FYI | Jan 16 2012
By Rudi Filapek-Vandyck, Editor FNArena
For reasons I will explain in the weeks ahead, my attention during the annual year-end break has turned towards the principle of mean reversion. I wholeheartedly agree with the likes of Nobel prize laureate Daniel Kahneman there's too much research and analysis being released, regurgitated and quoted from that is flawed in its very core because few people genuinely pay attention to the fact that most events in life, in our lives, including in financial markets can ultimately be explained by that one very simple observation (if only we cared to pay enough attention) and that is that, given time, there's a strong tendency for trends to revert back to the mean.
Two major "events" that occurred in 2011 should now be on every investor's radar, in my opinion. One is that share market valuations in the US, represented by operational profits relative to share prices, are now back to levels not seen since the eighties. In other words: historically very low. The offsetting observation is that gross profit margins in the US are now back at all-time peak levels. The latter is a genuine worry.
While overall market commentary seems to be focused on better-than-expected economic data in the US, including labour market improvement, investors in Australia know from first hand experience that an improving economy does not automatically mean further improvements for corporate profits and certainly not automatically a good year ahead for investment returns from the share market. The way things are shaping up right now, the absolute horror scenario for US companies consists of a noticeably stronger US dollar combined with increased staff hirings, sluggish consumer spending, slowing growth in Asia and South-America and an abrupt end to the Bush era tax concessions and subsidies by 2013.
Let's not mention, for now, either rising bond yields or official interest rates.
I think a clear case can be made that valuations in Price-Earnings (PEs) terms are unlikely to deflate much further from here. This then puts the onus on profit growth.
This is not necessarily a blessing. Forecasts in the US are for sharply slower growth in the quarters ahead, starting right now. In Australia, where relative valuations are equally very low compared with the numbers we all got accustomed to since 1993, many companies already had their struggles to continue improving profits and rewards for shareholders. Many have failed post 2007. Many of Australia's largest companies will fail in the current fiscal year.
Think most banks. Think the large local oil and gas companies. Think BHP Billiton ((BHP)).
For investors, these themes combined have major implications. Maybe today's valuations (opportunities?) should be seen in terms of what is likely to happen with profits in FY12? (At least for those companies whose fiscal year ends between now and June).
My intention was to show you the charts that illustrate these two major themes, but my return from holidays has been accompanied by annoying technical problems that have proved immune to initial attempts to solve them. I'll keep the charts in store for a next opportunity.
In addition, it is my initial assessment post last week's shock profit warning by QBE ((QBE)) that analysts would have picked up much earlier that QBE was not a stock to own post 2007, if only they paid attention to the "reversion to the mean" principle. I intend to follow up on this shortly.
Last year, as many of you will recall, many of my favourite stocks ultimately ended up amongst the best performers for the year, generating a positive return while most investment portfolios, as well as the share market in general, recorded double digit losses. My ongoing analysis has already identified a handful of stocks that, on my assessment, should be considered worthy targets for confident investors. This will be another theme I will elaborate on in the weeks and months ahead.
There's always a multiple of factors in play, but I believe continuous in-depth research combined with correct macro-insights can go a long way towards finding the correct routes to successful investing in tomorrow's share market. Last year, my e-booklet "The Big De-Rating" provided many answers about how and why the overall investment climate changed post 2007. This year it is my intention to continue on this journey and to identify the stocks that will suit best for the year(s) ahead. Are you ready to join me?
There are never any guarantees in life, least in finance and investing, but I am quite excited about this year's journey. In addition, FNArena will further develop and add new services and applications that will further enhance insights and options for investors. I hope you will join me and the rest of the team (if you haven't already).
Stories that specifically deal with this subject will be tagged "Join Rudi's Journey" and, unlike the story you are reading right now, most of these stories will remain accessible for paid subscribers only. As a result, there will be less Rudi's Views stories in 2012. The Weekly Insights emails will remain accessible to both paid subscribers and to others, at a delay for others as per usual.
So… who's ready to join me?
Had enough of "Europe-itis" affecting your portfolio?
Look out for the next "journey" story coming up on the FNArena website… soon.
(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.)
P.S. – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. "Join Rudi's Journey" stories are being treated in similar fashion as Rudi's View stories, hence why the same email alert applies. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website, including those that have been tagged "Join Rudi's Journey".
