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The Bear Market Diaries – Episode 2

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Feb 24 2016

This story features SLATER & GORDON LIMITED, and other companies. For more info SHARE ANALYSIS: SGH

In This Week's Weekly Insights:

– The Bear Market Diaries – Episode 2
– Has Goldman Sachs Lost Its Mojo?
– Emerging Markets: The Big Deceleration
– #NigelNoMates On The Go
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

The Bear Market Diaries – Episode 2

By Rudi Filapek-Vandyck, Editor FNArena

The essence of portfolio management is the management of 'risks', not the management of 'returns'. All good portfolio management begins, and ends, with the premise!
[Benjamin Graham]

If market signals don't deceive, the Australian share market is more likely to put in a recovery rally in the weeks ahead, alongside most equities markets worldwide.

This will make life increasingly challenging for those investors who've positioned themselves for more carnage and damage ahead, including those who've fled to the sidelines and are now wondering what time is best to re-enter?

Expect the market bulls to come out and step into the limelight with extra gusto. The start of the new calendar year has left them battered and bruised with little relief and they want blood, revenge, vindication. This will be their moment to shine.

The share market is always divided between participants with a negative outlook and those who cannot but see the good things in life. Worldwide there are established armies of commentators and other sorts of experts who stick to their mantra no matter what. So when times get rough and all that appears on the horizon is more technical damage and share price weakness, the first group comes out of the woodwork and starts reeling out the same doom & gloom stories they've been repeating since the fall of the Roman empire and death of the dinosaurs.

But when share prices are on the up it's time for their adversaries to deliver some public payback and make sure their fans/clientele are aware of the opposite version of history and recent events; all to be absorbed against an always positive, long term uptrend-view. There are far more positive minds in the market than there are negative bears and nothing sounds as compelling as a positive story against a background of a rising share market.

Expect to hear a lot about "the lows are in", "the worst is behind us", "markets had been misguided by fear", "investors can now buy back in with increased confidence".

It is possible, of course, that all that the world was worried about at the start of 2016 was simply a mirage, a temporary regression into baseless fear. Personally I doubt this will prove to be the case, but, of course, I can be wrong (wouldn't be the first time either).

If anyone feels the need to go all-in bullish and fully ignore the Benjamin Graham quote at the beginning of this story, I suggest open a price chart for the ASX200 between 1/10/2007 and 31/03/2009. Amazing how many rallies the share market experienced in what would ultimately end with a loss of more than 50% of total value at the start of the chart, isn't it?

Again, I am not by default predicting we are going to repeat that 2008 experience, but I very much doubt this year is going to present investors with one quick scare, after which it will be back to business as usual.

Crisis? What Crisis?

One of the obvious observations to make is most experts and commentators have been left scrambling during the first two months of the year to explain as to why exactly global risk assets were sold down so heavily in the opening weeks of calendar 2016. To some, this is the ultimate proof it's all about markets having a hissie-fit, without much fundamental value or justification. In other words: investors should simply treat this as market volatility; an opportunity to load up on cheaper assets and focus on the longer term uptrend.

Most experts (on my observation) have a rather short memory. In many cases, this suits them well too. What they seem to have forgotten is back in 2008, when the new calendar year started in exactly the same fashion as this year, nobody really had much of a clue either. Sure, we'd all become aware of derivatives linked to US mortgages that had gone wrong, but how serious could this become, really? This was the time we all started talking about "subprime". It was the "subprime crisis". By the end of the year, subprime had morphed into "The Global Financial Crisis", otherwise known as GFC.

I guess what I am saying is not that I have all the answers, but in a world of tightening US dollars, too much debt (just about everywhere), Emerging Markets struggling for growth, fading confidence in central banks' policies, more and more extremities (now it's negative interest rates), evaporating corporate earnings growth around the world, ongoing bullish expectations and relatively high asset valuations, not to forget desperate authorities in Japan and equally uncomfortable leaders in China, the exact name for the downturn we are being confronted with in 2016 will be decided by what possibly comes next.

And we are all hoping it's not going to be called the China meltdown crisis or the European disintegration crisis, or something of the same order. Venezuela can go bust without anyone giving a hoot, but Brazil cannot.

When it comes to seeking for answers in the usual economic and financial indicators, this very much remains a case of beauty is in the eye of the beholder. Corrected for inflation, most of the world's economies are struggling to show positive growth. If we take China's statistics at face value (and look really dumb), then global manufacturing is on the brink of a recession. If we assume China's numbers are inflated, global manufacturing already is in a recession (negative growth compared with previous year).

In the USA, the Conference Board's index of leading economic indicators printed a negative number for the second consecutive month in January. This is a rather rare occurrence and increases the risk for a recession later in the year, even though the Conference Board itself has tried to sooth market concerns by stating the "six-month growth rate remains consistent with a modest economic expansion through early 2016".

Don't be fooled by commentary suggesting a US recession is a prerequisite for a bear market for equities. This is not the case. There have been four bear markets without a US recession. Rare but possible nevertheless.

Moving Battle Lines

As is easily shown on the price chart below (thank you, Yahoo!), the Australian share market has been in a downtrend since mid-2015. In a similar fashion, it can be argued the 2007-2009 bear market actually started in August of 2007 when the demise of Bear Stearns sent shock waves around the world and global equities temporarily in a downward spiral. Who was to know the quick snap back rally back to new highs was effectively the last breath of the as ever blindly ignorant equities bull?

In simple terms, while drawing a comparison with the trench wars of WWI, bears and bulls armies have been slogging it out around some key territorial land marks. At first there was stiff resistance at 5000 and few believed it would be broken, but then it did and the bulls had to regroup and defend 4900, which seemed impregnable until it did and we even had to endure the ASX200 trading below 4800 a few times.

However, on short to medium term valuation metrics, 4800 or below looks extremely cheap so it takes actual bad news, instead of simply fear, to keep equities at such level. No surprise, in the absence of bad news, the bulls are going to charge forward and reclaim as much territory as possible.

On my observation, stockbrokers are now talking about a "bear market rally", meaning they will instruct their clientele to jump on the bandwagon now, but jump off when things start looking toppy again. I think this is a change in mind set from the general attitude prior. This may well become a self-reinforcing process further down the track.

The Future According To UBS' Charts

Last week, I wrote in bear markets it often is best to pay more attention to what technical chartists have to say rather than listen to fundamental analysts as the latter more often than not rely on yesterday's assessment and cannot genuinely grasp as to why the world has suddenly turned against them. Just like in 2008 they couldn't possibly grasp how a problem with a few mortgages in the US could justify selling the banks in Australia. Witness events and commentary from the past eight weeks.

As one would expect, there is no consensus among technical chartists about what comes next, or how the playbook for 2016 is going to unfold. I have seen a few predictions this downturn is likely to find a bottom in Q1 2017. If correct, the similarities with 2007-2009 will be striking and confounding many, including myself.

One team of technical analysts deserves to be commended because on my observation the TA team at UBS has been close to the mark in reading market events and direction in the year past. Which is why I think their prognostication deserves to be repeated and highlighted. Short term, their view is the market will start a counter-trend bear market rally which is likely to last several weeks. After that, we are likely to see renewed weakness but the bottom in that downward move won't be as deep as what we witnessed this month. I can already picture the commentary by many a market bull (it's over!).

Here's the UBS TA team's missive: "we still recommend long-term investors to use strength into Q2 to sell since into deeper summer we expect to see new lows across the board".

What the team is saying is there will be another rally, which shall take indices even to higher levels than the rally that is expected for the weeks ahead, after that markets will be looking for new lows. In calendar terms, the real battleground will be in July-August, during the Northern Hemisphere's summer months. Given the seasonal patterns of that time of the year, one should not be surprised to see the battle extend into September and possibly even the first two weeks of October.

Regardless of whether we believe the UBS team's projections, or even whether these projections will be correct or not, the underlying message remains the same: don't get too confident about events and outcomes in the short term. This is likely going to be a drawn out process.

I note Geoff Wilson, still one of the investment icons in Australia, has also expressed a forecast this market is likely to find a bottom in October this year.

My personal view remains unchanged: patience and cash are now every investor's best friend. Make sure you use both wisely.

Make Sure You Have A Plan

Regardless of all the noise and distractions short term, all investors should keep in mind that nothing lasts forever and this bear market too shall pass, eventually. So what you need is a plan, a structured strategy to make sure your wealth doesn't incur too much damage but you also want to benefit from lower asset prices and from the next sustainable upswing, whenever it occurs.

Jeffrey Saut, Chief Investment Strategist at Raymond James in Canada, recently shared his experiences on how different types of investors employ different strategies during bear markets. He thinks investors without any plan will end up being a rabbit, only capable to respond emotionally and impulsively, but mostly positioned to stare clueless into the shining light. Don't be a rabbit, make a plan.

Those investors who design a strategy end up in two camps: assassins and hunters. Reading Saut's description for the two, I have been both in the first two months of 2016.

Assassins set their pain threshold and cull ruthlessly once a share price falls too far. It means you are not exposed to limitless losses, regardless if you ever bought into Slater & Gordon ((SGH)), Atlas Iron ((AGO)), Whitehaven Coal ((WHC)), or other share market dogs.

Hunters are on the look-out for cheap assets. They start nibbling when share prices get too cheap to ignore.

In all cases, the trick is to be able to look through short term considerations, while showing immunity to noise, volatility and uncertainties. Rule ten of Bob Farrell's famous ten market rules states: bull markets are more fun than bear markets. That's a statement that proves its value pretty much every day in a bear market.

Past experiences suggest dividend stocks are a winning strategy during bear markets, but investors have to be prepared to suffer capital losses, or else buy dividend stocks at discounted prices, or buy dividend stocks that hold up their value. Already it is clear investors are very hesitant to say goodbye to their shares in Sydney Airport ((SYD)) or in Transurban ((TCL)), but they seem to have no such hesitation when it comes to the banks. Different stocks for different strategies?

A second proven strategy is through gold and/or gold mining stocks. However, at this stage I would preach caution as gold's outlook and drivers are far less certain this time around, unless you are relying on Armageddon, plus share prices of gold producers in Australia are way too popular for their own good. Which is why the sector has started to receive downgrades from stockbroking analysts.

Thirdly, robust solid, defensive & reliable cash generators with an impeccable track record, risk profile and balance sheet can still generate positive returns even when the broader market cannot. Amcor ((AMC)) shares are up 5% year-to-date, and so is Wesfarmers ((WES)). Carsales ((CAR)) shares are up 1%. Medibank Private ((MPL)) shares have gained 16% since December 31. Clearly, understanding the difference between these shares and the bulk of the share market is going to help you a lot with your strategies and portfolio performance throughout the remainder of the year.

As indicated earlier, the strategy I have employed for the FNArena/Vested All-Weather Model Portfolio was to get rid of all potential weakness and focus on strength. Part of my consideration was that robust companies in good health were more likely to prove investors wrong during February reporting season. Thus far, this approach has worked with the likes of Amcor, Orora ((ORA)), Transurban ((TCL)) and APN Outdoor ((APO)), to name a few. This strategy would also have worked for companies including Sydney Airport, Brambles ((BXB)) and ResMed ((RMD)), among others.

So far so good with the portfolio proving much more resilient than the broader market throughout 2016's early year turmoil. But maybe it's better to wait until reporting season is done and dusted before drawing any conclusions. Next week might be the better time to update on my strategy with more colour and detail.

A reminder: in my first story for the new year I declared 2016 the year of conviction. To re-read why:

Has Goldman Sachs Lost Its Mojo?

Many a stockbroker is showing off its in-house stock picking abilities through so-called Conviction Lists, even though they all carry their own specific names, not necessarily mentioning any "conviction" behind the stock picks selected. Given these baskets of individual favourites tend to outperform the market, and often by a wide margin, FNArena on occasion reports on composition and performances of these lists.

One of the best performing lists has been Goldman Sachs's Australia Small and Mid Cap Focus List. On their own track record assessment, the list since inception on 16 January 2012 has outperformed the ASX Small Ordinaries Accumulation Index by 42%. Its return over the past twelve months is 15.9%. No doubt, these numbers are making many others in the market envious.

But tide has turned, and dramatically so with Goldman Sachs' small cap stock picking ability heavily impaired by the robust change in market dynamics thus far  in 2016.  Performance to date is double digit in the negative (-10% as at Monday one week ago) and we can only assume that by the next update -ceteris paribus (all else being equal)- the result might look even uglier. This conclusion is based upon the observation that Goldman Sachs' selected list of conviction buys for the year ahead includes names such as Amaysim ((AYS)) and 3P Learning ((3PL)). Both stocks got clobbered in days past as the market didn't like their financial reports.

Other names on the list, such as Blackmores ((BKL)), FlexiGroup ((FXL)), McMillanShakespeare ((MMS)) and Sirtex Medical ((SRX)), have suffered from selling pressure as well thus far. The list is completed with AUB Group ((AUB)), Fisher & Paykel Healthcare ((FPH)), Genworth Mortgage Insurance Australia ((GMA)) and Sky City Entertainment ((SKC.NZ)).

Goldman Sachs' local headaches in the small cap space must be small beer compared with the fact the mothership in the US reportedly had to unwind five out of six conviction trades for the year. Talking about changing market dynamics and finding oneself on the wrong side of the stick.

Meanwhile, and staying in the US market, portfolio strategists at Morgan Stanley have equally been forced to issue an implicit "sorry" to clients as the opening weeks of 2016 destroyed their positive track record, leading the strategists to question whether the world had suddenly turned upside down?

Emerging Markets: The Big Deceleration

The share market always provides what investors are looking for. This is not only true in terms of listed stocks and popular investment themes, but equally so in terms of in-depth analysis. The past years (multiple) have seen global GDP growth decelerate at steady pace. Did we see a lot of research highlighting this? Not really. There was the occasional report, and, of course, there was my book (*), but otherwise scant research resources were allocated to the subject.

This year the number of reports already has visibly multiplied and it's probably only fair to assume this trend is set to continue in the weeks/months ahead.

One report from Citi analysts drew my attention in that it undermined the general assumption that growth in Emerging Markets will, at some point, start reverting to the mean again (read: improve from current underlying weakness). Citi analysts have dared to question the logic, even though widely accepted as a "given", and they have singled out Brazil as this year's test case.

The team at Deutsche Bank has equally proved more productive than usual, which generated an excellent update on this matter, concluding "Asian economies by and large facing weakening growth and declining credit momentum, under-pressure asset markets, and continued drag from high household and corporate leverage". In other words: the situation is rather weak out there and we don't think anyone should be expecting a quick turn around.

Deutsche Bank's report contains various excellent charts and graphs from which I have picked three. In order of appearance: China's declining momentum (calculated on proprietary methodology), structurally declining GDP growth numbers across Emerging Asia (numbers displayed are 3-year averages) and the explosive surge in household debt throughout the region.

(*) In November last year, FNArena released my eBook Change. Investing in a low growth world. Scroll down further below for more info.

#NigelNoMates On The Go

Nigel spent a fair amount traveling last week, including being present at an Investment Committee gathering at a financial institution in Sydney CBD. Below is an impression of Nigel enjoying his time on the fast ferry between Manly and Circular Quay in Sydney.

I am keeping the world up to date about #NigelNoMates' endeavours and adventures through my Twitter account @filapek, but his presence is clearly catching on with FNArena starting to receive emails with best wishes to Nigel, and the likes.

Rudi On Tour – Who's Afraid Of The Big Bad Bear?

They seem to come along every eight years or so, the dreadful bear market so many investors detest, causing risk appetite to evaporate and share prices to reset at lower levels. Every time the cause and follow-through are different. So what lies at its origin this time and what's going to be the likely outcome? As a self-nominated bear market expert, I will be sharing causes, explanations, insights and strategies for investors who want more than keeping their fingers crossed while hoping for the best.

I will be presenting:

– To Perth chapters of both Australian Shareholders' Association (ASA) and Australian Investors' Association (AIA) for presentations on Monday 9th May, both afternoon and in the evening.

– At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).

Here's the link to Amazon:

See also further below.

Rudi On TV

– I shall be hosting Your Money, Your Call Equities on Wednesday, 24 February, Sky Business, 8-9.30pm
– My next appearance on Switzer TV will be this Thursday, 25 February, between 7-8pm

(This story was written on Monday 22 February 2016. 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.

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: or via Editor Direct on the website).



Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible):

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