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The Bear Market Diaries – Episode 5

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 16 2016

This story features DOMINO'S PIZZA ENTERPRISES LIMITED, and other companies. For more info SHARE ANALYSIS: DMP

In this week's Weekly Insights:

– The Bear Market Diaries – Episode 5
– Housing Market Turning
– Be Ready To Be Trumped
– #NigelNoMates Not Enjoying A Holiday
– Australia In Transformation
– Catching Up On The Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

The Bear Market Diaries – Episode 5

"To paraphrase the old duck test: if it looks like a bear, growls like a bear and does its business in the woods like a bear, it probably is a bear. A renewed sell-off in the MSCI World index would not be the slightest bit surprising."
[Charles Gave]

By Rudi Filapek-Vandyck, Editor FNArena

Exact three weeks ago today, I wrote investors should prepare for a share market rally (see The Bear Market Diaries – Episode 2).

By no means was I the only one making the prediction and it is but fair to say the strength of the rally since has taken most analysts and market watchers by surprise.

A cynic would say: thank you to all the shorters who got squeezed. An observer of history would add: this is exactly how the play book unfolded in early 2008.

Not that I am predicting an exact copy of the 2008 scenario eight years later, or that anyone wants to be reminded about that experience. October 2007-March 2009 in finance circles today is the equivalent of Lord Voldemort of JK Rowling's Harry Potter series: He whose name shall not be spoken out loud…

Sharply Increased Volatility

One of the easiest observations to make is that volatility has picked up significantly. This is no longer the same share market that confidently ran up to near 6000 by May last year.

Instead we are now witnessing battles between sellers and buyers, reading conflicting signals and economic indicators, and observing lots of short term momentum offset by longer term uncertainties. This rise in volatility can be measured and those who do already are making comparisons with 2008 and with 2009 ("He whose name shall not be spoken"), as well as with 2003, 1938, 1934, 1933, 1932.

(Source: Bespoke Research)

A marked spike in day-to-day volatility is, of course, but one indicator that something fundamentally has changed in equity markets. GaveKal's Charles Gave designed his own diagnostic tool to gauge market health and it is his observation we are definitely no longer in a continuation of last year's bull market.

Though Gave's market technical tool can emit a false signal (never happened within the current context, the designer adds), Gave is leaning towards the admission that we are following the play book of a bear market.

The crucial question for investors then becomes: what type of bear market are we talking about? Is it going to be a repeat of the devastation suffered between late 2007 and March 2009? Or will it remain a gentler bear market, the version that has been described by strategists at Credit Suisse as the "gummy bear" versus the "grizzly bear"?

Credit Suisse prefers the gummy bear version, but Charles Gave remains as yet unconvinced, arguing it remains too early to make that prediction in a conclusive manner. The difference between the two is in the gentler version, most if not all of the damage has already occurred. In the more severe version we could only be half-way, or worse.

One of the key observations made by Gave is that a severe bear market ("Ursus Magnus" as he calls them) usually coincides with a US recession, though there have been recessions linked to more benign bear markets and in one case (1980) a recession in the USA did not cause a bear market at all.

On current market conditions, represented by a negative reading in his proprietary bear market indicator, Gave suggests investors should remain defensive, not be fooled by this sudden outburst in apparent investor optimism and not add more risk to portfolios.

Resources Back In Spotlight

One of the spectacular come-back stories witnessed over the past three weeks has been a significant revival in beaten down resources stocks, both miners and energy producers, as well as their second derivatives, engineers and services providers.

Capital gains of between 50-100% are not out of the ordinary and, yes, there's been an 18% jump in the price of iron ore in one single day.

But beyond the extreme low valuations prior, the short covering and the preparedness by value investors to take a long term view, what does this mean exactly? Will it prove sustainable?

The question in particular seems all-important because back in 2008, resources stocks were the last to hold up until money abandoned that sector from September onwards. This time around, the sector has already endured a relentless bear market since 2011. Better to be cheap than expensive when the grizzly howls, right?

These questions have led to intense soul-searching at Goldman Sachs, the house that gave us a failed US$200 a barrel crude oil prediction in mid-2008 (everyone knows about that one), as well as a five year long negative view on commodities post 2011 (literally nobody quotes that one – ever).

Goldman's response has been a resounding negative.

Yes, there's an argument to be made that resources stocks had been pushed too low; there had been too many shorts in the same, small fish pond; the relative valuation gap between High PE stocks and low PE stocks had blown out to historic proportions; there are signals of a long overdue supply response; China is back on the growth stimulus route, et cetera

At the end of the day, so goes the argument from Goldman Sachs, it all seems way too soon, too quickly. Investors shall have to be patient for longer, not misinterpreting seasonal changes as a fundamental market recovery. In other words: it's a false start, similar to the ones witnessed in 2015. This is about sentiment, and a weaker US dollar, and about investor positioning, not about sustainable market deficits.

Oil Better Not Rally

It looks like the abyss has been avoided for global oil markets, but over-supply still rules and oil companies globally, not only the fracking industry in the USA, are keeping a close eye on the price and futures' forward curve to re-start facilities and spend on new projects again. Hence, concludes Goldman Sachs, it is imperative the price of a barrel of crude does not move higher from here.

Goldman Sachs has a relatively upbeat vision for the outlook for crude oil prices beyond 2016, but this requires more pain now to make sure global oil markets are staring at a pending deficit at the start of calendar 2017. Too high a price today or in the weeks/months ahead has the potential to distort this scenario. Higher oil prices offer producers the chance to hedge at higher levels, virtually guaranteeing more production for longer.

Ideally, energy prices go through a significant sell-off again. The second-best scenario is flat lining for the next three months ahead. Under no circumstance should oil rally above US$45/bbl, argue the analysts. It will be a self-defeating move and reduce the rally potential for 2017.

For what it's worth, Goldman Sachs is currently forecasting crude oil will re-settle in a range between US$55-60/bbl in 2017 at which point there shall be a resumption in lost production. So there is your built-in market volatility. There too is your natural ceiling, ceteris paribus.

Investors looking to play the above scenario are being advised to take selective exposures. An advice that seems but apt in the Australian share market too where many a share price inside the energy sector already appears to be reflective of Goldman Sachs' proposed oil price range for the coming years.

"We do not believe the recent rally, or even our 2017 outlook, will lift all boats."

Abandoning Panic

Credit Suisse is one of market participants who relies on its own gauge for investor risk appetite. No surprise, the Credit Suisse Global Risk Appetite Index moved firmly into negative territory ("Panic Mode", according to CS) in January but it has now swiftly bounced back.

History shows a retreat in general optimism is but to be expected, but this by no means assures we are going to revisit the lows/panic seen earlier this year. Taking a closer look at the history of this Index shows all kinds of scenarios are possible. During the bear market of 2000-2003 there even was a temporary reprieve back into exuberant optimism before sentiment retreated back into panic mode. This is the reason why the period is displayed as two separate negative phases on the Credit Suisse time line.

Just goes to show: there is not one definition, not one indicator, nor one blue print when it comes to an equities bear market. The best advice for investors thus remains: have a plan, be patient, value your cash and stick to your convictions (try not to be bamboozled by short term movements, no matter how convincing they seem).

In my first story for the new calendar year, I declared 2016 will be the year for investor conviction. I still stand by that statement.

Probably apt to repeat the quote of the fund manager I used in that same story: "we cannot predict the future, but we can manage risk".

Housing Market Turning

Australian builders are erecting more premises than there is demand. Add another twelve months or so and pretty much every state, except New South Wales, is going to be faced with over-supply.

Such was the message from last week's Building Forecasting Conference by BIS Shrapnel. The Sydney-based forecasters under supervision of Robert Melor and Frank Gelber recently found themselves in hot political water when they entered the national discussion on negative gearing, but when when it comes to paring supply against demand, the data-crunchers at BIS Shrapnel can usually be relied upon.

Needless to say, the dynamics in Australian housing are turning. The frenetic activity levels from 2015 should not be extrapolated into the coming years. Economists at UBS too believe industry data should be carefully watched with recent momentum indicators weaker than anticipated. UBS does not think this is the start of something sinister. The economists talk about a "housing moderation rather than a downturn".

BIS Shrapnel from their part wish to emphasise  prospects of over-supply are going to translate into slower activity for builders and for building materials suppliers, but not necessarily for property prices. BIS Shrapnel is working off a flat outlook for prices and if there will be any weakness it'll be shallow, according to Melor & Co.

Damn! say all the offshore hedge funds that burnt their clients' money, and their short term performance, by taking on short positions against Australian banks in February.

Be Ready To Be Trumped

He's been moving like a gorilla through the American political landscape and showing no sign of losing steam. Donald Trump. Europeans already see their prejudices highlighted, but soon, one assumes, everybody else will start paying attention too.

(Source: Fairfax Media)

Can The Donald really make it to till the end and declare victory in America's presidential race? You can trust the Americans to elect the dumbest, shallowest marionette, one hears the Europeans sigh. But can The Donald pull it off? Really?

#NigelNoMates Not Enjoying A Holiday

It's amazing what a few weeks of rising share prices does to general market sentiment. All of a sudden the same questions keeps popping up in communications with investors: have you sent Nigel home yet? Is he on holidays? Is it time to buy a stuffed bull?

We all like to pretend we're capable of forming medium to longer term visions, but share prices moving into one direction short term nevertheless remains a decisive factor as to how we feel about the market. And this is where things get "interesting". Technical analysts see resistance levels approaching. Sceptical strategists, such as the ones at Morgan Stanley, stoically maintain this is not a time to add to equities exposure (instead they advocate now is the time to sell shares that had a good run).

Technical analysts at UBS, whom I have quoted from before, had previously anticipated markets would rally from their February bottoms into April, but the swiftness of the upswing has made them shorten that call. Instead, equities are now expected to run out of puff before the end of this month.

Assuming these forecasts prove accurate and global equities will soon be trending lower again, though not as violently and as fiercely as earlier in the year, then a comparison with 2008 looks all the more striking (not that anyone wants to see a repeat of that experience). Bottom line: wild upswings do not deter Nigel. He's not going anywhere. Better not forget he's sticking around.

Australia In Transformation

It has been one of the key themes in my own analysis of the Australian share market (see my eBook Change. Investing in a Low Growth World) and now Morgan Stanley has added its own voice to the subject as well. "Australia in Transition: Ten Winners from Five Structural Themes" was released last week; 72 pages of research into how best to approach the future through the lens of an Australian equities investor.

The underlying thesis: favourable trends that have underpinned investment returns from the Australian share market have either peaked, or are under threat from structural change in China's growth model or disruptive competition.

The five themes identified as a road map for the structural change at work are:

– Global expansion
– New economic infrastructure (think household solar and batteries, NBN, physical infrastructure, etc)
– New export economy (agri/food processing, education, tourism/gaming, and healthcare/biotech)
– Technological disruption
– Demographics (Health and aged care versus housing and consumer-related industries)

Morgan Stanley identified ten potential winners, but the list is on the analysts' own admission, by no means exhaustive or static. Winners selected are Domino's Pizza ((DMP)), Goodman Group ((GMG)), Virtus Health ((VRT)), Lend Lease ((LLC)), Vocus Communications ((VOC)), Mantra Group ((MTR)), Treasury Wine Estates ((TWE)), Aconex ((ACX))), Aveo Group ((AOG)) and Sonic Healthcare ((SHL)).

Catching Up On The Past

In case you missed some of the preceding stories, here's your chance to catch up (in reverse order):

Rudi's View: 2016 is The Year Of Conviction

Rudi's View: Who's Afraid Of The Big Bad Bear?

The Bear Market Diaries – Episode 1

The Bear Market Diaries – Episode 2

The Bear Market Diaries – Episode 3

The Bear Market Diaries – Episode 4

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
– 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 14 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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