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The Bear Market Diaries – Episode 4

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 | Mar 09 2016

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

 In This Week's Weekly Insights:

– The Bear Market Diaries – Episode 4
– Reporting Season – Before And After
– WorleyParsons Rallies – ETFs & Shorts
– Oil – When Everyone Sees Recovery
– #NigelNoMates: Sticking Around
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

The Bear Market Diaries – Episode 4

By Rudi Filapek-Vandyck, Editor FNArena

"Investors should brace themselves for a challenging year ahead with markets likely to continue to be both volatile and low-returning".
[Vanguard Asia Pacific head of investment strategy, Jeffrey Johnson]

Quite amazing, if you think about it.

US equities are within a whisker (circa 2%) away from a positive return year-to-date and only 6%+ below the all-time high.

If Australian equities keep going at the pace they've been rallying since the start of the month, they'll soon be able to show positive numbers for calendar 2016 too.

Makes one wonder, what was all the fuss about at the start of the year?

Brief Recap

Last year I wrote a book(*). One of the main themes in it is that global growth has steadfastly disappointed post GFC. GDP growth in the number one economy, the USA, has averaged 2% over the past six years which is the slowest pace post a recession for as long as statisticians have kept records.

Then there's China, where growth has been slowing, and still is slowing, no matter what the exact numbers are. China's slowing in particular has been weighing on other Emerging Markets too. The result has been a steadfast deceleration in global trade and growth.

Not so well understood is that the five-year decline in commodity prices has also become one of contributing factors to struggling global growth. This seems counter-intuitive. After all, companies like Amcor, Ansell, Qantas, Coca-Cola Amatil and many others in Australia and the rest of the developed world are benefiting from cheaper input, but in most Emerging Countries, beaten-down commodity prices have had a devastating impact on government revenues and on private sector activity.

Picture Western Australia as a country on its own, now struggling to keep people in the work force, while property prices in mining regions have collapsed and producers of metals, bulks and energy have but one goal: lower costs and generate enough cash flows to stay in business.

When I visited Africa over three weeks in December-January, I witnessed first hand how poorer countries like Malawi, Mozambique and Zimbabwe have struggled in recent years. Gone are the international headlines about Africa, the next frontier or even the next engine for global growth. Instead, newspaper columnists now look back to 2011 when such headlines appeared regularly in Europe and elsewhere, and then follow up with a self-deprecating joke or simply with the question: what went wrong?

Africa remains the world's prime display of corruption and incompetence. Nothing is too crazy for it not to be happening somewhere on the continent. Now low prices for commodities are genuinely having a noticeable impact.

It's easy to dismiss this as "but that's just Africa", a side-show in the global economic mix, a potential that seems never ready to move beyond future promise, but the situation on the ground in Africa provides me with a better understanding when I read reports on Brazil, Russia, the Middle East, Emerging Asia, commodities regions in China, et cetera.

It's tough out there, and for big chunks of the global economy it's not getting any better soon unless we see much higher commodity prices, sustained.

Slowing Growth

Financial markets tend to operate on narrow vision and short attention span, but nothing you just read has been spectacularly new. So why the global sell-off in January and February?

Fingers have to be pointed at sovereign wealth funds, many of whom had to make a mental shift from what else am I going to buy next to what do I need to sell in the short term? A little panicky, perhaps, many decided to offload equities across the globe as soon as the new year started. It may well have been a case of sovereign wealth funds in a similar conundrum think alike – all at the same time. Many of these funds are linked to a government whose expenses and income depends on commodity prices.

However, the real culprit, I believe, has been the USA, where the oil and gas industry has been one of few steady pillars beneath the 2% GDP growth, plus, of course, small entrepreneurial frackers who've helped create global over-supply and by now represent a sizeable portion of the American high yield bond market; enough to put the fear into investors who've experienced the subprime fallout post 2007.

Most of all, higher rates and a stronger US dollar when corporate earnings growth ex-buybacks seems in Struggle Street, is not conducive to further Price-Earnings ratio expansion. In particular not when some economic indicators are rolling over, raising doubts about economic health and whether the next recession could be on the horizon.

In other words: global sub-par growth, which is likely to remain with us for longer, only started to genuinely affect financial markets when US investors started to take notice and became concerned about whether all of the above might well be starting to impact on the US economy and on US corporate profits.

USD  & The Fed

For now, all seems forgiven. The market has priced out prospects for a rate hike move by the Federal Reserve in 2016. Thus the US dollar is, on a trade weighted basis, some 2-3% lower than at the start of the calendar year and it has been a lot lower in February. Hence why gold put in a double-digit percentage rally over the month. But also why commodities and equities globally are now erasing all the losses from the opening weeks.

Risk assets love a weaker greenback. This has thus far been surprise development number one.

How long can it last? Surely, the Federal Reserve remains ready to continue "normalising" US interest rates?

Maybe not.

The US population will vote for a new president later this year and the Fed usually stays far removed from politics, hence it is traditionally very reluctant to change interest rates when political campaigns reach fever pitch. Does this mean the second half is off the radar? We're already in month three of the first half and March is seen as not a viable option for a rate rise, by just about everyone.

No rate hikes from the Federal Reserve is likely to keep a lid on the US dollar, which benefits global risk assets. A lot will thus depend on how determined Janet Yellen & Co are to continue lifting US interest rates with financial markets putting on a tantrum every time the Fed moves rates (or is about to).

Making matters even more uncomfortable for Yellen & Co is that Japan seems to have moved into full "madman panic" mode, with the BoJ having joined the ECB, the Swiss, the Danish and the Swedes by pushing short term interest rates into the negative. Extreme stimulus by large central banks such as ECB and BoJ pushes up the relative value of the US dollar. Witness how the USD Index in February first fell from 99.5 to 95.5 as investors priced out any Fed rate hikes, but then swiftly rose to 98.5 as the ECB confirmed its "whatever it takes" stance, and the BoJ introduced negative rates.

The big question mark for global markets now is: how feasible are further rate hikes by the Fed with two major central banks already pushing the greenback higher?

A weaker US dollar also reduces the need for China to possibly further devalue its own currency.

Commodities & Currencies

The potential fall-out from the international currency battle ground for Australia may well come through a higher Australian dollar. A weaker greenback stimulates commodity prices which -all else being equal- feeds into a stronger Australian dollar (as well as supporting currencies for other commodities producers such as CAD, NZD, SAR, RUB, BRR, et cetera).

Australia also still offers world-leading bond rates and they will continue to attract attention within a context of negative rates in major economies, exacerbated by any hesitation/postponement on behalf of the Federal Reserve. Already I heard one fund manager predict AUDUSD can possibly revisit 80c later in the year. It was supposed to be at 65c by now.

All of a sudden, two more rate cuts from the RBA later in the year, as predicted by some, don't seem completely out of the question. In particular not if the 3% GDP growth reported for the final quarter of 2015 proves too flattering for Australia's true performance in the quarters ahead, as suggested by many.

The end of the yield trade? Really?

The Big Switcheroo

Risk assets have put in a quick switcheroo over the past two-three weeks. In short: assets that had performed earlier in the year are now being abandoned for those that had sold off. The result is a world in reverse from the scenario followed earlier in the year.

Shares in Fortescue Metals ((FMG)) have more than doubled in price since closing at $1.62 on February 12, can you believe it? In the same breath, Burson Group ((BAP)), one of the most solid and attractive growth stories in the Australian share market, whose shares had risen no less than 18% since the start of the year, has lost 10% in recent sessions.

The choice between these two options seems easy to short term oriented market participants (follow the momentum), but for an investor with longer term horizon, the crucial question will be whether the current market switch will prove nothing but a temporary burst in an unchanged longer term channel, or whether this time there is more substance to support the revival?

The world is still awash with over-supply, and there's debt and sub-par growth everywhere, yet some analysts/investors believe there is sufficient improvement in conditions on the horizon to make this a rally to join. Since this is also a time when seasonality is favourable for key commodities (crude oil, iron ore, et cetera), we won't be able to establish whether this is correct until much later in the year.

The bigger picture of a growth-constrained world, with central bankers mingling and interfering, most companies still on the defensive, currencies all-important battle grounds and politicians pretty much absent in the face of deflation/disinflation and polarising societies, I cannot help but think the current bout of euphoria is going to run into the same headwinds and questions that put the fear into the global community at the start of January.

In Australia, analysts, commentators and investors have covered a lot of ground since May last year, but the share market as represented by the ASX200 is still moving inside the same range as it has done since; between 4700 at the bottom and 5350 at the top. We're somewhere in the middle right now.

Apart from the understandable reflex action to secure profits after the strong run up since mid-February, this is probably a bad time to become too positive/complacent about the market's outlook. After all, the world hasn't changed much over the past four months or so. It's just that the market mood has.

All that has happened, really, is someone shouted banks and resources look oversold and a few others thought the guy might have a point. Next thing they knew, they'd initiated a stampede.

Mood swings are what will determine the way forward.

See opening quote of this story, taken from the AFR from the weekend past.

(*) Change. Investing in a Low Growth World. See further below.

Reporting Season – Before And After

It's a pity Macquarie waited this long before releasing its own assessment of the February reporting season, otherwise I would definitely have included the table below in my own analysis, which can be accessed here.

Macquarie's analysis is not different from my own: the Australian share market is faced with its second consecutive year of negative earnings per share (EPS) growth, but take out miners and energy companies and it doesn't look too bad. The big question mark from here onwards is whether the anticipated recovery in FY17 & FY18 will need to be scaled back, and by how much. If recent experiences are anything to go by, both numbers will look a lot less by the time companies get ready to release their actual performances.

Macquarie is the only one one who has published a nice table with an overview of the changes that occurred over February. Sine the inclusion of the table didn't happen with my Reporting Season Review, it has been included below.

Macquarie's conclusion: "At the half way point for 2016, Industrial earnings growth now sits at 0% (market ex resources at 1%) which means if history is a guide, it is going negative (it is difficult to think that 2017 will be the first year in 12 where analysts underestimate earnings and actual growth ends up being above where expectations began). Relative to our own base case, the 2016 earnings trough is unfortunately getting deeper and the 2017 recovery riskier/shallower unless we begin to see conditions for stronger sales growth emerge. At this stage there is significant downside risk to 2017 growth estimates."

Bright spots during reporting season, as identified by Macquarie, were Airlines ((QAN)),((VAH)), Health Insurance ((MPL)), ((NHF)), Retail ((JBH)),((NCK)), ((TRS)), Outdoor and Online Media ((CAR)), ((OML)), ((SEK)) and Paper and Packaging ((AMC)), ((ORA)).

WorleyParsons Rallies – ETFs & Shorts

According to Goldman Sachs' analysis, some 4.5% of the shareholder register in oil sector services provider WorleyParsons ((WOR)) is being held by passive high dividend ETFs. The company announced on February 24 there would be no final dividend payout for shareholders. One would think this would be the trigger for the stock being removed from indices and ETFs, which in practice means more selling thus a lower share price.

WorleyParsons shares have more than doubled in price in just over two weeks, and they were still rallying strongly on Monday (+10% on the day).


It gets more confusing with Goldmans research signalling 30% of all trading volumes since the company reported December half financial numbers has been linked to those passive ETFs who were supposed to be selling. WorleyParsons is also one of the most shorted stocks on the ASX. According to the latest available ASIC data on this subject, short positions represent some 12.5% of all outstanding shares.

Not sure what to make of all this, other than future updates by ASIC are likely to reveal less short positions. I also note, Monadelphous ((MND)), once upon a time the undisputed star in the sector, is still carrying nearly 18% of short positions on its register. (See also daily & weekly updates on shorts on the FNArena website).

Oil – When Everyone Sees Recovery

This would have surprised many, if they'd given it some attention. Deutsche Bank downgraded Origin Energy ((ORG)) on Friday to Hold as the share price post recent rally is now, on the analysts' calculations, incorporating an average crude oil price of US$58/bbl.

Yes, you read that correctly. Origin's share price, which was decimated from $13 in Q2 last year to below $4 earlier in the year, now trading above $5 is already anticipating a big rise in the price of crude oil which was last seen trading below $40/bbl still.

Deutsche Bank's assessment seems to corroborate similar research conducted by analysts at UBS and at Credit Suisse whose calculations also suggested most oil & gas stocks are already assuming a sizable recovery in energy prices, notwithstanding the fact share prices are still at depressed levels. Here are the two illuminating paragraphs from the most recent update by Credit Suisse on this matter (keep in mind this was published some ten days ago now:

"On purely producing/sanctioned assets we estimate Woodside is pricing in ~US$62/bbl, Oil Search ~US$70/bbl and Santos ~US$58/bbl. At US$50/bbl oil they have -30%, -49% and -52% downside, respectively. At US$70/bbl they have 17%, 1% and 67% upside, respectively.

"On our risked NPVs we estimate Woodside is pricing in ~US$59/bbl, Oil Search ~US$61/bbl and Santos ~US$55/bbl. At US$50/bbl oil they have -27%, -31% and -40% downside, respectively. At US$70/bbl they have 22%, 29% and 88% upside, respectively."

#NigelNoMates: Sticking Around

The big rally has arrived and so have the emails asking whether now it is time to bury Nigel in the back garden and forget he paid a visit in the first place. Nigel thinks it is way too soon to leave the stage. He reminds everyone his is a longer term approach, not to be deterred this easily by a week-long of shorts covering and fund managers recalibrating their portfolios.

I am keeping the world up to date about #NigelNoMates' endeavours and adventures through my Twitter account @filapek.

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

– On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
– I will be appearing as guest on Sky Business's Lunch Money, 12.30-2.30pm on Thursday
– Also on Thursday, I will appears as guest on Switzer TV, Sky Business, between 7-8pm
– On Friday, around 11.15am, on Sky Business, I shall make another appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 7 March 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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