Lower For Longer Remains In Focus

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

In this week's Weekly Insights:

– Lower For Longer Remains In Focus
– Sell Resources In May?
– Expert Equity Tips For Aussie Investors
– Catching Up On The (Bear Market) Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

Lower For Longer Remains In Focus

By Rudi Filapek-Vandyck, Editor FNArena

"The most divisive stocks in Australia are not BHP Billiton or Woolworths. They are Transurban, GPT, Sydney Airport and friends, the stocks every value manager loves to hate because of their sensational valuations and flawless share price performance."
[Journalist Vesna Poljak in the AFR last weekend]

I don't like the term "defensives" when it comes to labeling stocks on the share market. I find it's often used in the wrong manner and only serves to confuse investors who already have so much daily market noise to cope with.

Woolworths ((WOW)) is supposedly "defensive", yet shareholders saw the value of their shares decline by more than one third over the past two years. Woodside Petroleum ((WPL)) also is often labeled "defensive" and of "high quality", yet its shareholders too suffered capital losses of more than one third in less than two years.

Metcash ((MTS)). Origin Energy ((ORG)). Even the banks have been called "defensive" in years gone by, but if their share prices drop by double digits just as easily as for the next biotech hopeful with no profits and no predictable prospects, then what good is a label that cannot live up to its promise?

Let's set the record straight on a few key misunderstandings: yield stocks are not by default low risk. If they go ex-growth, their securities will still be de-rated and their dividends openly questioned and potentially reduced. Companies that go ex-growth do not automatically become "defensive" despite many assigning the label to, for example, Woodside Petroleum, for that exact reason.

It is, however, true that stocks such as Transurban ((TCL)) and Sydney Airport ((SYD)) are killing it on the share market, and they have been for an extended period now. These stocks are often also referred to as "defensives"; they might carry a lot of debt and depend on a lot of government goodwill but they still don't match the risk profile of a Fortescue Metals, for example.

In recent times, these stocks have received the label "Expensive Defensives". The label has become one of the popular buzz words in 2016 and reveals as much about the successful investment stories attached to Transurban, Sydney Airport and others, as well as about fund managers' struggle to get their heads around valuations and prospective returns.

The Era Of The New Defensives

In medieval times, "defensive" meant behind the walls of the local lord's castle to where plundering thieves and pillaging warmongers had no easy access. In rugby it's the last line of players who will literally throw their bodies on the line to prevent the opposition from breaking through and scoring.

In the share market it means a much lower chance for a sudden profit warning and subsequent share price shellacking. No matter the joy expressed by many a value investor after such an event, every investor no matter what disposition, philosophy or experience hates to wake up with one (or more) of his investments going into free fall.

How does one prevent, or at least minimise this from happening? The old proven and tried methodology is to seek out valuation bargains. Fairfax Media shares were trading at 36c in October 2012. By April 2014 they'd surged above $1. Alas, today the shares are trading around the 90c mark and only because of speculation related to off loading the New Zealand old media operations.

Needless to say, if you are playing the game of buying ultra-cheap, you have to be patient and know when to jump ship. Post April 2014 total return on Fairfax shares is very much dependent on timing/entry points and on collecting the dividends.

Despite its proven track record, the many academic papers and Warren Buffett still being alive, this is not an investment style that suits everyone and all circumstances.

The alternative would be for an investment that equally carries low risk for disappointment but with a high certainty for positive performance. Enter stocks like Transurban and Sydney Airport, but also CSL ((CSL)), Amcor ((AMC)), InvoCare ((IVC)), ARB Corp ((ARB)) and Burson Group ((BAP)), among others.

When was the last time you heard about a profit warning from any of these companies?

Contrary to examples like Fairfax, or Myer ((MYR)) which seems to be the new Phoenix in the share market right now, shares in these "New Defensives" have not shown one explosion to the upside and a lot of volatility since. Instead they've displayed a remarkably low level of day-to-day volatility, including during the hairy-scary bear market fears of January-February this year, and shareholders have instead enjoyed market beating investment returns.

What's not to like?

Gold Plated Investment Returns

"This time is different". The phrase reminds investors of the dying days of the dotcom bubble that burst in March 2000 or more recently when commodities were believed to be in a multi-decade Super Cycle rally. It sends shivers rolling over the spine of many a battle-hardened funds manager.

But isn't the share market constantly in transformation and in flux, just like the global economy is right now? Sixteen years ago, News Corp was the 20% index heavyweight to which everyone paid attention. Today, the shares can be comfortably ignored as its weight no longer matters, literally. It was only in 2008 that mining and energy companies made up some 39% of the ASX200 in Australia. Today the total percentage barely reaches to 12% (It was even lower earlier this year).

Never before in their active careers have investors and fund managers been confronted with such a low, troubled growth environment as is the world right now, with so much debt, so much central bank stimulus, so little inflation and global interest rates as low as they are today. At the same time, technological and geographical barriers are disappearing, while important inputs such as consumer spending and demographics are changing too.

Many of the stocks that today are being grouped together in the basket of "Expensive Defensives" in essence represent the right characteristics for the current global context; including solid, predictable growth, quality products and assets that have a relatively low risk for immediate disruption, growing dividends supported by steady, predictable cash flows and a track record for delivering on, if not exceeding, investor expectations.

I've said this before, but more than happy to repeat it: when was the last time anyone can remember a profit warning from any of these companies?

Readers familiar with my own market analysis and commentary since 2008 already know this: replace "Expensive Defensives" with "All-Weather Performers" and the story pretty much tells itself, not in the least through investment returns since. FNArena publishes a monthly update on share prices that have my attention because of my specific research/focus (exclusively available to paying members – see also bottom of this story). Below are five stocks I randomly picked from last month's (April) update.

Note the consistent (out)performance for these stocks over the past six years (the returns calculated below are ex-dividends).

When Is Popular Too Popular?

To the dismay of everyone who refuses to jump on board, and to the frustration of all those experts & commentators who've kept repeating the same mantra: it won't last forever, these stocks, as a group, have simply accelerated their outperformance in 2016. Take a quick look at the following performances since December 31 (again: excluding any dividend payouts):

– Amcor +20%
– Brambles +12%
– Burson Group +16%
– CSL +7%
– Domino's Pizza +17%
– Goodman Group +14%
– Orora +22%
– Sydney Airport +13%
– Transurban +17%

So much for a low return environment, hey? There's an easy argument to be made in that most of these stocks are enjoying additional support from lower interest rates in Australia and from a weakening Australian dollar, on top of their top notch growth and yield prospects and their near flawless track record post-GFC.

Regardless, one quick view at the share price gains achieved over the past 5.5 months shows most gains are what the ledger usually shows at the end of a full calendar year. New money is flowing in this month, and it is pushing up share prices further for stocks that already have been exceptionally generous for loyal shareholders.

Stocks that perform well in the share market ultimately land on many an investor's radar and the performance of the stocks mentioned simply deserves every investor's attention. No two ways about it. Short term, it appears now everyone is getting on board the proven success stories. CSL's FY17 Price-Earnings (PE) ratio has now surged above 25x. But Sydney Airport's projected dividend yield next year is still 4.6%, ex-franking. Brambles only has one more stockbroker left with a price target above the current share price (Citi).

Underlying message: momentum and popularity are on the up, pushing up share prices and increasing the chances for a corrective pull back due to temporarily overheating, but these share prices still have room to appreciate further, in particular if additional support arrives from a weaker AUD and/or further RBA rate cuts while serious question marks remain for resources and other cyclicals, as well as regarding the banks and the Federal Reserve's intentions.

Is The Trend Still Our Friend?

Two trends unmistakably stand out when reading economists' projections and international strategy reports this month: the lower for longer environment is still making its presence felt through further declining expectations. In Australia, a general consensus is firming around at least one more RBA rate cut, but there could be more. At present the cash rate is 1.75%. Even an institution such as CommBank is now forecasting 1.25% next year (2x more rate cuts). 1.00% is not seen as too crazy a prediction by many.

The same underlying dynamics remain in place for the Federal Reserve in the US. Bond  markets are not pricing in any rate hikes this year and economists keep pushing out their expectations, not only for when the next hike might be announced (December only?), but also concerning the new ceiling for US rates moving up.

Economists at the aforementioned CommBank, for example, have now expressed their view the Fed Funds rate might not reach higher than 1.75%, with a risk the Fed stops at 1.0-1.25%.

Lower for longer still very much remains in place and this explains to a large extent the price action in May globally. I do however believe the FOMC is playing with fire and markets may not remain this supportive if they start disbelieving the hawks inside the committee and doubting whether the Federal Reserve can ever get interest rates sufficiently higher without damaging the US economy and/or corporate profits.

The latter question might well become all-important now the technical picture for US equity indices is once again deteriorating.

P.S. Given all of the above, it should surprise no-one the FNArena/Vested Equities All-Weather Model Portfolio continues to outperform the broader share market, even as we have raised cash levels and reduced direct exposure to Australian equities.

Sell Resources In May?

UK-based Morgan Stanley Resources analyst Tom Price put together an interesting report full of charts and anecdotal insights, supporting the view that "Sell in May" does work, in particular for resources stocks.

His view is summarised in the graphic below. Investors who feel comfortable with the saying history doesn't necessarily repeat itself, but it does rhyme might consider following up Price's advise and come back to buy back in the sector by October.

Expert Equity Tips For Aussie Investors

Stockpickers at Citi updated their "Citi Focus List Australia/NZ"; essentially the best Buy ideas according to Citi analysts.

Were added: Eclipx ((ECX)) and Spotless ((SPO)). Were removed: Stockland ((SGP)) and Tatts ((TTS)).

Others on the list remain:

– Aconex ((ACX))
– ANZ Bank ((ANZ))
– Aristocrat Leisure ((ALL))
– Brambles ((BXB))
– Newcrest Mining ((NCM))
– QBE Insurance ((QBE))
– Santos ((STO))
– Vitaco Holdings ((VIT))

Meanwhile, over at Credit Suisse, Macquarie Group ((MQG)) was removed from its Australian Top Picks.

Remain Top Buys according to CS:

– Westpac ((WBC))
– Challenger Financial ((CGF))
– Lend Lease ((LLC))
– Stockland
– Caltex ((CTX))
– Amcor ((AMC))
– Syrah Resources ((SYR))
– Fairfax Media ((FXJ))
– JB Hi-Fi ((JBH))
– Qantas ((QAN))
– Spark Infra ((SKI))
– Mantra Group ((MTR))

Over at Deutsche Bank the local Model Portfolio has equally gone through changes.

Added were: Vocus ((VOC)), Link ((LNK)), ResMed ((RMD)), Sydney Airport ((SYD)) and Commonwealth Bank ((CBA)). Removed were: QBE Insurance, Computershare ((CPU)), Qantas, Bank of Queensland ((BOQ)) and ANZ Bank.

Other constituents of the Model Portfolio are:

– Oil Search ((OSH))
– Santos
– BHP Billiton ((BHP))
– Rio Tinto ((RIO))
– Pact Group Holdings ((PGH))
– CSR ((CSR))
– Fletcher Building ((FBU))
– Boral ((BLD))
– Incitec Pivot ((IPL))
– Aristocrat Leisure
– Star Entertainment ((SGR))
– Harvey Norman ((HVN))
– Wesfarmers ((WES))
– Healthscope ((HSO))
– Westpac
– Stockland
– Suncorp ((SUN))
– AMP ((AMP))
– AGL Energy ((AGL))
– APA Group ((APA))

Catching Up On The (Bear Market) Past

There's no denying a change in the outlook for domestic interest rates is providing support for the Australian share market. Forget about indices revisiting prior lows. Instead, now the hunt is on to participate in equities on the "lower for longer" outlook.

There is no need for #NigelNoMates to stick around, at least in the medium term. Those readers who'd like to look back at the opening stories for the year, when things looked a lot different, can do so via the list below (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

– The Bear Market Diaries – Episode 7

– The Bear Market Diaries – Episode 8

Rudi On Tour

I will be presenting:

– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Sydney, 26 May (sold out)

– To Melbourne chapter of the Australian Shareholders' Association (ASA) on 6 July

– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Melbourne, 6 July (sold out)

– 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: http://www.amazon.com/Change-Investing-Low-Growth-World-ebook/dp/B0196NL3KW/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1454908593&sr=1-1&keywords=change.investing+in+a+low+growth+world

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, 12.30-2.30pm, on Thursday
– Later on Thursday, I shall make a guest appearance on Switzer TV, Sky Business, between 7-8pm
– 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 16 May 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: info@fnarena.com or via Editor Direct on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

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): https://www.fnarena.com/index2.cfm?type=dsp_signup

FNArena has reformatted its monthly price tracker file for All-Weather Performers. We have updated until April 30. Paying subscribers can request a copy at info@fnarena.com 

Click to view our Glossary of Financial Terms