When Uncertainty Is The Only Certainty

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In this week's Weekly Insights:

-When Uncertainty Is The Only Certainty
-Rudi On Tour

When Uncertainty Is The Only Certainty

By Rudi Filapek-Vandyck, Editor FNArena

"There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."
[Jesse Livermore, legendary speculator]

After an unusually savage October sell-off, the subsequent bounce-back rally has been rather mild and unconvincing in character, raising the obvious question: is there a message in there somewhere about the future direction of risk assets?

To some with a negative mindset, and on my observation there is a growing number of bears out there, the answer is unequivocally affirmative. The weak bounce, these expert voices argue, is but another bad omen for what the future holds for global investors in risk assets.

I am not yet convinced by this argument, as there simply is too much uncertainty out there to allow for a quicker and bolder move upwards. Within this context, I'd suggest it would have been rather surprising if equity markets by now had rallied strongly at a time when corporate results in the US are rather lukewarmly received, while stress is rising in Europe, the Federal Reserve is about to provide an update, bond yields are on the rise (again), and all eyes are on deteriorating indicators for the Chinese economy.

We also have mid-term congressional elections in the US this week and here the short term outlook is actually positive. Below is a chart released by Tracey McNaughton, global strategist at Wilsons this week. It shows that, irrespective of the outcome, US equity markets have always rallied post the mid-term elections; at least going back as far as 1950.

Hence if history repeats we should see the return of positive momentum later in the week, which no doubt is what short term traders are looking forward to. For investors looking beyond this week, however, there is no certainty but for the fact that uncertainty remains a key ingredient for financial markets, and is likely to remain exactly that for the weeks ahead.

In Australia, the banks' financial results have been "encouraging", at least for the short term, but for the fact they were not worse than feared, but these results are not good enough to trigger a sharp rally, potentially dragging the rest of the market along. Banks are the most and closest researched sector of the local market, by a long way, thus hoping for something substantially better than what the crowd is already anticipating almost never pays off.

Share prices of domestic banks look cheap, yes they do. But a lot more is needed to re-rate the sector and within the present context that simply does not seem feasible. Investors should note the best the Big Four can do under the circumstances is keep costs contained and pay out a flat dividend. In contrast, Macquarie Group ((MQG)) has no such operational restraints, again lifting guidance for the full year with analysts confident guidance for 10% growth can still be beaten.

Compare the pair, and draw your own conclusions. But I'd add: if you ever wonder why "value" investors are having such a hard task at hand, the evidence is right in front of us. Macquarie versus ANZ/CBA/NAB/WBC/BOQ/BEN. The riddle to solve is only too difficult for those who refuse to see.

Meanwhile, profit warnings from the likes of Wagner Holding Co ((WGN)) are yet more evidence it isn't easy for local investors to position for the boom in infrastructure spending that will underpin domestic GDP in the next three years, while investors are visibly truly uncomfortable with the outlook for housing, and the flow-on effect for Australian households' spending next year, and possibly beyond.

Note the yield on ten-year US Treasuries only fell marginally as equities tanked in October, and it's back to 3.20% alongside the relief rally. The threat of more mayhem because of rising bond yields is not going away in a hurry.

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For investors (as opposed to short term speculators) the general context is that calendar year 2018 remains on course for the worst annual performance since the GFC for many an investor across the globe. US equities have become the last asset holding up, whereas others have faltered along the way, and even US indices are finding it tough to remain in positive territory as the end of year beckons, with a smaller number of stocks providing positive support.

Investors in Australia like to bemoan the fact local shares seldom are able to keep up with the US, but they certainly would not like to swap with peers in Germany, Italy, Hong Kong or China, to name but a few (far) less attractive alternatives. Global equities ex-USA peaked in the first quarter of 2017 already and the number of positive performances since has gradually reduced.

This development has escaped most investors in Australia because the local share market remained until recently among the few ongoing up-trending share markets. The trend was brutally broken during the October sell-off, which also pushed year-to-date performance, including dividends, into the negative, albeit only marginally.

Now consider the stats published by Deutsche Bank this week. Of the 38 assets monitored, only four (4) managed to escape a negative performance in October. Gold, UK government bonds, German government bonds and one share market: the Bovespa in Brazil, as investors welcomed the new strongman as the country's freshly elected president on the perception he'll put in place business friendly policies.

All this implies, of course, that just about everyone has been losing money in October, regardless whether portfolios were tilted towards US treasuries, credit, commodities, energy or equities. The only real saviours turned out to be cash and gold. US bonds, including high yielding corporate bonds, only helped to stem losses through lesser negative returns, but returns for the month were still negative regardless.

October's sell-off also pushed an additional five assets into negative return year-to-date with the total in assets still positive now reduced to nine, in local currency terms (see table below). Year-to-date Australian equity markets are down -0.5% on a total return basis (meaning: in local currency, including dividends, as at the end of October) while Australian 10-year government bonds are up 2.65% (all through coupons), the main credit bond index is up 2.64%, and the AUD has fallen -9.4% against the USD. Again: not too bad on a relative comparison.

In light of the public debate about whether October's sell-off is but the opening salvo for the next emerging bear market, or not, maybe the better question to consider is whether the global bear market for risk assets already started sometime back in 2017, and a shrinking group of assets, including equities in Australia and in the US, are only now starting to fall in-line with the rest?

Even if the answer to that question turns out positive, with hence negative consequences for the Australian share market, this need not automatically become a repeat experience of 2008, but I suggest keeping an open mind, preparing for potential scenarios to both upside and downside from here onwards seems but the prudent strategy to employ right now.

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In terms of the shorter term outlook for the Australian share market, a study by Longview Economics into share market corrections of at least -10% since May 1928 might provide us with a blueprint of sorts of what to expect in the weeks, if not months ahead.

Longview's analysis has over the period identified 19 such "crashes" and only one (April 1937) did not follow the pattern of a severe sell-off, followed by a relief rally, subsequently followed up by another sell-off so the underlying message here seems clear: be prepared for another leg to the downside, exact timing unknown.

Equally interesting, and I am sure you'll all agree with me on this one, is there's more than a 50% chance the second sell-down might go deeper than the first, but usually the extra percentages to the downside remain quite limited, with Longview setting the range between -0.1% & -3.9%. In a small number of cases, there is another rally higher, which then is followed-up by yet another test of the earlier lows established during the two prior sell-offs.

While history seems to provide a pretty straightforward pattern (with one exception to date), there is no guidance on timing or duration for the various stages or the full process. Sometimes the relief rally is only short and selling resumes within a few days, whereas in 1962 it took the US market 85 trading sessions (circa four months) to revisit the low point of the first sell-off.

Special note: Longview excluded from its analysis the heavy sell-offs that led to protracted bear markets further down the road.

Readers who missed my recent updates might also like to read:

–What Beyond The Rally

–Could This Be The Start Of Something Different

–Out With The Garbage

–Investing Used To Be So Much Easier

Alternatively, paying subscribers can simply visit Rudi's Views on the website; the archive goes back more than ten years.

Rudi On Tour

-ASA Parramatta, on November 14, 5.30-7pm

Rudi On Tour In 2019

-ASA Inner West chapter, Concord, Sydney, March 12
-ASA Sydney Investor Hour, March 21
-ASA Toowoomba, Qld, May 20
-U3A Investor Group Toowoomba, Qld, May 22

(This story was written on Tuesday 6th November 2018. It was published on the Tuesday in the form of an email to paying subscribers at FNArena, and again on Thursday as a story on the website).

(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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– 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.
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(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.) 

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