Late April 2019: Selected Charts

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In this week's Weekly Insights:

-Late April 2019: Selected Charts
-Orora And Xero
-Rudi On TV
-Rudi On Tour
-Rudi Talks

By Rudi Filapek-Vandyck, Editor FNArena

Late April 2019: Selected Charts

Weekly Insights this week is built around a selection of charts from recently released research and strategy reports, interspersed with brief market commentary to illustrate the current status of equity markets globally.

The framework for sending this story out via email is smaller than for display on the website. In case some of the charts included are difficult to decipher, subscribers can revisit this story on the website from Thursday morning onwards, with all charts in larger format.

Low volatility has swiftly returned to global equity markets, allowing key indices to resume recovery and uptrends, with US indices reaching for new all-time record highs while the Australian share market has posted a fresh 11.5-year high.

From inside the broad church on Wall Street passers-by can hear the same gleeful sermon echoing onto New York corners and streets every Sunday morning: Thank you Jerome Powell, thank you Federal Reserve.

Last week central banks in Canada and Australia further joined the world's Big Four -the US, Europe, China and Japan- by leaning towards further accommodation and, if required, monetary stimulus. Instantly, equity markets have discovered there is more optimism available, pushing share market indices higher, irrespective of the many troubles and question marks that were so prominent only five months ago.

There is no room for second guessing as to why financial assets globally are back into a buoyant mood. Probably the best way to illustrate the difference between late 2018 and the first four months of 2019 is through Morgan Stanley's line up of asset performances per annum below.

Markets have gone from "almost everything works" back in 2017, to "nowhere to hide" in the second half of 2018, to now back to "everything shall be all right".

Behind the apparent swift return of broad market optimism though, a painful conundrum has opened up for many a professional investor: when and where to deploy all or parts of the overweight in cash that is still sitting on the sidelines?

Algos, robots and short term traders have been licking their fingers since the week after Christmas, but most investors have remained cautious, if not sceptical, and kept a large portion of their portfolio in cash.

Investors would have been waiting for pull backs since mid-February, only to see equity markets grind their way higher. Further adding to this year's dilemma are the fact that earnings forecasts ex-USA are still sliding -in particular true in Australia ex-resources- while many a strategist cannot see much more lasting upside from present levels, unless bond yields go much lower (and stay there) or earnings forecasts can rise soon.

A hard core worry wart would add: and what if/when inflation starts to pick up in a meaningful manner? Better watch out! But so far the data are painting the opposite story. See also the latest CPI read in Australia. It's why a larger number of market participants is now convinced the RBA is ready to start cutting the cash rate, sooner rather than later.

The market approach below from Shaw and Partners CIO Martin Crabb is certainly not universal, but it shows today's dilemma for investors: the "fair value" for the Australian share market (which is seldom crossed for a prolonged time; see April 2015) suggests there really is not much left for further returns ex-dividends, in a broad, general sense, but that doesn't mean markets are about to fall into a heap either. There is still so much cash on the sidelines…

Meanwhile, analysts at Citi report their proprietary Bear Market Check List essentially remains in "no worries" territory. Share markets will have to rise a lot further and for a lot longer to start troubling their bear market indicator, say the analysts.

Historical analysis conducted by Macquarie shows the importance of movements in bond yields for income providing equities, but investors might want to pay attention as not every yield stock is impacted equally.

Some benefit from falling bond yields, some benefit from rising bond yields. Of more importance, perhaps, is that "growth" beats all temporary headwinds; a fact not shown on Macquarie's graphic overview, but one that should never be forgotten.

Stocks such as Goodman Group ((GMG)) and Charter Hall ((CHC)) have performed well on the back of falling bond yields, but their performance has been equally assisted by robust growth and the prospect of robust growth continuing.

As such, the overview by Macquarie below is nothing but a generalised framework, it does not include the absence or prominence of growth for individual companies affected by bond market movement.

Shorter term, the US corporate reporting season is providing support for US markets, and by extension for share markets in Australia and elsewhere. Never mind that Australian banks are now cutting dividends, with Bank of Queensland ((BOQ)) recently doing exactly that.

National Australia Bank ((NAB)) might first pay out more franking credits ahead of a possible Labor government, but analysts have little doubt NAB's dividend reduction now or a little later is pretty much a fait accompli.

Conditions will have to sour further and for longer to also put dividends at Westpac ((WBC)) and CommBank ((CBA)) under threat, which is certainly not impossible. However, such a scenario would have been more feasible, perhaps, if global central banks were still tightening, but they are not. The domestic bond market is now priced for two RBA rate cuts in 2019.

Medium term, investors and analysts in the US are keeping the faith in the return of positive growth in US corporate profits by Q4 2019; see the graphic overview below.

Question: what are the chances for US equities to experience a meaningful "correction" while general belief in this prospect remains intact?

Within this context investors should be keeping their fingers crossed that Morgan Stanley's proprietary leading indicator for US corporate profits will be proven wrong.

As suggested below, the indicator is showing quite a steep deterioration from here onwards, which would temper overall enthusiasm and potentially raise some nasty question marks for markets trading on above average valuations.

Morgan Stanley strategists have been surprised by the share market's strong V-shaped recovery. They had been warning for a negative Q1 reporting season, but that proved largely off the mark.

Let's take this back to Australia and more specifically to the banks locally… Market chatter about more dividend cuts has been offset by a softening in overseas funding costs, which has created a positive platform from which slightly higher estimates of profitability have pushed share prices higher.

As suggested by the graphic display from Wilsons below, share market performances for Australian banks often reflect a tightening or softening in overseas funding costs, predominantly in direct correlation to bond movements in the US.

 As far as that other important segment of the Australian share market is concerned, resources stocks have been enjoying a very favourable environment thus far in 2019.

It's still about China, of course, but as shown on the graphic below, China's positive impact nowadays comes with more benign upticks in infrastructure spending.

China is transitioning towards more services as its domestic economy is facing unfavourable demographics, among numerous changes taking place, including greener policies for energy usage and commodities intensity.

But the fate of resources might be closely tied-in with what comes next in China's meticulously managed credit cycles. Right now, or so it seems, the credit expansion inside the Middle Kingdom is back 'on', but Macquarie's graphic also shows cycles are becoming shallower.

Macquarie's overview also shows China's credit cycles seem to spend more time near bottoms, probably reflecting Beijing's reluctance in pressing the credit expansion button too quickly/too often given the large amount of debt that has already been built up through prior credit expansion policies.

My personal view is that general industry shock post-2011, combined with a mountain of worries about what future demand might look like, has created a highly favourable environment for major producers of metals and minerals. Or to put it in layman's terms: it's the supply side, stupid!

Many a miner is swimming in cash, and stoically refusing to do anything else with it than pampering shareholders with share buybacks and large dividends.

Expectations for a general pick-up in spending have thus far not been met, thus the question remains: how long before contractors and engineers can welcome a big increase in spending on projects and equipment?

The one insight that is keeping analysts optimistic, at least for the equipment side for the industry, relates to recent Morgan Stanley research from which the graphic below stems: average mining machinery is now 10 years old, the oldest age recorded in three decades. Is it any wonder supply issues have become more common? How long before investing starts picking up in a meaningful manner?

Domestically, Australia continues to struggle with a long-winded property downturn, of which the flow-on impacts are being felt by discretionary retailers, automotive dealers and landlords. The core of the domestic problem is predominantly concentrated in the over-building of high rise apartment blocks.

The graph below from the economics team at National Australia Bank shows the change in market dynamics for apartments post 2015; this is a nasty looking reversal of fortune. Investor expectations for a quick reversal in market trend are probably best kept on ice for the time being.

Meanwhile, back in the USA, "the most hated bull market in modern history" has seen investors withdraw funds from US equities in each of the past four years, and the first four months of 2019 (not shown) have seen a continuation of this pattern. So how can US equities be enjoying such a strong rally when money prefers to flow elsewhere?

The answer is corporate share buybacks, of course. As is clearly shown on the graphic overview below, American companies have been the number one buyer of their own stocks, and the numbers are many times larger than what looks like, in comparison, tiny net funds outflows.

But make no mistake: Corporate America has been so flush with cash, they also spent increasing amounts of cash on shareholder dividends (including technology companies which have become quite the reliable payers) as well as on capex; see chart below.

With Australia pretty much obsessed with its housing downturn gripping the capital cities, it may not be widely known average house prices in the US have been falling as well.

Am I seeing too much convergence or is the "financialisation" of the global economy leading to similar patterns across country borders? Car sales are declining in multiple countries.

Another surprising observation is that adjusted for population growth, total miles driven by American cars peaked in 2005 and has been tracking sideways since at a level resembling the late 1990s.Thanks to Dennis Gartman for pointing this out.

One thing that needs to be pointed out is that excess liquidity provided by the world's most important central banks has provided tremendous support for asset prices (see: global equities) but it doesn't cure all economic or fiscal ailments.

See the graphic below for the steep fall in global trade volumes which are yet to show a meaningful recovery. Maybe this is why so much hope is adhered to trade agreement discussions between Washington and Beijing?

Finally, and this time without an accompanying graphic, a lot of commentary is being spilt on the apparent discrepancy between the "bearish" story derived from ultra-low bond yields and the "bullish" story from ever rising equities. I don't agree with such simplistic assessment.

Global bond markets are not telling a "bearish" story, they are reflecting the low inflationary environment in which we are operating, further supported by prospects of central bank intervention and, most likely, the swift return of Quantitative Easing (QE) in case economies need ongoing support.

As such, bond markets and equities anno 2019 are not in contradiction with each other; we are witnessing near perfect symbiosis. And so much cash is sitting on the sidelines…

Orora And Xero

Last week I received a question from a subscriber on my views regarding packaging company Orora ((ORA)) and accountancy software developer Xero ((XRO)). I have decided to share my response with other subscribers and readers of Weekly Insights.

Thanks for your question.

Both Orora and Xero have been on my list of selected stocks I follow closely for quite a while, see also All-Weather Performers on the website. Both are also included in the All-Weather Model Portfolio I have been managing since late 2014.

I have a suspicion that Orora hasn't had many friends of late because of the high oil price, and because Amcor is about to conclude a major acquisition in the US. As funds managers like to be part of the new Amcor story, they probably shifted some funds into Amcor and out of Orora.

I also believe that, as a result, investors are currently undervaluing the shares, suggesting your timing could be ideal.

Xero shares are much more beholden to what happens on the Nasdaq in the US. Its shares are not as undervalued as Orora's, but shorter term a lot will depend on their next financial market update.

As with Aristocrat Leisure, TechnoloyOne, DuluxGroup, etc Xero reports out of season. The calendar on the FNArena website shows Xero's FY19 results release is scheduled for 16th May.

Longer term, I think both companies are well-positioned for robust growth for many years into the future. Which is why they are included in my personal selection in the first place.

Good luck with it all,

Your Editor

Rudi On TV
My weekly appearance on Your Money is now on Mondays, midday-2pm.

Rudi On Tour In 2019

–ASA Melbourne, May 1
-ASA Toowoomba, Qld, May 20
-U3A Investor Group Toowoomba, Qld, May 22
-AIA Adelaide, SA, June 11
-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1

Rudi Talks

Audio interview two weeks ago about what's happening in the Australian share market:

https://www.youtube.com/watch?v=FpCnk1RSnCY

(This story was completed on Sunday 28th April 2019. It was published on the following Tuesday in the form of an email to paying subscribers, and will be again on Thursday as a story on the website).

(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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