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The Bear Market Diaries – Episode 7

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 | Apr 13 2016

This story features TELSTRA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: TLS

 In this week's Weekly Analysis:

– The Bear Market Diaries – Episode 7
– Cash Is King In Australia
– Telstra's Growth Outlook Challenged
– BHP's Climate Change Confession
– NigelNoMates Not On Holidays
– Catching Up On The Past
– Rudi On Tour
– Nothing Ever Changes, Does It?
– Rudi On TV

The Bear Market Diaries – Episode 7

By Rudi Filapek-Vandyck, Editor FNArena

"I think the real problem is that monetary policy is very largely economic forecasting. And our ability to forecast is significantly limited".
[former Federal Reserve Chair Alan Greenspan during last week's forum of four living Fed current and former Chairs in New York]

If observing global equity markets has taught me one thing in years past it is that markets always assume the future will simply be a continuation of the past, unless proven otherwise.

This explains why many correct forecasts can seem so utterly wrong at first. It also shows why taking guidance from market direction in the short term can lead to big disasters further out.

Global share markets had a big scary hissie fit at the start of the year, after having ignored in late 2015 that global pressures had started to build. Such pressures were always going to appear with the US Federal Reserve intent on normalising interest rates, which strengthens the US dollar. When the US dollar rises a lot of cracks start appearing worldwide.

In January a stronger USD kept pushing down global oil prices, which pulled down other commodity prices, which unsettled investor perception of global growth and the state of the global economy. Eventually Janet Yellen and the committee of regional Fed governors got the message and they released the tension by abandoning their intention to hike rates four times this year. Even though nobody genuinely believed the Fed would raise four times in 2016, a change of guidance was all that was needed to bring market relief.

It is important to understand the Fed's softening on monetary tightening means a lot for global assets and financial markets in 2016, but it does not solve the key problem that is lurking behind every day's share market volatility: global growth remains in a funk, sub-par with little prospect of significant improvement on the horizon, though some are counting on the impact of cheaper fuel to spur on consumer spending later this year and in 2017.

Fed's Welcome Relief

In such an environment, the direction of interest rates through translation into FX strength or weakness becomes the all-important denominator. Just ask Mario Draghi at the ECB or Haruhiko Kuroda at the Bank of Japan. Or Janet Yellen for that matter. At last week's historic forum in New York, combining for the first time four living former and present Chairs of the US Federal Reserve, Yellen emphatically stated the USD is not an active consideration when the FOMC votes on the Fed Funds rate.

But we all know the greenback plays an important role. If only through market turmoil which essentially acts as a timely tap on the Fed Chair's shoulder just so she gets the message: this is not working. You'll have to go back to the drawing board. Every central banker worth his/her salt eventually gets the message. So did Yellen.

Post market relief, which has seen equities, commodities, bonds and currencies reset in super-quick fashion, the question remains about potential longer term implications of the latest change in Fed policy intention. The US bond market seems pretty sanguine about it all, not pricing in one full 25bp Fed rate hike until late Q1 next year.

Lowering The Fed's Neutral Rate

Enter Commonwealth Bank of Australia. On Friday last week economists at CBA released a research report explaining their latest views on US interest rates. Bottom line: CBA now expects a slower pace in the Fed tightening cycle and a lower end point.

On revised projections, US interest rates will be hiked twice in 2016 (in line with the FOMC's expressed intention), then again twice in 2017 and then maybe (their emphasis) two more times in 2018. Previously, CBA was working off an assumed Fed neutral rate of 2.5%-3.0%. Now the new neutral rate is believed to be at 2%.

The implication here is that US interest rates might not go higher than 2% maximum. And it might take a long while before they actually get there (hence the "maybe" for 2018). Do the maths. The Fed hiked to 0.25% in December. Even if CBA's projected 6x increases for 2016-2018 prove correct, the Fed Funds rate will still not be at 2% by the time the calendar opens up for 2019.

Others, like Macquarie for example, had already lowered their Fed neutral rate to 2% as well as tempered expectations regarding the potential pace of FOMC rate hikes. But CBA is the biggest deposit holder and home loans lender in Australia. Many years of observing the financial sector have taught me this would not be a change made lightly.

As a matter of fact, you can bet your bottom dollar these revised projections have gone all the way to the top of the bank and the team of economists would have been asked to map out what this means for the bank's assets and strategies for the years ahead. These are career defining moments inside the CBA towers in Sydney CBD.

The paragraph that sums it all up from the CBA report: "Recent Fed action is hardly a signal of resounding confidence in the US economy. The problem is that nominal growth, globally, is weak. Spare capacity is wide spread. Inflation expectations are falling. And confidence is fragile. Policy makers everywhere are cautious, and sensitive to currency strength."

Even so, CBA economists acknowledge their revised trajectory -woeful by historical standards- might still prove to be too optimistic. At present, the Fed Funds futures market is pricing in just 37.5bp of tightening over the next two years (to 0.74% by March 2018).

Lower + Slower For Longer

We can all blame former Fed Chair Alan Greenspan for today's predicament, or his successor Ben Bernanke. At last week's four Fed Chairs forum, Paul Volker, the man who killed the debilitating inflation monster in the 1980s, candidly refused to endorse the monetary policies put in place after his departure. "I watch all my successors with great awe", was his get me out of jail public statement.

Let's be honest, there's likely to be a multiple of factors conspiring behind the persistent de-rating of global growth: the notable absence of government policies (pointed out by Bernanke at the forum), demographic changes, technological changes, the global addiction to debt, the inevitable slow-down in China, companies buying back their own shares or paying out more dividends rather than upping capital spending, negative interest rates and clamping down by regulators pushing lenders into more conservative strategies.

The list surely is a mighty long one, and all indications seem to point towards one conclusion: slower growth for longer means lower rates and a slower pace of hiking towards a lower neutral rate.

Enter the so-called debt trap. Here's what Claudio Boro, head of the monetary and economic department at the Bank for International Settlements (BIS), and Piti Disyatat, director of research at the Bank of Thailand, concluded on this subject in 2014:

"The accumulation of debt and the distortion in production and investment patterns induced by persistently low interest rates hinder the return of those rates to more normal levels. Low rates thus become self-reinforcing."

You didn't genuinely think the global thirst for yield was about to end soon, were you?

Gold, The Big Beneficiary

We have already witnessed one of the swiftest turnarounds in the history of modern finance and its name is gold. Only four months ago, after the Fed had hiked in December, gold bullion was breaking below US$1100/oz and forecasts for sub-US$1000/oz prices in 2016 were rife.

Since then gold in USD has rallied from its low point of US$1050/oz to the mid-US$1200/oz, turning it into one of the best performing assets in Q1 2016. In my opinion, all the world's gold bugs should send Janet Yellen a Christmas card in December. Always nice to say thank you even if this was never what Yellen & Co had in mind.

If US bond futures are correct and CBA's revised slower for longer might not cut the mustard in a slow growth with lots of risks environment, then surely there's more to come for gold bullion. But how much exactly?

As per always, it's very difficult to obtain an impartial view on gold's outlook. One either has to rely on devoted gold bugs whose reasoning doesn't always stack up, and neither their calculations, but their focus remains without exception always on blue sky highs in the stratosphere, or one has to rely on predictions and assumptions by investment bankers who by default hate/dislike gold for what it stands for is anti-establishment, and this includes the rich and filthy rich on Wall Street (and all their loyal servants).

This is why a February update on bullion by National Bank Financial Markets in Canada deserves to be praised and highlighted because it tries to cut through all the sentiment and noise by simply outlining gold's major price drivers and their potential impact this year. Forecasting, as per always, is more art than science, but it pays to take note from forecasters who conduct their task as if it were science and then treat it as an art while wearing the hat of an investor.

The four major drivers for gold are, according to NBF's assessment:

– the US dollar
– stock market volatility
– real interest rates
– inflation

NBF analysts have build a model around these four inputs. The model predicts that were equity markets to experience a 2011-type of turmoil/weakness, this would allow gold bullion to gain around US$162/oz. If somehow things turn out worse, a la 2008, NBF assumes central bankers will be quicker to act this time, but gold bullion would still gain some US$330/oz.

When the report was released, in mid-February, gold bullion was priced around the same level as where it trades today. Hence both predictions can still be taken as guidance, respectively implying 13% and 26% in potential gains from owning gold in USD.

Recent revelations by the US military have shown the late Osama bin Laden was a gold bug, with correspondence prior to his death including predictions of bullion priced at US$3000/oz. For those predictions to come through, we'd have to assume much darker scenarios like negative interest rates in the US and potentially a significant loss of confidence in central bankers' abilities.

While certainly not impossible, I would not necessarily be in favour of hinging one's investment strategy on such a dark outcome for the year(s) ahead, but as an insurance policy against further mayhem and sudden hiccups in the economic trajectory and otherwise, I think gold is back as a natural hedge/insurance policy.

As such I believe it should be on every investor's radar.

See also: Fool's Gold? Know Thy Enemy! (published 1 November 2014)

Cash Is King In Australia

As most of you would know, FNArena has been surveying investor sentiment and portfolio allocations since 2011 in cooperation with the Australian Investors' Association (AIA). The results from the March survey were released less than two weeks ago: More Equities, Less Cash & Fixed Income

Hence why my interest was piqued when representatives of global investment firm Legg Mason descended into Sydney last week to provide more colour to the results of their global investment survey. Given Legg Mason is not FNArena or AIA, their interest primarily lies with high net worth individuals. This year they added a section on Millennials.

All in all, the results for both surveys are, underlying, quite similar. You, the Australian investor, have become more cautious and whether you are a net worth individual or a small punter with limited budget, your expectations have taken quite a hit and your portfolio allocations are reflective of it. The obvious danger from both these factors combined is that most Australians do not expect to generate enough wealth by the time their focus will shift to comfortable retirement.

One stand-out observation made by Legg Mason is that while Australia is held in high regard and seen as an attractive destination to invest in globally, local investors are far more subdued about prospects for domestic investments. My suggestion this gap is due to macro versus micro, with Australian investors locally watching a share market that hasn't gone anywhere for two years and that's not even mentioning the Top Twenty's performance, failed to trigger much of a discussion at the media presentation.

Legg Mason representatives are far too nice people to criticise their fellow fund managers who've stacked up on banks and resources stocks far too early and for far too long, plus I might formulate my proposition a little better next time, given another chance.

Putting the numbers in a global & intergenerational perspective, Australian investors are decisively more conservative than their international peers, and local Millennials beat their Baby Boomer parents to it. Whereas the FNArena/AIA survey shows average cash levels remain at historically elevated levels (18-20% of portfolios), Legg Mason's survey places cash at 28% of portfolios; making cash the number one asset for high net worth investors, ahead of real estate at 25% and equities at 22%.

Telstra's Growth Outlook Challenged

There's no doubt Telstra ((TLS)) and its shareholders have benefited in recent years from the NBN deal struck with labor government and ongoing struggles of Vodafone/Three in the mobiles space.

If anyone wonders why the share price is now close to $5 and nobody anymore mentions $7 as the next target, then look no further than a pick-up in competition for mobile customers plus the market realising the NBN (otherwise known as the National Broadband Network) is going to leave a serious dent in Telstra's group revenues.

No wonder Telstra has now joined the Big Four banks as being regarded ex-growth while questions continue rising about its ability to keep growing the dividend.

A recent update by UBS again highlighted the questions at stake: can Telstra defend its market share once the NBN has levelled the playing field for all competitors across most regions? How deep exactly can margins fall post NBN? Can Telstra continue to find growth in mobile? Can growth be sufficiently found in new products and/or new markets?

UBS, for its part, is still projecting ongoing growth in dividends for the years ahead, but nothing spectacular, plus UBS analysts stress these projections require Telstra management can provide a positive answer to most questions raised. While the share price does look cheap, UBS analysts seem adamant investors should expect no re-rating until the market is confident in Telstra achieving positive outcomes.

Sounds a lot like the banks.

To set the general framework: UBS is projecting Telstra's dividend can rise to 32c this year and to 33c and 34c respectively in FY17-FY18. After that, it's 34c for as far as the eye can see.

BHP's Climate Change Confession

The Big Australian might have lost its lustre as an automatic inclusion in many a local investor's long term investment portfolio. We reckon the impact from the disappointing past five years will still reverberate for many more years to come.

On a regular basis we hear horror stories about investment portfolios that have been literally decimated on the back of overweight allocations to the likes of Santos ((STO)), Woodside Petroleum ((WPL)), Rio Tinto ((RIO)), Origin Energy ((ORG)) and the Big Australian, even without mentioning the potential impact of smaller players such as Whitehaven Coal ((WHC)), Atlas Iron ((AGO)) or LNG Ltd ((LNG)).

One story we heard last week was about one old lady who still holds $1.2m worth of BHP shares, having never sold one share in her life. We can only ponder about the wealth creation that must have excited between 2004 and 2011, but then the subsequent losses… phenomenal!

BHP surprised at the recent Macquarie Climate Change forum by providing a rather detailed insight into how the Big Australian sees its future including under the scenario of a 2 degrees rise in global temperature. Base case is that its own operational profits are likely going to take a hit of between 5-20%.

To interpret these numbers in the correct context: BHP projects its beaten down earnings before interest, depreciation and amortisation (ebitda) for FY16 are likely to double by 2030. A rise in global temperature by 2 degrees Celcius is projected to reduce this prospect by between 5% and 20%.

Worst hit, in BHP's opinion, will be thermal coal. The Big Australian believes iron ore will prove to be resilient, and so should be crude oil. The latter two explain as to why the overall impact, if correct, remains rather benign. Analysts at Macquarie, while lauding the company for taking such a strong leading role on Climate Change for the sector overall, think BHP's assumptions might be too rosy as far as crude oil is concerned.

#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

The Bear Market Diaries – Episode 6

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
– I will be appearing as guest on Sky Business, 10am-noon, on Wednesday
– I will be appearing as guest on Sky Business, 12.30-2.30pm, on Thursday
– On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 11 April 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):

FNArena has reformatted its monthly price tracker file for All-Weather Performers. Paying subscribers can request a copy at 

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