "expensive".
Throughout 2017 the local market's PE had been consistently near or above 16x while the dividend yield has been closer to 4%.
Some strategists are also referring to rising profit forecasts at the same time as share prices remain under pressure but FNArena's observation on this account is rather mixed. Note also the US corporate reporting season is about to start while in Australia the banks are preparing for the release of interim reports.
What is not apparent from these statistics is that the gap between lowly valued, low growth companies and the highly valued, high growth companies in March had again blown out to proportions not witnessed since mid-2016, after which a major money flow rotation ensued. I don't think a similar rotation is on the cards this time around, but that gap has only narrowed a smidgen since last month, and predominantly through banks, large resources, etc falling less than the likes of Altium, Afterpay Touch, Corporate Travel Management, Cochlear, et cetera.
Don't be surprised if the period ahead sees "value" outperforming "growth". Apart from the large gap between the two groups, banks and other low growth blue chip stocks look cheap on many an investor's spread sheet, and this is likely to attract attention. Also, with fear of inflation and rising bond yields rampant, investors feel safer buying into lowly priced assets rather than joining popular trades, which carry added risk of being a crowded trade.
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Paying attention to seasonal patterns is a popular endeavour among investors and their advisors. It is likely many will welcome an April bounce as the return to normal seasonal trading, even though January, February and March have proved to be rather unseasonal.
But with April-May often marking the end of the seasonal upswing for global equities, should investors now fear they will be given only a rather limited window of opportunity?
Here I think it is important to point out seasonal patterns only manifest themselves when nothing else more powerful impacts on financial markets. Usually, when normal patterns are broken this tends to also distort the pattern thereafter. Like when the September sell-off occurs in August, it won't happen again in September.
In similar fashion, it is my observation "Sell in May" tends not to apply when share markets already started on an uncharacteristically weak note during what is usually a strong performance period at the start of the new calendar year.
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Look beyond the short term, and beyond Trump's my-bazooka-is-bigger-than-yours approach towards China, and I must point out I have seldom witnessed such a bifurcation in views and predictions about what is really going on in the world of economics, interest rates, corporate profits and central bank policies, as is in place today.
Scenarios for the future being put forward are:
-Global growth is strong and shall remain strong. Against this backdrop, the Federal Reserve might be underestimating the inflation risks building in the US economy. Some are warning of an outbreak in inflation, which will force bonds to sell-off (yields higher) pushing equities in a downward spiral. Buy gold as protection as the US dollar shall remain weak;
-Others believe the US economy stands out as a beacon of strength, but Europe, Japan, China and emerging economies are already losing momentum, and the gap is only getting larger. This creates a whole different dynamic in that the US dollar will strengthen and thus technology stocks in the US will resume market leadership while US bond yield are being tamed through lower bond yields elsewhere;
-Others believe the US economy is not as strong and healthy as economic data suggest. One major point of contention is the declining savings rate for US consumers. Some are predicting the US economy might be on course for a recession in 2019. Look out for a flattening bond curve, and for potentially significantly lower share prices;
-In Australia some experts have started talking about the RBA potentially having to support consumer spending in 2019 by cutting the cash rate, rather than starting to lift rates. There are increasing signals stress is building among investors looking to sell apartments, while luxury goods are no longer flying off the shelves, with debt collectors observing asset rich but cashflow poor Australian households seem increasingly under financial duress.
Some experts see potential for a genuine credit crunch as authorities clamp down further on the Big Four banks post Royal Commission embarrassment.
I think it remains way too early to decide which of these scenarios might get the upper hand, but the consequences of getting it wrong will be severe, if not disastrous. This is why I expect financial markets to remain on tenterhooks for much longer.
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, noon-2pm
-Friday, 11am Skype-link to discuss broker calls
Rudi On Tour
-An Evening With Rudi, Paddington, 11 April (sold out)
-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, late June-August 1
-Presentation to ASA members and guests Wollongong, in September
-Presentation to AIA members and guests Chatswood in October
(This story was written on Monday 9th April and the first part was published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part two will be published on the website on Thursday).
(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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