A Market Full Of Strength, And Questions

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In this week's Weekly Insights:

-A Market Full Of Strength, And Questions
-One That Got Away: GUD Holdings
-IPO Monitor
-Conviction Calls: Bell Potter, UBS And Shaw
-Telstra: The Other View
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

A Market Full Of Strength, And Questions

By Rudi Filapek-Vandyck, Editor FNArena

The Reflation Trade, all-dominant in the second half of calendar 2016, has hit the pause button in 2017.

Less ebullient economic data. The first 100 days of the Trump administration generating a lot of controversy and hot air, but very little in the form of tangible progress. Crude oil prices running against an impregnable barrier in the mid-US$50s/bbl. US bond yields retreating from rally highs. The Federal Reserve sticking to its cautious, gradual projections.

The combination of all these factors has meant investors were left reconsidering their positions and projections. Mining companies thus corrected, with the strong rally in 2016 leaving plenty of investors with plenty of profits to secure while bank shares held up, but even they have found the going tougher over the past two months.

Three of the Big Four in Australia, plus Macquarie Group ((MQG)), are about to release financial results while announcing half-yearly dividends. The real litmus test will be how share prices respond after going ex-dividend later this month.

Not that any of the above has held the local share market back in April. After a difficult first set of weeks in January, the ASX200 powered higher in February and in March, then added yet another positive performance in April.

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A correction for resources stocks plus a tougher going for Australian banks implies fresh money had to flow into other stocks to keep pushing major indices higher. Investors have responded by revisiting quality industrials, including small and mid-cap growth stocks; those that were eagerly left behind last year when all that mattered was "are you cheap and cyclical?"

This revival of the Best and Most Resilient in the Australian share market has translated into a noticeable come-back for All-Weather Performers such as CSL ((CSL)), Amcor ((AMC)), ARB Corp ((ARB)), Carsales ((CAR)), and others. In fact, FNArena subscribers visiting the dedicated section on the website can see most stocks mentioned enjoyed solid gains in April.

In addition, investors showed renewed appetite for smaller and midcap growth stories, including Altium ((ALU)), NextDC ((NXT)), WiseTech Global ((WTC)), Speedcast International ((SDA)), Breville Group ((BRG)), as well as the China consumer stories A2 Milk ((A2M)) and Bellamy's ((BAL)).

Meanwhile, the resurgence of traditional yield stocks continues, as long as there is no direct exposure to bricks and mortar retailers, with the notable exception of Telstra ((TLS)). The record high popularity of online retailer Amazon in the USA is having an inverse impact on bricks and mortar retailers on the ASX. Shares in Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) are well off their recent highs, and so is Super Retail ((SUL)), but for smaller peers the dominant trend remains persistently south.

Watch share prices for Shaver Shop ((SSG)), Baby Bunting ((BBN)), RCG Corp ((RCG)) -the latter after a second profit warning on Monday- and shudder. This looks like graveyard territory, despite the fact that all have been on lists of favourites and conviction buys in 2016. Furniture retailer Nick Scali ((NCK)) remains the stand-out exception in this segment of the market.

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The international debate over whether equities are overvalued, and whether current levels will prove sustainable, is not foreign to Australian equities. Here the average Price-Earnings (PE) ratio remains above the long term average of circa 14.5x, but there is a valid argument this premium is supported by still exceptionally low bond yields.

While just about every expert and his dog expects to see higher bond yields going forward, it is merely the pace at which bond yields rise that has a direct impact on equity markets and investor sentiment. At least in the present context. Last year's Big Switch occurred alongside a rapid increase in US bond yields. A repeat this year would likely require an outburst in inflation, which will be a surprise if it eventuates, or big stimulus from the Trump administration, which equally will come as a "phenomenal" surprise, were it to ever materialise.

The average Price-Earnings (PE) ratio for the ASX200 sits above 16x for FY17, and at around 15.5x for FY18. These numbers are above the historical average, but not alarmingly so. Of more concern, possibly, is the observation the average PE for the Big Four Banks has now risen above 14x on FY18 forecasts. Historically, most times this is as high as it gets for the sector, further illustrated by the observation CommBank's ((CBA)) implied dividend yield has now fallen below 5%.

History also shows this PE level is usually not sustained for a prolonged period. All this can change, of course, if the upcoming results force analysts into lifting forecasts and valuations. But what applies to the banks also applies to large segments of the share market in general. It goes without saying, all worries about index levels and share price valuations can be overcome with a big boost to corporate profits, but what are the chances, really?

Projections for corporate profit growth in Australia remain robust for FY17, but this remains a story of resources, predominantly. Few analysts to date have been willing to incorporate growth for resources stocks beyond 2017. In fact, last week I discovered Macquarie has started to project negative growth for the sector next year, and thus only negligible growth for the Australian market overall.

Underlying these projections there remains a positive undercurrent as industrial companies such as CSL, Ramsay Health Care ((RHC)), Aristocrat Leisure ((ALL)), Corporate Travel ((CTD)), others will continue growing, but at what point will their share price be deemed too excessive?

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Like a helium balloon in a public swimming pool; one cannot hold back tested and proven quality industrial stocks for long. Such is my observation over many years of monitoring Australian equities. Hence, it has been no surprise to see the All-Weather Model Portfolio jumping back to life in February and March, and following up with a market-beating catch-up performance in April.

If anything, our cautious attitude in light of high valuations and multiple threats has been holding back the Portfolio's performance, given a healthy chunk of our funds is being held in cash. Entering May, investor attention seems to focus on North Korea and on seasonal patterns ("Sell in May"), but maybe Pimco's Head of public policy, Libby Cantrill, summed it up best when she stated:

"We've been skeptical that comprehensive tax reform would pass through Congress quickly; our view remains that if we see action on tax reform at all, it won’t be until the end of 2017 or the beginning of 2018, and it will likely be smaller in scale and scope than any of the proposals we have seen to date. And if action on taxes slips beyond that time frame, it would become increasingly likely that we won’t see action until after the midterm elections (if at all), a development that markets would not welcome."

This is the problem with equity markets high on hope and expectations: disappointment and nervousness can hit anytime. Or never. Probably best not to go full in either way.

One That Got Away: GUD Holdings

One company that has been on my radar for a while is GUD Holdings ((GUD)) and with good reason. If management's strategy to rebuild this former dividend stalwart around fuel transmission and other automobile parts proves successful, we might be witnessing the birth of a fresh All-Weather Performer on the local stock exchange. This is not a regular occurrence.

Unfortunately for investors who as yet have not caught up with this corporate transformation, the company has been providing fans and stockbrokers with positive feedback in the months past and the share price started a relentless rally in early February, pushing the price above $12.50 while none of the stockbrokers covering the stock has a price target that comes even close.

On Monday, we had the confluence of two non-aligned events, both negative, and the share price responded swiftly to the downside. First up was funds manager Wilsons, whose analyst decided it is time to downgrade to Sell. Wilsons' valuation/target doesn't reach higher than $9.97, or close to -20% below the share price close on Friday.

Amongst observations made by Wilsons is that GUD shares are now more highly valued than Bursons Group's ((BAP)), while recent history shows a discount of -20-35% was pretty much standard. Clearly, the market likes the prospect of a potentially successful turnaround, but maybe it likes this story too much?

Stockbroker Morgans added the observation that GUD shares, from a technical perspective, look overbought, overpriced and well due a correction. Stockbroker price targets aside, Morgans' technical chartist reports levels of support are located at $11.71, then $11.14, then $10.30.

Most stockbroker targets were set in February, at the interim result, though Macquarie updated in early April with a price target of $10.40. Both Citi and Credit Suisse are only marginally higher at $10.45. One to keep an eye on, for sure, but not one to chase after such strong momentum. Patience can be a real asset when applied diligently.

IPO Monitor

Last year FNArena teamed up with OnMarket BookBuild in order to provide readers and subscribers regular updates on Australia's booming IPO market, as well as give investors easier access to fresh ASX listings.

As this is not an exclusive alliance, FNArena only benefits when investors sign up through our dedicated channels. If you are interested, and you want FNArena to benefit too, use the following link:

https://au.onmarketbookbuilds.com/?refID=97XGXOZ5

Or click through via the final page of the PDF report update we published last week:

https://www.fnarena.com/wp-content/uploads/2017/04/OnMarket-2017-First-Quarter-IPO-Report-FNArena.pdf

Among the observations included inside the report:

-Only two out of eight IPOs from January are still in positive territory today. One of the two, Lifespot Health ((LSH)), experienced a jump of 100% on the first day of listing
-February was the best performing IPO month in Q1 with most listings adding to their gains from Day One
-The Materials sector is back, offering 10 out of 26 IPOs in Q1 2017
-Best performing sectors have been Industrials and Healthcare

Conviction Calls: Bell Potter, UBS And Shaw

Personally, I don't like the term "Defensives", but I am all too aware others are using the term in abundance, so here they are, the Top Ten Defensives as identified by Bell Potter Head of retail research, Peter Quinton:

-GPT Group ((GPT))
-SCA Property Group ((SCP))
-Stockland ((SGP))
-Transurban ((TCL))
-Spark Infrastructure ((SKI))
-CSL ((CSL))
-Challenger ((CGF))
-Link Administration ((LNK))
-Coca-Cola Amatil ((CCL))
-Orora ((ORA))

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Strategists at UBS reiterated their allegiance to the global reflation trade last week, arguing what we are witnessing right now is nothing but a pause in a trend that has much longer to run. UBS's Model Portfolio therefore remains Overweight resources stocks and Underweight bond proxies.

UBS is also Overweight stocks that benefit from higher US interest rates. Domestically, i.e. Australia-specific, the strategists find it difficult to identify favourable trends. They've chosen the East Coast gas crisis -through AGL Energy ((AGL)) and Origin Energy ((ORG))- as well exposure to public sector infrastructure investment. UBS reduced its weighting to local banks to Neutral.

In terms of individual stock decisions, UBS strategists have added AGL Energy, Brambles ((BXB)) and Sims Metal Management ((SGM)) to the Model Portfolio. They dropped Amcor ((AMC)), Costa Group ((CGC)) and Star Entertainment Group ((SGR)).

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Chief Investment Officer Martin Crabb runs a Magnificent Seven portfolio for Shaw and Partners clientele and the selected basket is running ahead of market performance after four months in 2017. Albeit, it has to be said, this outperformance is largely the result of Qantas' ((QAN)) inclusion; up more than 25% since January 1st.

The Magnificent Seven currently comprises of:

-Flight Centre ((FLT))
-Qantas
-BHP Billiton ((BHP))
-Henderson Group ((HGG))
-Alumina Ltd ((AWC))
-Lend Lease ((LLC))
-Mirvac ((MGR))

Note: since early March, every Weekly Insights has contained updates on Conviction Calls by stockbrokers and other experts in the local share market. See Rudi's Views on the website.

Telstra: The Other View

Last week, I wrote a story on Telstra ((TLS)) in which I dared to made a few predictions, including:

-Investors better not hope for a return in share price to $5, not to mention $6 or higher
-Ultimately the board will be forced to reduce the dividend, but not in the short to medium term
-The downward trending share price will find support as the yield differential with peers has widened considerably

For those who missed out, see last week's Weekly Insights: Telstra Is Not BHP.

There are opposing views though. Two local experts who are stridently in disagreement with me on this topic are telco analysts at Shaw and Partners, David Spotswood and Annabel Riggs. The two are rating Telstra Sell with a twelve month price target of $3.78, suggesting a lot more pain lays in store for today's loyal shareholders.

Shaw and Partners' view is, at its core, premised on the assumption that present industry dynamics for the telecommunication sector in Australia are negative for everyone in the industry, with consumers possibly the sole beneficiary. This then leads to the prediction Telstra's pain will stretch a lot further than what analysts at Deutsche Bank, UBS, et al are willing to contemplate.

And this then leads to the projection of a much greater earnings and cash flow shortfall than is being reflected in current market consensus forecasts. These consensus forecasts, by the way, don't project Telstra will cut its dividend this year or next. I explained last week, most analysts believe Telstra's 31c annual payout is not under threat until, maybe, 2019 or later.

Shaw's Spotswood and Riggs are challenging that assumption with a projected payout of 28c in FY18, next to be followed up by a further cut to 25c.

Shaw's revised projections are possibly the most bearish I have come across to date. They also stand in sharp contrast with analysts at JP Morgan who believe Telstra shares still deserve to trade at $5 as its market position and pricing power is much more resilient than the market is giving it credit for in 2017.

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, 11.15am Skype-link to discuss broker calls
-Thursday, 12.00-2.00pm, co-host in the studio
-Friday, 11.15am 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

Telephone: 1300 368 448

(This story was written on Monday 1st 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 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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