Rudi’s View: No Time For Over-Confidence

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Dear time-poor reader: how much longer can this rally continue and what are the internal signals?

No Time For Over-Confidence

By Rudi Filapek-Vandyck, Editor FNArena

The share market is now divided, roughly, in two groups of investors.

Those who have been buying shares over the past three weeks are feeling like they have been very much rewarded for it.

The other group has at least one eye fixated on the deteriorating situation on the ground in New York and elsewhere in the US and cannot help but wondering whether the first group is living in the land of delusions or what?

The latter group is supported by a large army of technical analysts and chartists and by scholars of history who assure us all this is but normal pattern during a Grand Bear Market; first comes the savage sell-off, then follows the strong rebound, but ultimately prices will end up trending lower.

If history repeats then rallying almost 900 points from a brief revisit near 4400 is that strong rally. But what if this Bear Market doesn't play fully to the script?

It's not like someone high up in the Himalayas is reading from an age-old script and everybody on ground zero is listening and obliged to follow the guidelines.

We never had central banks around the world, including the Federal Reserve and the RBA, going all-in to make sure we will not relive the Great Depression.

We never had widespread government support programs of the current size and impact. Never.

And we might not have seen the end of fiscal initiatives either as all governments will be hell-bent on getting their economies back up and running as quickly as possible once this year's pandemic and Great Global Recession are dealt with.

Though, increasingly, it is starting to dawn on everyone, getting back up and running after moving into lockdown won't be quick, smooth or easy.

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On Friday (Thursday US time), the Federal Reserve showed it knows a few things about how financial news and markets operate.

The decision to expand the central bank's asset purchase program by including higher risk assets including high yielding corporate credit and bonds from struggling US municipalities coincided with one of the darkest days in the world's history as far as US unemployment is concerned.

That, of course, was not a coincidence. The Fed's announcement surprised many, and it deliberately took the attention away from the sad news on the streets where more than 16 million jobs went missing in just three weeks. Not even the Great Depression during the 1930s can match that.

US financial markets on the day told the tale: the Fed has now removed two major concerns for further financial mayhem; local governments won't be cascading into defaults and bankruptcies, and the same applies to many low quality, highly risky and vulnerable US companies whose public debt needs to be rolled over or refinanced this year.

Many of those who have been watching with open jaws all of the Fed's moves since the US repo market stopped operating in an orderly fashion in August last year are openly wondering where this will end? Will this ever end? Can it?

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This crisis has cut so deep into today's fragile global financial system that central bankers are giving up their full independence and become more closely intertwined with the executive powers that rest with their respective governments.

It happened first with the Bank of Japan. As the Federal Reserve's latest policy broadening required the explicit approval of US Treasury, it is now also happening in the US. Speculation is already rife it won't be long before the Federal Reserve starts buying US equities.

To continue the parallel with Japan: the Bank of Japan today owns more than 75% of all Japanese ETFs; it owns trillions of Japanese government bonds equal to 100% of the country's GDP, approaching 50% of all outstanding government bonds in the country.

The BoJ is now a major shareholder in nearly 50% of all Tokyo-listed companies, and the number one shareholder in 23 Japanese companies. For all we know, the BoJ might already be the largest individual owner of Japanese stocks. Hence the question asked is very apposite: will this ever end?

At the very least there are two obvious conclusions to be drawn from this year's events:

1.) The problems are huge, complex and very, very serious

2.) Central bankers are determined to stay on top, and their actions and willingness to intervene have no boundaries

There are limits as to how much central bank policies and interventions can achieve, of course. Japanese equities have merely tracked sideways since late 2017, through highly volatile waves, and they still fell down in a heap when the Global Bear Market arrived in February.

It is not inconceivable, in the short term, that the Fed removing two of the outstanding risks increases confidence among investors overall, and more might feel encouraged to put more money into the share market.

Statistics improving regarding this year's global pandemic is a further positive.

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I cannot help but suspect the real test for current optimism in global equities is still in front of us. Economies move rather slowly. Economic data and indicators move even slower.

We have as yet not seen the full extent of this Global Recession that is unfolding right here, right now.

Equally important, while authorities are starting to focus on when and how to open up economies again, it becomes increasingly obvious that in the absence of a cure or vaccine, the world cannot resume as per pre-February lest the covid-19 virus simply makes a second-wave come-back, and societies might have to go into full or partial reverse yet again.

Right now it feels like share markets are reflecting a lot of optimism. Investors who are buying are not necessarily wrong, but neither are those watching from the sidelines, scratching their head.

There is still a lot of bad news coming towards us. Governments and central banks cannot perfectly time their next compensating move on each and every occasion. It'll be interesting to see how markets behave in the weeks ahead.

The US corporate results season will likely reveal some new insights too.

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In Australia, I remain a proud owner of shares in CSL ((CSL)), as many among you are well aware. CSL has become far more than the best performing large cap stock in this market.

As the current largest index constituent, and with its businesses largely unaffected by the pandemic and the economic recession, I believe CSL has now become the market leader.

Its share price moves signal whether the trend still has sufficient oomph left to move a lot higher, or lower under prior circumstance.

On Thursday, the CSL share price staged another surge higher to close at $329; a whisker away from the February all-time record high of $340.

While this is very much testament to what a fantastic company this is, and the market appreciates it as such, it also fits in with all of the above, and with my sensing that equities post the rally off the March bottom are already reflecting a lot of optimism.

I also observed post writing my Rudi's View story published on Good Friday (see below) that many of the High Quality stocks put forward by other experts have equally recovered swiftly from the Sell-Everything days in February and early March.

More evidence that Quality gets punished less severely during the dark times, plus it recovers more quickly.

It might also indicate that, unless investors are willing to rotate out of these Quality stocks and into the more vulnerable, beaten down cyclicals and lower quality stocks, this share market might find itself in somewhat of a bind.

This looks even more so the case with an historic OPEC-plus-the-world voluntarily cutting production this weekend, but sector analysts have already concluded it'll prove too little, too late.

The world is running out of storage while supplying too much oil into global markets, a situation alleviated but not remedied by the latest agreement.

I have not been a fan of owning oil & gas stocks, and I'll say it again: watch that oil price as it looks to have built in too much optimism for the short term.

Another crash in the oil price would likely drag equity markets lower as well (if only because that's how algorithms have been programmed).

The flip side is that once global demand recovers, and such agreements remain in place, the bounce in energy markets shall be violent and fast (all else remaining equal).

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Summarising all of the above, I remain of the view it's best not to be over-confident about either scenario. Financial markets have a habit of surprising in the opposite direction of what the majority of market participants is anticipating.

Maybe too many investors are waiting for this rally to deflate and re-test the March bottom? Only time will tell.

In the meantime, the All-Weather Model Portfolio has been able to limit losses, helped by a large cash holding, exposure to gold and ownership of High Quality All-Weather Performers that have followed in CSL's slipstream. The Portfolio has remained cautious, nibbling at existing positions throughout this market upswing.

The Portfolio's largest positions are (in order of magnitude) gold (through an ETF), CSL and NextDC ((NXT)).

One of the stocks that has my attention is Fisher & Paykel Healthcare ((FPH)), a New Zealand-originated excellent performer that usually sits in the shadow of ResMed ((RMD)), which might explain why I never included it in my selection of All-Weather Performers in the past.

Similar to what has happened to NextDC recently, High Quality outperformers that recovered much quicker have recently suffered due to profit taking, which is excellent news for those among you who are still on the look-out to add more of such names to your portfolio.

I have now added Fisher & Paykel Healthcare to my list of "potential All-Weather Performers", alongside Bapcor ((BAP)) and Iress (IRE)). That list in particular might need some additional inclusions, but I am not in a hurry.

No need to bet either way. This market can, and probably will, surprise us all. Make sure you don't have to blame yourself in case markets go the other way than what you'd like them to do.

And stay safe.

ERRATUM

Last week I quoted Ord Minnett senior investment analyst Sze Chuah, but forgot to check her gender. Shame on me. My sincere apologies to Sze. I can now truly say it won't happen again.

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FNArena subscribers have access to a dedicated section on the website on my research into All-Weather Performers.

See also my writings from the weeks past:

-Cheap Quality & Conviction Calls (Must read for everyone looking to upgrade his/her portfolio) https://www.fnarena.com/index.php/2020/04/10/rudis-view-cheap-quality-conviction-calls/

-How Deep, How Long, How Far? https://www.fnarena.com/index.php/2020/04/09/how-deep-how-long-how-far/

-Bear Market Observations https://www.fnarena.com/index.php/2020/04/03/rudis-view-bear-market-observations/

-How To Survive The 2020 Bear Market https://www.fnarena.com/index.php/2020/04/02/how-to-survive-the-2020-bear-market/

-Global Recession Is Next https://www.fnarena.com/index.php/2020/03/27/rudis-view-global-recession-is-next/

-Things To Watch, Expect, And Avoid https://www.fnarena.com/index.php/2020/03/26/rudis-view-things-to-watch-expect-and-avoid/

-All-Weather Stocks & Cash https://www.fnarena.com/index.php/2020/03/19/rudis-view-all-weather-stocks-cash/

-The Bear Market That Changes The World https://www.fnarena.com/index.php/2020/03/17/rudis-view-the-bear-market-that-changes-the-world/

(This story was written on Monday 13th April, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story 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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