Reasons For Doubt

This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS

By Rudi Filapek-Vandyck, Editor FNArena

Listening to all the experts and commentators who share their "wisdom" and "insights" in the margin of the Australian share market, there's nothing going on in US equities, other than portfolio re-adjustments following a general realisation the herds had once again moved too far into one direction, neglecting the laggards and allowing the gap to widen to extreme measure.

To be fair, it does happen that all there is to a sudden shift in general sentiment is one such simple and straightforward explanation. Most times, however, there's more to it, even if it's not always immediately obvious what other factors might be exerting their influences behind the daily market chatter.

In this case, I have a strong suspicion the shift out of wildly speculative "growth" stocks and into more defensive value and yield assets has been triggered by a general realisation that profit growth for corporate America may have hit a snag and that seems but a genuine reason to pause for a share market that has arguably been on a tear since early March 2009.

Observe, for example, on the chart below how earnings estimates in the US have been deteriorating thus far in 2014 and there seems to be acceleration in the trend in recent times.

At face value, there's nothing abnormal about this as the US reporting season has just started and US companies have a long tried and tested habit of first guiding securities analysts to lower expectations and then releasing earnings beats during the reporting season. Only this time there appears to be a little more to this story.

As highlighted by Glushkin Sheff's Dave Rosenberg, consensus forecasts for Q1 have by now descended into negative territory and if confirmed by actual reports, this would mark only the second time since 2009. In other words: US corporate profits are on track to reveal their worst performance since the third quarter of 2012 when actual profit growth delivered remained below the zero percentage line. Back in 2012, investors anticipated -correctly- that profit growth would accelerate in the following quarters and equities rallied as a result.

This time around, however, things look a bit different. The past two quarters have seen US companies delivering better growth numbers than immediately after Q3 2012, in particular the final quarter of 2013 was an absolute cracker with profit growth achieved no less than 8.5% on average for the companies that make up the S&P 500, handsomely beating already lofty expectations for 6.2% growth.

Even if actual results turn out to be better than the forecast minus 1.4% in earnings per share growth, this quarter is still likely going to show the slowest growth number in a long time. Making matters worse is that early reports have put the bias to the negative side. According to the WSJ, more than a third of company reports thus far have missed expectations against a long running average of 20% missing forecasts. Admittedly, only 4% of companies have reported to date, it's still early days, but it seems to me the general set-up in the US is one that would make quite a number of market participants a healthy degree more cautious.

This looks in particular appropriate given the general background is still one of high optimism and bullish investor sentiment. As per usual, behind the rather benign looking numbers to illustrate the disappointing performance of US equities thus far this year, are much larger individual movements hiding. The median Russell 2000 stock is down nearly 30% from its 52 week high and down 19% from its high over the last three months while the median Russell 1000 stock is down over 10% from its 52 week high.

None of this is indication the bull market that sprang to live in March 2009 is dying right here, right now. As a matter of fact, some commentators in the US are suggesting all companies need to do is make references to the bad weather and share prices will resume their uptrend again.

Besides, the US economy is about to accelerate to higher growth numbers and this should put firm support under estimates and share prices. At least, such is the general view among economists and strategists to date.

What if this view were to be challenged in the quarters ahead?

Economic data and indicators in the US are now bouncing after some pretty disappointing reads for the earlier months in the year. While just about everyone blames this on "bad weather", there is a small group of analysts who believes the weather has been masking the fact the US economy has genuinely experienced a funk in its growth rhythm during the months past, weather or no weather impacting.

Consider, for example, the observation that retail sales growth in the US is now at a 4.5 year low. Mortgage applications have given back 85% of their two-year recovery. Existing home sales have fallen by 15% since mid-year. And while data for February and March look better than for December and January, they haven't bounced in a way that suggests the weather had severely depressed momentum during those prior months – within this context the bounce in data, including labour market updates, actually looks rather tepid.

The underlying message here is that unless things improve quickly and noticeably for the US economy, economists are likely to be forced to scale back their projections. Might this also affect the present tapering program of the Federal Reserve under the leadership of Janet Yellen?

Show us another 2-3 months of falling home sales, says economist David Carbon at DBS Group, and the Fed surely will change course.

Maybe it's too early yet to ignore gold or to assume the only way is up for the US dollar?

Below are a selection of charts that support the sceptical views of today's minority (thanks to David Carbon at DBS Group). Note DBS Group is not projecting another recession on the US horizon, but merely a muddling through with growth oscillating around 2.2-2.3% after a minor bounce in the current quarter. This, however, can potentially trigger major ramifications for profit expectations and investors risk appetite, not to mention US monetary and fiscal policies later in the year.

While the jury remains out on whether the rest of 2014 truly belongs to the optimists, or whether investors should prepare for alternative scenarios, I think it is but logical to assume all the major questions that can be attached to the observations outlined above will remain on investors' minds, until we have seen a definitive outcome either way.

How soon 2013 has morphed into but a distant memory.

El Nino Good For Insurers

In light of my market analyses from years past, I might as well start a regular feature titled "Why Industry Dynamics Matter So Much More Than Just About Anything Else". Recent examples from the local share market include Goodman Fielder ((GFF)), Metcash ((MTS)) and Coca-Cola Amatil ((CCL)). Investors should also pay extra attention to CSL ((CSL)) as there seems to be a growing perception among healthcare analysts that growth will become a tad more difficult to achieve in the years ahead and this might start weighing on the Price-Earnings multiple.

But changing industry dynamics are not by definition negative as proven by the likes of Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) and it would appear that this will also be the case for the insurance sector in the year ahead. Bureau of Meteorology estimates suggest there is a greater than 70% chance we will see an El Niño developing for the Australian winter this year. Analysts at Morgan Stanley were quick on their feet to highlight this should result in lower claims for insurers. Less rain across Australia should also benefit motor insurance companies, but the most relief should stem from less hurricanes in North-America.

Dennis Gartman Warns 

US-based trader and publisher of daily The Gartman Letter, Dennis Gartman, has copped quite a lot of criticism and ridicule in recent years. Most of it is related to the fact that Gartman has no qualms in making big calls, and neither does he shy away from abandoning any of those calls as soon as the market shows them to be incorrect. After all, Dennis Gartman was the original source who provided Nick Leeson with the toxic trading idea that ultimately led to the downfall of British Institution Barings. The key difference, a proud Gartman explained many years later, was that Leeson stuck to it despite the market signalling otherwise, while Gartman had simply read the message, taken a small loss, and moved on to the next idea instead.

Gartman also has the habit of ruffling feathers among precious metals bulls. The fact that he is often bullish gold in currencies other than USD makes him an easy target and leads to internet jokes such as "Gartman bullish gold against Zambian Kwatcha". For good measure, he usually picks either JPY or EUR and as far as I am concerned there's absolutely nothing wrong with this. Gold is a currency, not a commodity. Isn't this the ultimate reason as to why so many gold bulls remain positive about the outlook for bullion? If gold is a currency it seems but perfectly logical to seek out its strengths (or weaknesses) against the most appropriate FX benchmark at any given time.

Anyway, last week Gartman showed the value of carrying three decades of active market participation when the first Friday of the month saw an unexpected sharp fall in US equities, only to quickly show buying support seemingly reappearing. Gartman was not to be fooled, calling for underlying weakness to reveal itself again once the initial bounce had run its course. This is exactly how last week's scenario played out.

Right now Gartman seems quite nervous about what might transpire for US equities. "Should the S&P take out March's low at or near 1825 and then close below there at the month's end we shall be on the ill receiving end of a truly foreboding technical signal that we’d really prefer not seeing develop. Attention must be paid".

Friday's price action in the US has provided further evidence that what investors are witnessing this month is best not to be underestimated, in Gartman's opinion. For good measure, Gartman remains of the view that US equities are in a bull market, and will remain in a bull market once the current correction has run its course. He also believes the potential short term damage from the correction that is unfolding is large enough for traders to either move to the sidelines or to set up protection.

US indices have not tested their 200 day moving averages since late 2012 but Gartman believes it'll happen this time, with potential for worse in the form of a monthly reversal. The latter would likely signal more volatility and weakness for months to come.

(This story was written on Monday, 14 April 2014. It was published in the form of an email to paying subscribers on that day. Also note there will be no Weekly Insights next week due to Easter Monday).

(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)

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

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RUDI ON TOUR

I have accepted an invitation from the Australian Shareholders' Association (ASA) to present to members (and others) in Wollongong on June 10. Title of my presentation: The Share Market: Always The Same, Always Different.

Click to view our Glossary of Financial Terms