A Strange Case Of Dr Jeckyll And Mr Hyde

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In this week's Weekly Insights:

– A Strange Case Of Dr Jeckyll And Mr Hyde
– Central Banks And Interest Rates
– Buy The Dip Works
– Don't Ignore The Shorts
– Rio Tinto: Capital Management Excitement
– Commodities Super Bulls: They're Back!
– Rudi On TV: The Week Ahead
– Rudi On Tour Visits Brisbane In September

A Strange Case Of Dr Jeckyll And Mr Hyde

By Rudi Filapek-Vandyck, Editor FNArena

Nearly one month ago I predicted the upcoming reporting season in Australia would be a rather schizophrenic one with elevated valuations, a struggling domestic economy, too high expectations, geopolitical tensions and cash on the sidelines looking to enter all contributing to a situation whereby investors would want share prices to weaken, so they can buy on the dip, but not too much so as to scare them away.

The video of that reporting season preview can be accessed HERE

Little did I know at that time that once I started digging deeper into expectations for this month's reporting season, I'd only find more reasons to make this month's experience even more schizophrenic than I already thought it would be.

On pure form of the moment, financial stocks should crown themselves King of the sharemarket this month. Just about every analyst who covers insurers, wealth managers or banks seems convinced there are strong profit reports waiting to be unleashed on Australian investors on the back of ongoing favourable dynamics. The problem is: nobody wants to buy more financial stocks.

These stocks (not just the Big Four Banks) have essentially pushed and carried the index to where it is today and both funds managers and individual investors are probably already overweight as is with the likes of Magellan Financial ((MGF)), Henderson Group ((HGG)), Challenger Financial ((CGF)), Computershare ((CPU)), Insurance Australia Group ((IAG)) and NIB Holdings ((NHF)) leaving most others in the market well behind since 2012.

If analysts expectations prove correct, the supremacy of the Financials in Australia shall not come to its end this month. At least not in terms of operational performances. CommBank ((CBA)), for example, should reveal an all-time record profit. Both Suncorp ((SUN)) and NIB are expected to announce extra dividends.

Good news for the faithful and the loyal, but nobody's genuinely going to reel out too many accolades because there's plenty of doubt about valuations -for just about every stock under the banner- and there's plenty of chatter about "rising risk of de-rating", in case of the banks, and the inevitable turn in the cycle for insurance companies.

Which is why the central themes that should determine the outlook for Financials have a lot in common with the rest of the market:

– any cost reduction initiatives?
– any share buy backs or other capital management initiatives?
– any de-mergers or splits?
– any more plans for acquisitions?

In the background of all this lies a general perception that market consensus forecasts for the year ahead are too high, and they will need to be cut, but hopefully not by too much. It also appears the general expectation is that companies are more likely to provide conservative guidance for the coming year. On FNArena's own calculations, the underlying expectation is for 11% in earnings per share growth in FY15. Assuming this falls by some 4% over the year ahead, this would leave the share market rather fully valued instead of extremely cheap or overvalued. But for most investment portfolios, it's all about what happens to individual stock prices.

And here the share market's true schizophrenia is revealing itself through recent share price movements for perennial disappointers such as QBE Insurance ((QBE)). After issuing yet another write down, the share price crashed to near $10, but at that level QBE has found buyers willing to hold on a relative valuation comparison and a longer term view. Remarkable is that, according to public data, there are almost no short positions in the stock.

Big resources stocks have done their utmost to regain investors' favour but here too there remain plenty of question marks about their outlook, predominantly because the supply response continues to build in iron ore (though not so much in H2 this year) while that long mooted recovery for coal prices hasn't shown up yet and copper and crude oil have thus far also refused to fully participate in renewed interest in the sector, no doubt triggered by some hefty gains for producers of nickel, aluminium, graphite and zinc.

As was clearly prevalent when Rio Tinto ((RIO)) released its interim report, the top end of the sector is now all about how quickly can debt be reduced in order to facilitate more rewards for shareholders? Similar themes will dominate when BHP Billiton ((BHP)) reports, as well as Woodside Petroleum ((WPL)) for which the dividend outlook remains uncertain. For other large cap energy stocks, investors will pay more attention to progress on completing giga-LNG projects than on short term results. The potential dispute between contractor Bechtel and the unions can spoil the profit report release for these companies.

There are many others for which the actual profit performance will likely play second fiddle, at best. Think Orica ((ORI)) and the potential spin-off or sale of the chemicals division. Sims Group ((SGM)), having just announced a multi-year turnaround plan. SAI Global ((SAI)): whether the take-over is any closer to being finalised? Treasury Wine Estates ((TWE)): same question.

Come to think of it: this year we have an unusually high number of stocks for which actual profits won't matter, really. We can add Energy Resources of Australia ((ERA)) to this group as well.

Another revelation that came to the fore is that Australia has essentially ran out of decent investment alternatives in the Food & Beverages sector. Once upon a time this was the home ground for multiple investor favourites, as it is overseas, with household brand names such as Foster's, Southcorp Wines, Lion Nathan and Coca-Cola Amatil. Today, the first three are no longer separately listed, Goodman Fielder ((GFF)) is about to de-list, idem for Treasury Wines and Coca-Cola Amatil ((CCL)) is a big name from the past in serious trouble, facing some serious question marks about genuine prospects and growth.

Sure, investors can still pick and choose from the likes of Retail Food Group ((RFG)), Collins Foods ((CFK)), Freedom Foods Group ((FNP)) and Domino's Pizza ((DMP)), but the risk profile clearly is not the same.

Domino's Pizza has now climbed its way up to the select group of high multiple stocks in Australia, and expectations remain high. In fact, some analysts are still expecting the upcoming result will prove better than already lofty projections. High multiple stocks in Australia are on par with the banks: thus far they have absolutely killed it in the profits growth department, and many are likely to continue doing exactly that this month, but valuations are high and so is the group of investors who's asking the question: how long can this continue?

The same question divides the analyst community which is why ratings, valuations and targets for stocks such as REA Group ((REA)), Ramsay Healthcare ((RHC)) and Domino's Pizza are all over the shop. So far the record for these stocks is rather mixed, with Navitas ((NVT)) surprising in a negative sense pre-season and REA Group failing to surprise last week.

It's probably simply a reflection of the current state of mind that many commentators were quick on their feet to point out that REA Group is a high PE stock, and such stocks cannot afford to not meet market expectations. This still doesn't answer the question: is REA Group simply an example of a stock that failed to meet investor expectations, similar to JB Hi-Fi ((JBH)) on Monday, or is REA Group an example of the fact that PEs in certain cases have run too high so that expectations cannot be met?

We might as well repeat the same question for the banks, the discretionary retailers, internet stocks and many of the All-Weather Performers, including Invocare ((IVC)), CSL ((CSL)), G8 Education ((GEM)) and Veda Group ((VED)).

On that note, I spotted the first initiation of coverage on recently listed Healthscope ((HSO)) on Monday. WilsonHTM has started off on a Buy rating and with a price target of $2.51, double digit percentage above the share price.

Not all that has performed well is now by definition out of puff and not everything fresh will prove to be a golden opportunity.

Let the games begin.

Note: FNArena keeps a daily record of released company results and the subsequent analyst responses. This happens in the form of a daily story which can be accessed either via the daily email or directly via the website. FNArena subscribers can download a detailed overview in excel format attached.

Central Banks And Interest Rates

A thing of beauty is a joy forever, said poet Keats once. In Finance, however, everything of beauty is subjected to the daily movements of prices and fund flows. Yet, thanks to IG Market's Chris Weston -on Twitter- I came across the illustration below from HSBC as to where global central banks are positioned vis-a-vis interest rates and this one I simply find too good to not highlight this week. Enjoy.

Buy The Dip Works

An interesting point was made by Colin Twiggs last week. Accompanying the chart below, Twiggs points out those trying to time the market, thus fleeing when weakness announces itself in order to return later, would have likely missed out on the biggest gains over the past two years as every time it appeared a serious correction was in the making, a strong rally ensued instead. The two strongest months are highlighted by green arrows and both follow one or two months of share price weakness.

Another point Twiggs didn't make is that the chart also suggests this bull market is being extra kind to those investors whose strategy is to buy in the dips. Might be partially a result of too much cash on the sidelines while all the investors who own it have the same idea.

Don't Ignore The Shorts

Shares in Cochlear ((COH)) have rallied no less than 25% since May, from some $56 all the way up to $70 and while we'd like to believe management and the board that it's all to do with better performance in the US and the launch of a new technologically advanced hearing aid, the real reason has probably more to do with the fact that short positions had built up to no less than 17.8% of Cochlear's outstanding capital. That is large bunch of shorts and from the moment panic sets in and they all start covering their positions… Which is, of course, exactly what has happened.

Cochlear was the number one most shorted stock in the Australian share market ahead of its result, as everybody could have seen from our very own The Short Report, available 24/7 on the FNArena website and without a single doubt worth a visit now and then. Note that we publish a news story on shorts every Thursday, but the data are available 24/7 with daily updates on the website.

As one would expect, retailers, mining services providers and smaller mining stocks, iron ore producers in particular; they all feature high on the list of most shorted stocks. I wouldn't be surprised if Cochlear doers not remain the sole "rocket" this month.

Rio Tinto: Capital Management Excitement

Observation: despite all the hullabaloo and the excitement post Rio Tinto's ((RIO)) market-surprising interim earnings report, surprisingly little has changed in terms of broker ratings and forecasts. Market consensus sticks by the view this year (December) will remain a struggle as most of the production increases occurred in H1 and the price of iron ore is expected to settle at a lower level.

In terms of ratings, of course, everybody already rates the stock a Buy, while in price targets consensus has now moved to $79.91 from $77.84 before the release. This brings little relief as the share price is still only in the mid-$60s. But could this be the time to revisit the $70? (Hasn't happened since the publication of the 2013 results in February).

Forget about pure earnings growth. The board has made it clear debt levels are coming down and shareholders will become beneficiaries of it. Deutsche Bank put it all together in one fine graph, showing debt and gearing is now on a down slope and "equity attributable to shareholders" is growing. This should keep market spirits positive.

Commodities Super Bulls: They're Back!

Most stock broking analysts in Australia appear to have found peace with a rather benign outlook for commodities. Gone are the days of crazy hazy 2004-2007 when China's appetite seemed insatiable and producers' luck simply knew no end. Instead we now have supply catching up while large operations are running at higher efficiency and with less interruptions. Developed economies are on the mend, but it's not what it used to be. Even Emerging Markets are no longer growing at the same break-neck speed with struggling China the prime example.

In terms of price forecasts, most analysts anticipate sizeable upswings for the sector laggards from recent years, including zinc, nickel and aluminium. At some point, coal markets shall improve too, and the same goes for zircon and titanium, and eventually even for uranium. But don't expect any fireworks from gold, or iron ore, or crude oil. Unless, of course, most analysts are missing some vital information.

What vital info are we talking about? Well, maybe the fact that China's transformation to middle class income consumers is way too slow and the country will embark on a super-duper investment spree in infrastructure projects instead! Hong Kong based investment services provider Reorient is making a big case for a new boom in commodities demand on the back of Chinese infrastructure plans that do not seem to have elicited a lot of excitement across the globe just yet. As per usual, the numbers look phenomenal and it's going to put a rocket under the prices of commodities that have supposedly seen their best performances in the past.

Reorient is talking a new boom which shall be bigger than the one experienced in 2004-2007 because the mining industry is not adding enough supply for the demand surge that is building from China's high speed train links, inter-city train links and national super grid. To show their conviction behind the call, Reorient has added Atlas Iron ((AGO)) and Fortescue Metals ((FMG)) to their short list of preferred stocks, but acknowledges it might take six months before investors come to realise there won't be enough iron ore around come 2015. (This seems like a big call given the production increases planned for the year, but nothing's impossible, of course).

For the near term, Reorient's favourites are zinc, nickel and aluminium – pretty much in line with just about everybody else.

"Expect parabolic moves in share prices".

Rudi On TV: The Week Ahead

On request from readers and subscribers, from now onwards this Weekly Insights story will carry my scheduled TV appearances for the seven days ahead:

– Thursday – Lunch Money – Sky Business – midday-12.45pm
– Friday – Your Money, Your Call, Bonds versus Equities – 7-8pm
– Monday – Sky Business – circa 11.20am (Broker Calls)

Rudi On Tour Visits Brisbane In September

On Wednesday, September 3, I will be presenting in Brisbane twice. First at 2.45pm on invitation of the Australian Investors' Association (AIA) and later in the evening on behalf of the Australian Technical Analysts Association (ATAA)). More details to follow.

(This story was written on Monday, 11 August 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(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

For paying subscribers only: we have an excel sheet overview with share price as at the end of July available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms