Share Market Necessity: Know Thyself

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Share Market Necessity: Know Thyself

By Rudi Filapek-Vandyck, Editor FNArena

In this week's Weekly Insights:

-History, Our Guide: Third FOMC Rate Hike
-Feb Reporting Season: Large Caps Come-Back Confirmed
-Conviction Calls: CLSA and Morgans
-Share Market Necessity: Know Thyself
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

History, Our Guide: Third FOMC Rate Hike

Amongst ongoing bullish sentiment, and market commentary, Canadian strategists at Canaccord stand out with a less optimistic outlook for US and global equities. Their view is based upon what they describe as the Three Steps and a Stumble rule.

History suggests whenever US interest rates are being raised three times in a row, with no rate cut in between, US equities experience a pull back, possibly even a (serious) correction, and are most likely to end up flat (unchanged) twelve months later.

Coincidentally, strategists at Citi observe how US indices are only 2% off from reaching targets set for year-end. Citi is not advocating investors should abandon ship, but the strategists do highlight stock picking and sector exposure are increasingly becoming key for further portfolio performance from here onwards.

Feb Reporting Season: Large Cap Come-Back Confirmed

February 2017 was the corporate reporting season that cemented the general come-back of large cap, Blue Chip stocks over their smaller sized peers on the ASX. Sure, Brambles ((BXB)) and Telstra ((TLS)) were amongst the month's stand-out disappointments, but overall the top end of the market delivered more beats and meets than misses, and underlying profit estimates went up, not down.

The latter is a unique in the post-GFC era in which every single reporting season has seen market EPS forecasts fall, never rise, when corporate Australia is unleashing financial results upon the investment community, until February 2017.

As resources and banks generated more beats than misses, strong growth forecasts remain in place, as well as the portfolio rotation that started in 2016, and the preference for large caps over smaller cap stocks.

On Goldman Sachs' calculations, more than $3bn in share buybacks have been announced in February; clearly indicating where board priorities are centred. Hint: it ain't in going out on an investment spree.

On FNArena's final assessment, some 35% of reporting companies beat market expectations. This is near the top of recent reporting seasons though both Feb-16 and Feb-15 showed slightly higher beats (37% and 36% respectively).

Equally remarkable: the 27% in recorded misses was the highest on record thus far.

In addition, the 1.4% average increase in stockbrokers' price targets was near the lowest increase registered since August 2013. Only August of 2015 showed a lower increase of 1.2%.

Overall, it appears the Australian share market is potentially en route to reporting the highest EPS growth post-GFC, could be +18% or higher, but ex-resources there remains a mid-single digit growth outlook only, which is more or less in-line with the experience of the years past.

For more details, see FNArena Reporting Season Monitor, as well as last week's Weekly Insights, February Reports: Ultimate Polarisation

Conviction Calls: CLSA and Morgans

Market strategists at CLSA have used insights from the February reporting season to implement three changes to their Top 15 of Conviction Calls for the Australian share market. Rio Tinto ((RIO)) is now replacing Alumina Ltd ((AWC)), while CSL ((CLS)) replaced QBE Insurance ((QBE)) and Wesfarmers ((WES)) was swapped for Origin Energy ((ORG)).

The other twelve on the list remain: AGL Energy ((AGL)), Amcor ((AMC)), Aurizon Holdings ((AZJ)), a2 Milk ((A2M)), Henderson Group ((HGG)), Incitec Pivot ((IPL)), Macquarie Group ((MQG)), National Australia Bank ((NAB)), Ramsay Health Care ((RHC)), Sydney Airport ((SYD)), Tabcorp Holdings ((TAH)) and Treasury Wine Estates ((TWE)).

Stockbroker Morgans added four new stocks to its list of High Conviction Stocks; Oil Search ((OSH)), Macquarie Atlas Roads ((MQA)), Bapcor ((BAP)), and Beacon Lighting ((BLX)) while removing Westpac ((WBC)), ALS Ltd ((ALQ)), Kina Securities ((KSL)), Catapult Group ((CAT)), Evolution Mining ((EVN)) and Impedimed ((IPD)).

Juicy detail: Westpac remains Morgans' favourite pick among the local banks, indicating Morgans is not expecting much from the sector at current share prices on a twelve months horizon. Morgans is also expecting some sorts of a performance catch up from smaller caps in 2017.

Share Market Necessity: Know Thyself

Investors are used to asking the share market all kinds of questions. Where are we heading? Which stocks are most likely to fail? Is there a theme behind the madness?

This time around, however, the share market has turned the tables, asking one straight question back: what kind of investor are you?

The answer to the question has become all-important since upward momentum in what is widely described as a bull market seems confined to a select group of sectors and stocks only. Invest in the right stocks and share price gains are there for all to enjoy. Elsewhere, however, a lot of pain has fallen upon investors owning stocks that are currently out of favour.

Take a look at the twelve months price chart for Mantra Group ((MTR)) below. It wasn't that long ago this stock was pretty much considered a "must have" to seek exposure to the theme of growing inbound tourism from China to Australia. Those Chinese tourists are still visiting in ever larger numbers, but the Mantra share price stoically refuses to join the uptrend that has pushed the ASX200 near 5800 by early March 2017.

As shown on the price chart, the Mantra share price is trading well below the 200 day moving average, as well as the 60 day moving average, and some 25% below consensus price target (grey-ish background). Making matters worse is all three lines are clearly in descent, as is the share price which is trending from higher up on the left hand side towards the bottom corner on the right hand side of the chart.

I'd like to challenge anyone to find any indication of a bull market anywhere on that price chart.

There are many more price charts for ASX-listed stocks that showcase similar trends and characteristics. No profit warnings have been issued.

A New Type Of Risk

To understand what is holding back share prices for the likes of Mantra Group, we have to make a short excursion into the past.

Ever since commodity prices peaked in 2011, the Australian share market has turned into an amalgamation of opposing trends for different sectors and market segments. There's always the occasional rally, of course, but resources stocks in general terms kept trending south for five long years since. By late 2013, they were joined by the banks.

It took a while before most investors caught on to these underlying trends, but by mid-2015 it was clear to everyone there were only a few exceptions among Australia's large cap stocks that were not eroding shareholders money, like CSL ((CSL)). By early 2016 being underweight, or absent, large cap stocks on the ASX had pretty much become the new trend du jour.

A big chunk of the investment funds that would normally flow into stocks like Commonwealth Bank ((CBA)), BHP Billiton ((BHP)) or Woolworths ((WOW)) instead went into solid reliable performers such as CSL, Amcor ((AMC)) and Transurban ((TCL)), and into small cap industrials, such as Mantra Group, and APN Outdoor ((APO)), and NextDC ((NXT)).

Fast forward to late 2016 when the unexpected winner of the US Presidential election is promising to reinvigorate the world's largest economy through tax cuts, government spending (on infrastructure) and less regulation. For investors, all that was "out" instantly became "in" and vice versa. The monies flowing out of previous winners has turned many portfolios into a war hospital filled with casualties.

In many cases, going down by -20% has simply proved a temporary pause in a much larger de-rating. Arguably, this process already started in August last year, after the Bank of Japan suggested central bank policies had reached their outer limit. It is still ongoing today.

Higher Bond Yields, Cheaper Cyclicals

Bond proxies, such as Sydney Airport ((SYD)), have quickly become a lot less popular, and share prices have suffered a blow, but the real victims in the Australian share market have been smaller cap industrials.

Problem number one is many a professional manager of funds is struggling to attract new inflows, if not battling outflows, so there are limited funds to allocate. Increasing exposure to the new momentum stocks -banks and resources- means other sectors have to be sold.

In a relatively small market as is the ASX, smaller cap stocks find there's nobody else around to jump to the rescue when professional fundies abandon ship. No natural support means lower share prices simply beget even lower share prices. Especially because after a while, they set off all kinds of technical trading signals, to the downside.

Problem number two is that, even after significant share price falls, many of the formerly much beloved yield and growth stocks still do not look particularly cheap. This point was saliently illustrated by market strategists at Citi recently.

As shown in the graph above, healthcare stocks and bond proxies are still trading on higher Price-Earnings (PE) ratios than the rest of the market ex-resources. Many of the cheaper priced companies, often cyclicals with leverage to improving conditions for commodities producers, can look forward to meatier growth in the years ahead, at least such is the present market expectation.

The above mentioned Mantra Group is trading on 15.7x FY17 market consensus estimate. Hansen Technologies ((HSN)) is on 20.5x. TechnologyOne ((TNE)) trades on a multiple of 33x.

In a global context wherein investors are trying to assess what exactly are the consequences of higher US interest rates, with cyclical growth on their mind, those stocks that proved immensely popular pre-August last year but do not form part of the market's new narrative, are likely to find there's now a much higher barrier to be part of the share market's upward momentum.

Beware The Bear Within

Investors usually do not want to hear about it, but irrespective of whether one believes Donald Trump is guiding global equities towards a new bull market, there is a nasty grizzly bear inside the ASX and his bear claws have a firm grip on smaller cap industrials.

In many ways, investors can draw comparisons with the wider-spread bear market of 2008 in that:

-in the absence of a genuinely positive catalyst, the underlying trend remains flat at best
-even with a positive catalyst, upward momentum might still prove only temporary
-in case of a negative event, punishment is immediate and significant
-to withstand downward pressure, a company needs to remain impeccable and surprise positively
-share price recoveries often occur through a prolonged bottoming process first

Even then it is not always possible to figure out why some stocks are being treated differently than others. It took a big upgrade to guidance for CSL shares to rediscover upward momentum, but Amcor's result equally beat market expectations in February, yet after the initial share price rally, the share price has ended up lower than where it was prior to the result.

Investors: Know Thyself

It goes without saying, this selective bear market too shall pass, eventually. About the exact timing, we can but speculate and guesstimate. In the meantime, holding high quality companies with many years of dependable growth ahead of them can be quite the frustrating experience. It's not part of present market momentum. Simple as that.

Which is why the share market is throwing one key question back at investors: what kind are you? Can you stomach lower prices for longer? Or do you feel safer when being part of the dominant market momentum?

Know thyself might well have become the most important strategy feature in today's ever changing context.

2016 – L'Année Extraordinaire

It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.

If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).

For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.

All-Weather Model Portfolio

In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.

This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: info@fnarena.com

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Tuesday around 11.15am, Skype-link to discuss broker calls
-Thursday, 12.30-2.30pm, co-host in the studio
-Thursday, interview on Switzer TV, between 7-8pm
-Friday around 11.05am, Skype-link to discuss broker calls

Rudi On Tour

Your Editor has been invited to present at the Australian Shareholders Association's (ASA) 2017 Securing Your Investing Future Conference to be held at the Grand Hyatt Melbourne from 15-16 May.

The conference details – www.australianshareholders.com.au/conference-2017

Speaker information – www.australianshareholders.com.au/speakers

Program information – www.australianshareholders.com.au/program

Those who register before 31 March 2017 will receive $70 off the registration fee. Telephone: 1300 368 448

(This story was written on Monday 6th 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: info@fnarena.com or via the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) 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.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

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

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