Rudi’s View: On Bear Market Alert

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In this week's Weekly Insights (published in two separate parts):

–Oz Construction Cycle: The Impact Is Now
-On Bear Market Alert
-Conviction Calls: CS, Shaw, Morgans, UBS, Bell Potter, Deutsche Bank
-CBA And The Premium Gone (Vol 4)
–New Website: Set Dedicated Email Alerts
-Rudi On BoardRoomRadio (Updated)
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

[Note the non-highlighted items appeared in part one on the website on Wednesday]

On Bear Market Alert

By Rudi Filapek-Vandyck, Editor FNArena

"Bear markets are inevitable: the question is not if, but rather when, the next one will occur. The problem is that, while bear markets are very obvious with the benefit of hindsight, they are very difficult to identify in real time."

Thus spoke Goldman Sachs strategists in their recent Global Strategy Paper, "Bear Necessities. Identifying signals for the next bear market". The 41-page report lines up the prime reasons as to why investors might be feeling antsy and uncomfortable in the present context:

1) The current bull market is already relatively long-lived and strong by the standards of history. Depending on one's definition, this bull market in US equities can be categorised as the second longest on record, as well as the second strongest on record.

2) On many measures equity markets (and other financial assets) are expensive versus history.

3) Margins (at least in the US) are at record highs, raising the prospect that they might have peaked.

4) After years of extraordinarily low interest rates and QE, which have driven and supported financial returns, we may be close to a turn in the central bank policy cycle.

Offsetting these major concerns are two major sources of support:

1) The free cash flow yield is high (this is true in most equity markets). This, explains Goldman Sachs, is a direct result of companies having held back on capex.

2) Equities are cheap versus bonds. This, of course, remains the case today, and probably for a while to come.

Historical research has taught Goldman Sachs to distinguish three types of bear markets:

1. Cyclical bear markets – typically a function of rising interest rates, impending recessions and falls in profits. They are a function of the economic cycle.

2. Event-driven bear markets – triggered by a one-off ‘shock’ that does not lead to a domestic recession (such as a war, oil price shock, EM crisis or technical market dislocation).

3. Structural bear market – triggered by structural imbalances and financial bubbles. Very often there is a 'price' shock such as deflation that follows.

By splitting bear markets into these groups the strategists find that:

– Cyclical and 'event-driven' bear markets generally see price falls of around -30%, while structural ones see much large falls, of around -50%.

– Event-driven bear markets tend to be the shortest, lasting an average of 7 months, cyclical bear markets last an average of 26 months and structural bear markets last an average of three and a half years.

– Event-driven and cyclical bear markets tend to revert to their previous market highs after around 1 year, while structural bear markets take an average of 10 years to return to previous highs.

So how do we recognise a bear market? Answer: we don't. Given every bear market is different, and caused by different triggers in different contexts, it is plainly impossible to recognise one in advance. Investors who often sell too early are most times not better off than those who wait until the early phase of the ugly bear market announces itself.

As long as one manages to avoid the bulk of the downturn, being early or not matters little, suggests Goldman Sachs. A lot of the research depends on timelines and on definitions used, something the strategists readily admit. For example, they'd be inclined to include April 2011 as the starting point of a brief bear market that lasted five months and ultimately pulled back US indices by -19%.

Including that particular bear market means today's bull market is merely of average length, instead of the second longest in history. The first part of that sentence would make investors a lot less worried than the second part currently does.

The end conclusion from the report won't encourage many investors who'd like to be prepared for when the next bear market arrives: the reliability of indicators tends to be low. "Sometimes it is not a single factor or event but a combination that can contribute to a bear market. On occasion it is not even possible to identify the key trigger even after it is over."

Undeterred, the strategists have selected five indicators that have worked best together, historically, in identifying the next bear market. These five are:

1. Rising unemployment as a precursor to the next economic recession with low unemployment identified as a consistent feature prior to most bear markets

2. Rising inflation has been an important contributor to past recessions and it tends to trigger monetary tightening

3. Flat yield curve; Goldman Sachs argues a flat or inverted yield curve in combination with high asset valuations can be a useful bear market indicator

4. Momentum indicators such as ISM and PMI surveys; typically, when momentum is elevated there's but a reasonable chance the pace will deteriorate and eventually move below recession levels

5. High valuations; they never trigger a bear market in isolation, but in combination with other fundamental factors, high valuations can imply the risk for another bear market is elevated.

Combining all of the above, Goldman Sachs strategist are of the view that while the risk for the next bear market is relatively high right now, suggesting the next market correction has the potential to morph into a bear market, they remain of the view the odds favour low return over the next twelve months rather than a true blue bear market.

The key to their non-bear market outlook is the shift in inflation risk, as "without rising inflation expectations, monetary policy can stay looser with interest rates much lower and more stable than in the past".

Here's the final conclusion from the report: "The combination of higher valuations but lower prospects for interest rates and inflation volatility leads us to expect lower future returns as a central case rather than an imminent bear market. Nonetheless, should inflation expectations rise, necessitating higher interest rates, then the probability would rise that the next bear market would be sharp and, with fewer options to ease monetary policy, it would likely be long".

Conviction Calls: CS, Shaw, Morgans, UBS, Bell Potter, Deutsche Bank

Market strategists at Credit Suisse are concerned the upcoming 19th Communist Party Congress in China might well become a turning point when Chinese policy makers change the direction or magnitude of the current expansionary policy measures. They have reduced their overweight position in Australian resources as a direct result.

This has resulted in the selling of Fortescue Metals ((FMG)) and of South32 ((S32)). The Credit Suisse Long Portfolio still includes BHP ((BHP)), Rio Tinto ((RIO)) and BlueScope Steel ((BSL)). The strategists have added Computershare ((CPU)).

Other stocks included in the Long Portfolio are ANZ Bank ((ANZ)), AMP ((AMP)), Caltex Australia ((CTX)), Star Entertainment ((SGR)), Adelaide Brighton ((ABC)), Premier Investments ((PMV)), Nine Entertainment ((NEC)) and EclipX Group ((ECX)).

Stocks on the Strategy Short Ideas List include Sydney Airport ((SYD)), ASX ((ASX)), APA Group ((APA)), Cochlear ((COH)), Healthscope ((HSO)) and Charter Hall Group ((CHC)).

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Shaw and Partners' Australian Large Cap Model Portfolio has used recent price appreciation in Lend Lease ((LLC)) shares to offload some stock and redirect it to Stockland ((SGP)) in order to keep the portfolio's overall exposure to real estate at 11.3%.

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They certainly like IPH Ltd ((IPH)) over at stockbroker Morgans. The stock is on the radar of portfolio managers for the Income Model Portfolio, as well as the Balanced Model Portfolio with the intention of adding extra exposure in case of further share price weakness. We can only assume Morgans has been buying more shares recently.

The latter has also been topping up BT Investment Management ((BTT)), while the former included Suncorp ((SUN)) in August with the intention of buying more of it, during times of weakness.

Morgans Growth Model Portfolio also bought a new position in BT Investment Management, while buying more of Commbank ((CBA)) and getting rid of South32 ((S32)).

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Small Cap specialists at UBS have used the August reporting season to select their Buy rated preferences: AMA Group ((AMA)), Autosports Group ((ASG)), Bapcor ((BAP)), Infomedia ((IFM)), G8 Education ((GEM)), NextDC ((NXT)), Premier Investment ((PMV)), Tassal Group ((TGR)) and TOX Free Solutions ((TOX)).

UBS's sole conviction Sell call is Ardent Leisure ((AAD)).

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Bell Potter's update on the local Tech Sector contained not one single Sell rating, but that changed a few days later as the share price for WiseTech Global ((WTC)) continued rising. I suspect the broker's downgrade to Sell has since been responsible to keep the bulls, and the share price, in check.

Bell Potter's Top Picks for the sector are Integrated Research ((IRI)) in top spot, followed by (in order of ranking) Adacel Technologies ((ADA)), Empired ((EPD)) and Senetas ((SEN)). The latter replaces Appen ((APX)) which is no longer included as a Top Pick.

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Deutsche Bank's Model Portfolio has added Medibank Private ((MPL)), WorleyParsons ((WOR)) and Santos ((STO)) while removing QBE Insurance ((QBE)), ALS Ltd ((ALQ)) and Woodside Petroleum ((WPL)).

Deutsche Bank strategists have also lowered their ASX200 index projection to 5900 by year-end (down from 6000 prior), to 6000 by mid next year, to 6050 by year-end 2018. The strategists are of the view the global economic backdrop remains supportive, but also this already is reflected in share prices, while earnings growth in Australia is likely to weaken again to mid-single digit percentage.

Note to paying subscribers: updates on Conviction Calls have been a regular feature in my Weekly Insights stories since early February this year, with only a rare exception. For past updates: see Rudi's Views on the FNArena website.

Rudi On BoardRoomRadio (Updated)

Audio interview from earlier this week (not to be confused with last week's):

https://boardroom.media/broadcast/?eid=59c0972724704206917147eb

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, noon-2pm
-Thursday, 7-8pm interview on Switzer TV
-Friday, 11.15am Skype-link to discuss broker calls

Rudi On Tour

– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update

(This story was written on Monday 18th September, 2017. It was published on the day in the form of an email to paying subscribers at FNArena. This is part one. The second part will be published on the website as a separate story on Thursday).

(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

(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.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to My Alerts (top bar of the website) and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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