Rudi's View | Dec 22 2014
(Update December 2014)
By Rudi Filapek-Vandyck, Editor FNArena
As I write this update, another post-GFC year is about to close, having delivered investors in the Australian share market yet another harsh reminder that risk is not but a four letter word and "portfolio diversification" does not by definition mean add energy, mining and resources services providers.
While these sectors are globally among the underperformers in this post-GFC era, in Australia the lesson learned by many investors is much harder as many stocks in these sectors have revisited share price lows last seen in early 2009, having often subsequently experienced yet another leg lower.
If I personally have learnt one valuable lesson since 2008 it is that successful investing starts with the right macro framework. Back in 2012, I travelled to Perth to deliver the message: thou shalt not invest in resources stocks. I did this on the basis that my own analysis suggested those companies would have a tough time to deliver consistency and sustainability in the absence of a strong underlying trend for the global economy, including in China.
Most of all, there are some powerful forces at work that are creating a different dynamic for equities. Yet on my observation, most newsletters, journalists, stockbrokers, market experts and commentators and, yes, investors too, are simply trying to emulate and to continue what used to work pre-GFC. Is the fact the share market hasn't played ball thus far simply a case of bad luck? Wrong timing? Australia versus the USA?
I beg to differ. While I am usually the first to mock experts that use the tainted phrase "this time is different", I do believe our collective memory casually forgets it never has been the same, really. It is generally accepted that equities are the best investment vehicle long-term, but history clearly shows it is imperative investors are in tune with what works at any given time. The differences are huge, as are the investment outcomes.
Back in the late nineties it was all about the Internet and Enterprise Resource Planning (ERP) and various other software companies. After 2000, however, these were the stocks that would destroy capital with a vengeance. In many cases, they would completely wipe out whole investment portfolios. Between 2004-mid-2008 the story was all about the awakening of China and the effects it had on natural resources. Yet again, post 2008, and despite a short-lived resurgence in 2010-2011, these stocks have turned into relentless capital killers.
The story does not change if we travel further back into time. Superior results in the 1970s came from owning the so-called Nifty Fifty, large household names growth stocks including IBM, Kodak, McDonald's, Disney and Polaroid. The 1980s was all about biotechnology and microelectronics, and about Japanese equities. Before that, in the 1960s, the superior investment trend was to own conglomerates that created earnings per share growth out of cross-sector acquisitions.
Today, I believe it is incorrectly reported all that matters is yield and income. This is -at best- half of the story and one that receives far too overwhelmingly most of the attention from experts, the media and from investors. The superior trend post-GFC is not about owning shares that pay dividends, it's about owning shares that are the least likely to disappoint. Trustworthy, reliable and sustainable dividend payers are only part of this story.
Today's share market dynamics, in my view, are a response to investors having experienced two severe bear markets inside one decade, changing demographics with retiring Baby Boomers understandably worried about volatility and share market corrections, and central bank policies which, in effect, are targeted at keeping global bond yields extremely low, thus forcing savers around the globe into accepting more risk.
The impact of central bank policies on investor strategies has been perfectly captured in the graph below. Those who have attended my on-stage presentations over the past years would be familiar with it as this graph has become one of my regular reference points to illustrate the underlying dynamics in the post-GFC era.
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Essentially, the implications of this graph are investors who do not want to take on risk are being forced into incorporating higher risk assets into their survival strategies and they have responded by going for the lowest risk options available that still offer real return (above inflation). Clearly, the first choice is real estate, the next step is to sort out the lowest risk options in the share market.
The easiest reference point for making these lower risk investment decisions is the past. Australian banks only had to cut their dividends once, in the midst of the GFC itself, and their share prices, with exception of National Australia Bank show a nice, continuous up-trending movement since the mid-1990s, only temporarily interrupted by the GFC. Tick. Telstra has not cut its dividend once since listing on the ASX and its share price has been clearly on the mend post Future Fund sell-out. Tick. Both Woolworths and Wesfarmers haven't cut their dividends for as long as anyone can remember. Their share prices too show a nice, long term uptrend on price charts, only briefly interrupted by the GFC. That's another big tick.
Baby Boomer retirees and SMSF-operators are not the only participants in the market. Fund managers have also changed their framework and they have essentially come to the same conclusion as I have (at least: the smart ones): quality, sustainable growth is not something that's available in abundance. Certainly not in the Australian share market.
We've all heard the famous reference about investors only discovering who has been swimming naked when the tide turns and the ocean retreats. Well, on my analysis, the weaknesses in the Australian share market were covered up and masked, pre-2008, by a set of exceptionally strong economic and financial tailwinds that turned just about every stock on the ASX into a sustainable performer. Now that the tide has reversed, however…
Today I am prepared to go one step further: viewed from the angle of sustainable, quality growth, I believe three-quarters of the Australian share market, if not four-fifths, is essentially non-investment grade. Trade these stocks as often as you like, but do not add them to your long term investment portfolio as an "investment".
Based upon my post-GFC analysis, part of my on-stage presentations about the Australian share market consists of labelling the majority of listed companies as being "cry babies". Most companies cannot perform on their own except, maybe, for a brief period. Beyond such brief periods of growth they need help from the economic cycle, the government, the currency, new technologies and innovations, or from the central bank – preferably from all of them combined!
This is why my share market analysis post-GFC has focused on finding the select few that are different. Companies that can grow regardless of whether the Reserve Bank might add one or two more rate cuts, regardless of where the Australian dollar might be in twelve months' time, regardless of whether China might announce yet another big stimulus program, or not. Believe it or not, those companies do exist. I labelled them "All-Weather Performers" because that's essentially what they do; perform when the sun shines as well as when it rains, hails or freezes.
Today's update carries on from the research and the updates I have published since 2008. As expected, today's list of companies is different from the one that was included in the 2012 eBooklet "Make Risk Your Friend. Finding All-Weather Performers In The Australian Share Market".
Before we move to the list of companies, I'd like to introduce you to research conducted by Macquarie Equities' share market strategist, Tanya Branwhite. Our respective analyses of Australian equities post-GFC are not completely the same, but there are many similarities. Even though many others have changed their approaches and their views about equities since the GFC, Branwhite, on my observation, comes closest to my own approach, angles, views and conclusions since. No surprise thus, Branwhite too believes only a select number of companies listed on the ASX has the ability to genuinely deliver quality growth and shareholder returns in a sustainable manner in the years ahead.
Branwhite's view starts with the thesis the global economy is now best viewed from the angle of a "Long Grinding Cycle", or as the Macquarie strategist likes to call it: LGC.
She argues de-leveraging households, businesses and governments continue to drive a more protracted low growth economic recovery than that seen in the past, such that the current cycle is not only longer in duration, but also characterised by sub-trend growth. For equity investors this means the best returns are likely to come from specific stocks, those offering sustainable, high yield or those combining growth with a reasonable yield or offering above-average growth. Sounds familiar?
You bet.
Unfortunately, for the Australian share market, Branwhite finds the Australian economy is by now well and truly entrenched into the global LGC. Making matters worse is that Australia is now a laggard, in particular vis-a-vis other key Anglo economies.
In general terms, Branwhite predicts the normalisation of equity market valuations against the continued long period of low growth leaves the outlook for equity market returns lower than the levels enjoyed over the last few years, plus with greater volatility. Investment returns are likely to remain "stock-specific" (Alpha) rather than "market-specific" (Beta), in her view.
In order to achieve superior growth, companies need top line growth (sales, revenues). This, says Branwhite, is the "holy grail" of the LGC.
So where can we find these companies? Macquarie offers a few suggestions:
– Companies that operate in segments of the economy where there's no shortage in demand, such as healthcare, and business services reflecting cost focus and a trend to outsourcing and consumer services;
– Companies in dominant market positions or oligopoly market structures;
– Companies with a broader geographic exposure that can tap into growth potential elsewhere
Readers who have kept track with my own research on All-Weather Performers will have instantly recognised some of the key characteristics that are no less than recurring themes in my own writings.
Below is my updated assessment, and selection, of All-Weather Performers in the Australian share market.
[For paid subscribers only. See eBooklet update "Make Risk Your Friend. Finding All-Weather Performers", Update December 2014]
