article 3 months old

The Bear Market Diaries – Episode 6

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 23 2016

This story features APA GROUP, and other companies. For more info SHARE ANALYSIS: APA

In This Week's Weekly Insights:

– The Bear Market Diaries – Episode 6
– Beaten By Buffett
– Add Industry Structure To Your Research
– Gold's Main Driver Is Yield
– #NigelNoMates Not Enjoying A Holiday
– Catching Up On The Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

The Bear Market Diaries – Episode 6

By Rudi Filapek-Vandyck, Editor

"Plus ça change, plus c'est la même chose".
[Jean-Baptiste Alphonse Karr]

On Friday one of my Tweets on Twitter read:

"The answer to all investor questions – no exceptions".

It accompanied a chart from a National Australia Bank report showing how the world had started selling the greenback ahead of last week's FOMC meeting. After Yellen & Co had surprised most observers by turning more dovish in the face of increasing global risks and challenges, USD weakness shifted into fifth gear.

So up went global risk appetite. Up went share market indices. Up went commodity prices. Up went share prices of producers of industrial metals and energy. Up went the banks. Up went the Australian dollar, and the Japanese Yen, and the euro, yes, even the Chinese yuan.

Weaker USD Brings Relief

The big public debate taking place across the globe right now is whether a surprisingly more dovish Federal Reserve is part of a coordinated central bank effort to prop up risk assets and kill off the deflation dragon, or whether Janet Yellen and the FOMC went solo, vindicating assistant governor at the RBA Guy Debelle's statement made earlier in the week that:

"every central bank would appear to like a lower currency; some say that openly and some don't actually articulate it… but obviously everyone can't have a depreciating currency".

One might even question how long the Fed and the American economy can continue to enjoy the benefits of a weaker USD. By extension, the same question also applies to commodities and other risk assets.

Let there be no mistake: a weaker greenback is what the world needs. It already has alleviated pressure in credit markets, injected new risk appetite into global assets and pushed up prices for energy and most other commodities. Two weeks ago (see Episode 4) I explained how commodity prices returning to levels last seen pre-Super Cycle had been devastating for revenues and growth in producing nations, which is why Emerging Markets are no longer the engine everyone believed they'd be.

The US economy too had found the going tougher as the greenback continued to rise, with corporate profits facing yet another headwind. Now the pressure has gone, everyone can pause, relax a little more and concentrate on the positives.

How Little Has Changed

The quote on top of today's Episode is an equivalent of The Lucky Country in France. It was first coined by critic, journalist, and novelist Jean-Baptiste Alphonse Karr deep in the 19th century. It's meant to be a sarcastic view on day-to-day politics. Literally translated it reads: the more things change, the more they stay the same (alternative read: they make a lot of noise, and talk and gesticulate a lot, those politicians, but at the end of the day, nothing fundamentally changes).

The same can be said of financial markets in 2015 and 2016. We've witnessed the Chinese struggle with their economic transformation and growth. The Federal Reserve has finally made that first rate hike. Global risk assets opened the new calendar year on a tantrum, but the worst opening to a new calendar year since the 1930s has now been followed up by the quickest recovery …since the 1930s.

If your name was Rip van Winkle, and you'd have slept between the middle of last year and yesterday, you'd be forgiven for thinking nothing has genuinely changed while you were dozing away. The world is still battling low (and slowing) growth. Too much debt and industrial capacity are keeping a lid on prices, on investments, and on growth. Global labour markets are in a better state, but societies are polarising and wages growth remains sub-par. Hence Donald Trump.

Governments are still MIA. And thus central bankers have become de facto goal keepers in a world of constantly changing goal posts, growing increasingly frustrated, having to resort to more and more extremist tools and stimulus. Somebody's got to do something, right?

Rumours: A Shanghai Accord?

In the face of rising doubt and criticism, and a downward sloping trend in achieving tangible results from ongoing monetary stimulus, it cannot be a surprise the latest moves by central banks have sparked rumours about a global agreement having been negotiated at the recent G20 summit in Shanghai. Conspiracy theorists are talking about a secret "Shanghai Accord" with the aim of weakening the US dollar.

Makes sense. Actually, it makes a damn lot of sense. But wait a minute! What about the ECB and the BoJ, as well as the PBoC, not to mention the RBA and Guy Debelle's admission "obviously everyone can't have a depreciating currency"?

If the G20 secret agreement conspiracies are correct, other central bankers have simply taken one for the team. In the end, what is bad for the world is ultimately a bad thing for each individual country too. Right now, a stronger USD is bad, and potentially very, very bad.

Note also: the weakening greenback effectively means China has been able to devalue too. More pressure released.

A temporary reprieve is ultimately just that, temporary. Unless, of course, the world changes for the better while central bankers are injecting monetary oxygen. One can but hope (which is not the same as betting your life savings on a positive outcome).

November Revisited?

All of the above shows how difficult a balancing act central bankers must follow to keep all stakeholders, including financial markets, happy in 2016.

Now that we've had the panic and the mayhem, the sudden switch and recovery, and the unexpected dovish turn by the Federal Reserve (Grand Accord or not), global equity markets are not that far off from where they finished 2015. So whereto from here?

One credible view is that US equities seem in a similar position as they were back in November. Same magnitude of rally after initial sell-off. Same overbought readings on technical momentum indicators. Last year, US equities spent the subsequent three weeks unwinding largely via sideways moves with a slight bias towards weakness.

Many people would settle for a similar unwind now, I am sure. Note this would still mean indices will continue setting lower highs on each upswing, which technically means the broader picture, underlying, remains bearish.

My Personal Indicator

I once labelled it my never-fail indicator, but that was at a time when the share market dynamics were quite different. Regardless, I couldn't help but noticing over the weekend all four major banks share prices are within touching distance of their respective consensus price targets. This would indicate risk appetite has enjoyed the bulk of its run now and a more cautious approach seems but appropriate.

I am not surprised that on Monday, while I am writing this Episode, the banks are retreating and in fact the share market in general is.

To those who are as yet not familiar with my banks indicator: banks in Australia often show the level of investor risk appetite or risk aversion. When share prices move beyond consensus targets this is a sign of irrational exuberance. The relationship has been observed over some fifteen years but went missing during the GFC and during the 2012-2013 rally when "yield" became all that matters.

Assuming the relationship has been re-established (I think this is but a fair assumption to make), banks share prices rallying to near their respective consensus price targets implies this spike in market optimism has now largely run its course.

Viewed from a positive angle: banks share prices did not rally past their targets, so there's no need for a large pull back. (Each paid subscriber can check the gaps via Stock Analysis).

Wishful Thinking?

Sometimes a good conspiracy theory can simply be too good to be true. It's only human nature to see "intelligence", "planning" and "intent" wherever a certain outcome seems to have been achieved. But what if it was due to simply plain luck? Coincidence? Unintended consequences? Are we hoping leaders at the central banks that rule the world have more wisdom, more skills and more market insights than they actually possess? Maybe because the alternative view is too scary to consider?

FX analysts at Brown Brothers Harriman did their best post-FOMC market surprise to rubbish the idea of central bank coordination:

"We suspect that rather than celebrating the success of the secret Plaza-like Agreement, officials are just as surprised and discombobulated as investors by the market action.  In our conversations with various officials, we do not get the sense that the rise of the yen, euro, and dollar-bloc currencies is wholly desired."

Even so, there's always room for that niggling question, given the Fed's inconsistent messaging over the year past: What do they know that we don't? (ANZ Bank)

Or has it just been a case of markets throw a tantrum and comforting Grandma Yellen at the Fed caves in?

Beaten By Buffett

Craig Ferguson, once upon a time an irregular content contributor to FNArena and nowadays running his own hedge fund, has written a book. The kind of book you might like to read if you think my personal views on the world and on financial markets seem rosy and optimistic. The kind of book that tells you to prepare for the you-aint-seen-nothing-yet type of Bear Market.

The full title of Craig's brain child is 'Debt, Defaults, Disinflation & Demographics: How to survive and prosper during the market meltdown of 2016-2017'. Recently I caught Craig boasting about how well his book was ranking in its category on Amazon, which made me realise I have absolutely no idea how my own book is doing. So I revisited Amazon.

Turns out 'Change. Investing in a low growth world' reached into the Amazon top sellers Top 20 in Australia last week in the category 'stocks'. Gotta admit, I was pretty pleased when I discovered my ranking, though it has fallen since.

Interesting to note that best sellers in the 'stocks' category still include all-time classics such as Peter Lynch's 'One up on Wall Street', as well as 'Reminiscences of a stock operator', and lots of books on Warren Buffett. Locally, Matthew Kidman's 'Bulls, bears & a croupier' still seems to be selling copies, as does 'Guppy trading'. Further down the rankings is also Marcus Padley's 'Stock market secrets'.

Thanks to all who bought and read a copy of 'Change. Investing in a low growth world'. Judging by the 5 star reviews on Amazon, you all found it money and time well spent.

Add Industry Structure To Your Research

Credit Suisse quant analyst Richard Hitchens clearly has a different interpretation of "industry structure strength" than I do, but his conclusion this has been a major theme in the Australian share market, separating outperformers from underperformers, in years past is something investors should pay attention to. It also supports my own research that led to eBooklets 'Make Risk Your Friend' (2x) and last year's eBook.

Bottom line: in a low growth environment, a supportive industry dynamic means outperformance in the share market. Of course, this on the premise management doesn't do anything foolish and is able to live up to expectations.

To put a concrete framework around the subject, Hitchens relied on Michael Porter's five forces competition theory model which are:

1. Competition or rivalry in the industry
2. Potential threat of new entrants into industry
3. Relative power of suppliers
4. Relative power of customers
5. Threat of substitute products

The value of all of the above is illustrated in the chart below which clearly shows those companies operating in a strong and supportive environment are the best choice for Buy & Hold investors. Those in a weaker industry structure clearly are not.

This is where things get interesting. Hitchens research into "industry structure strength" identifies stocks such as APA Group ((APA)), Carsales ((CAR)), Ramsay Health Care ((RHC)), Sydney Airport ((SYD)) and Transurban ((TCL)); all stocks most of you who paid attention to my own research post-GFC would be familiar with.

It also includes the likes of Scentre Group ((SCG)), Super Retail Group ((SUL)), Incitec Pivot ((IPL)) and Platinum Asset Management ((PTM)) which seem less logical inclusions. But then the list also includes Syrah Resources ((SYR)), Orica ((ORI)), Newcrest Mining ((NCM)) and Whitehaven Coal ((WHC)); companies I would never include myself.

Bottom line: paying attention to industry structure should be part of any investor's research into what stocks to own and which ones are best to avoid (or at the very least: best treated differently). Credit Suisse's approach to the subject also suggests there is a plethora of different ways to research this theme.

Gold's Main Driver Is Yield

Australian gold producers have created a lot of smiley faces over the year past, but one should never forget this has largely been an AUD-driven phenomenon. Admittedly, USD gold has been one of the best performing assets in the opening months of 2016 (say thank you to Janet Yellen), but its future outlook looks a lot less straightforward, at least once we move past the weaker USD stimulus.

Viewed from a pure yield perspective, and "yield" is one key driver long term, believe it or not, there's an argument to be made that gold today looks a bit pricey. Pimco's blog recently published a nice expose on the gold versus yield relationship and I don't think I can add much of value to it:

Of course, short term there can be multiple supportive factors in play including weakening equities, a retreat in global risk appetite, a softening US dollar, ongoing central bank stimulus and a firmer picture on price charts. Plus there's absolutely no guarantee American rate hikes are going to start anytime soon, irrespective of economists predicting inflation is making a come-back in the USA and elsewhere.

#NigelNoMates Not Enjoying A Holiday

Nigel remains sceptical whether central bank actions in March have now fundamentally re-shaped the outlook for the global economy and for financial assets.

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

The Bear Market Diaries – Episode 5

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.

– To Melbourne chapter of the Australian Shareholders' Association (ASA) in early July

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

– To Chatswood chapter of Australian Investors' Association (AIA) on September 7, 7pm, Chatswood RSL

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
– Still on Tuesday, I shall host Your Money, Your Call Equities from 8-9.30pm
– I will be appearing as guest on Sky Business's Trading Day, 12.30-2.30pm on Thursday
– Still on Thursday, I shall appear on Switzer TV, between 7-8pm

(This story was written on Monday 21 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): 

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms