Rudi’s View: The Year Of Shame (Part 1)

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No Weekly Insights, but today's Rudi's View story got a bit lengthy, so I cut its content in two parts. Non-highlighted items appear in Part Two later this week:

–2018, The Year Of Shame For Fundies
-Byron Wien's Ten Surprises For 2019
–Conviction Calls
–Join The CSL Challenge
-Waiting For February
–Pub. Beer. Pitt Street Research
-US Earnings Recession, But How Deep?

By Rudi Filapek-Vandyck, Editor FNArena

2018, The Year Of Shame For Fundies

Maybe the biggest surprise from 2018 was not so much that there were so few places to hide from persistent selling orders, once they started hitting financial markets, but that so few actively managed portfolios have managed to stay clear from temporary Armageddon.

As pointedly pointed out by award-winning journalist Jonathan Shapiro at the Australian Financial Review, the official industry line that has been constantly put forward against the global trend to use more and more passive investment products is that when the day of reckoning arrives, as it did in September 2018, investors will experience with their own eyes the safer hands of the experienced professional compared with the mindless mass-produce that can only result in something akin to passive carnage.

Not so. Quite the opposite happened with many a professional fundie having to admit this month performance in 2018, and more particularly in the final four months of the calendar year, has been quite the disappointment, with minus double digit percentage returns not the exception the industry would have touted beforehand.

As far as the full year's return is concerned, I have come across -15.8%, -19% and -23.9%. And those are the ones that spontaneously spring to mind. Clearly, there are quite the number of fundies around who are now forced to eat a whole lot of humble pie, potentially for a long time too.

The FNArena/Vested Equities All-Weather Model Portfolio achieved a narrowly positive performance in calendar 2018 (up a grand total of 0.75%), which doesn't seem much at face value, but in the context of the above this puts the All-Weather Portfolio in the better half of the industry. The ASX200 Accumulation Index returned a negative -2.84% while the median long only Australian equities funds surveyed by Mercer booked an annual loss of -4.2%.

Shapiro's story, Year Of Shame For Fund Managers, published on Monday, 21 January 2019, contains a number of hard hitting paragraphs and observations that are worth re-reading while the topic is still relevant:

"Morningstar and Lonsec both explained that having a "value" approach was the undoing of most large-cap managers. Cheap stocks simply got cheaper, while pricier ones gained. And some stocks that appeared good value at the start of the year, such as the big banks and AMP, were decimated by the unfolding Hayne commission."

"Some sophisticated investors have given up on Australian large-cap, "long-only" managers altogether. Some simply don't believe managers in this sector can add value above fees, which are being forced lower. Others believe good active managers may be out there, but identifying them beforehand is impossible."

"While a small group of funds are being hailed for navigating the toughest year in a decade, success is often short-lived in funds management. The table toppers of today are often the cellar dwellers of tomorrow."

CLSA only this week initiated coverage on the sector in Australia, predicting fund managers in Australia should still benefit from compulsory super and increased offshore distribution in the years ahead, while global equity markets might be enjoying a less negative time as well. But downward pressure on fees is here to stay, and so is performance pressure in an environment of lower returns overall and plenty of passive and lower cost alternatives around.

CLSA predicts M&A will become a feature as funds will be seeking expansion to counter lower fees.

As far as individual managers are concerned, only two received a maiden Outperform rating at CLSA; Magellan Financial ((MFG)) and Janus Henderson ((JHG)) with price targets of $33.01 and $30.87 respectively. Each of Pendal Group ((PDL)), Perpetual ((PPT)) and Platinum Asset Management ((PTM)) commences coverage with an Underperform rating.

Data crunching by some also revealed that Australia's list of best performing funds is, quite frankly, virtually the exclusive domain of industry funds, which must be an incredible embarrassment for a federal government looking to change the industry structure away from union-based domination. Apparently, all fifty bottom performers in the sector are retail funds, most owned by major banks and other large and well-known financial institutions.

And when it comes to ultimate embarrassment, funds owned by Westpac ((WBC)) and ANZ Bank ((ANZ)) are at the bottom of the bottom performers.

Industry legend Jack Bogle, founder of Vanguard's market cap weighted funds and indices, passed away early in 2019. As he reminded us all in 2013, "Beating the market is a zero-sum game for investors. Money managers, as a group, must provide the market return… But that return comes only before their exorbitant fees, operating expenses, and portfolio turnover costs are deducted. The zero-sum game before costs becomes a loser's game after costs."

As it turned out, 2018 was worse, a lot worse.

Below: Performance of major asset classes lined up by Morgan Stanley, 2008-2018.

Conviction Calls

Analysts at Canaccord Genuity have updated their Top Australian Stock Picks, and we can only admit the updated selection contains a few fresh inclusions that had not attracted my personal interest just yet.

Readers who have been reading my regular updates on Conviction Calls by stockbroking analysts in Australia would be aware the team at Canaccord Genuity specialises in the smaller end of the domestic share market.

The Australia Focus List, as it is officially labeled, presently contains ten members: Audinate Group ((AD8)), CML Group ((CGR)), Dacian Gold ((DCN)), Healthia ltd ((HLA)), Money3 Corp ((MNY)), Primero Group ((PGX)), Perseus Mining ((PRU)), Service Stream ((SSM)), Think Childcare ((TNK)), and Temple & Webster ((TPW)).

****

Over at Bell Potter, tech analysts Chris Savage and TS Lim have refreshed their thoughts and projections for the local technology sector. Their Top Three Key Picks for the calendar year ahead consists of TechnologyOne ((TNE)), Citadel Group ((CTD)) and Integrated Research ((IRI)).

If you are familiar with my own research into All-Weather Performers in the Australian share market, you know TechnologyOne is a long-time inclusion on my selective list, and it has been proudly held as a cornerstone investment in the FNArena/Vested Equities All-Weather Model Portfolio.

Citadel Group can be regarded as a smaller cap version of the TechOne success story, with lower marketcap and lower daily trading volumes, and with a direct link to the Australian military. Integrated Research would have disappointed many with a profit warning last year. This month's market update implies all remains well and last year was simply an aberration. Clearly, Bell Potter backs company management's confidence.

The broker recently downgraded Altium ((ALU)), after a strong rebound in the share price, while retaining WiseTech Global ((WTC)) as the sole key Sell inside the sector, which is equally value-based.

****

Portfolio managers at stockbroker Morgans decided to swap Ramsay Health Care ((RHC)) for a fresh exposure to Sonic Healthcare ((SHL)), while releasing a watch list for targets that may be jumped upon in case of share price weakness. This watch list consists of major banks in Australia, ResMed ((RMD)), Reliance Worldwide ((RWC)), Woolworths ((WOW)), and OZ Minerals ((OZL)).

Morgans' Growth Portfolio has added a small exposure to cheap bling retailer Lovisa Holdings ((LOV)), while rebalancing its holdings of oil and resources stocks by trimming Oil Search ((OSH)) and topping up Rio Tinto ((RIO)) and said OZ Minerals.

Elsewhere some extra shares in Telstra ((TLS)) have been purchased when a weakening share price was too much to ignore.

Its preferred plays among A-REITS are Aventus Group ((AVN)), Viva Energy REIT ((VVR)), and Centuria Metropolitan REIT ((CMA)).

Join The CSL Challenge

If you somehow missed it, earlier this month I launched the CSL Challenge. It is my attempt to provide an invaluable piece of empirical share market education to Australian investors who in large parts are too narrowly focused on income and franking, and otherwise have a deeply seated fear of stocks that trade on above average Price-Earnings (PE) ratios, wrongly believing such stocks are but one cliff away from falling into the abyss.

Instead, of course, stocks like CSL ((CSL)), ResMed ((RMD)) and Cochlear ((COH)) -quality if you ever saw some- have been among the most profitable, consistent and sustainable investments any type of investor could have made over the past two decades. My initiative has elicited some highly endearing messages from investors who have owned CSL shares over many years, and who are in full support of my initiative.

If you haven't joined as yet, all you need to do is buy one share, and join. For further info:

https://www.fnarena.com/index.php/2019/01/14/rudis-view-join-the-csl-challenge/

Pub. Beer. Pitt Street Research

An Australian biotech aficionado sits in a pub with a Dutch tech analyst. No this is not the opening line of a casual joke. It's the set-up of a new initiative by the two founders of Pitt Street Research. FNArena is distributor of Pitt Street Research reports, thus in a commercial relationship with them.

You can check out their new initiative at: https://www.pittstreetresearch.com/friday-beers/

US Earnings Recession, But How Deep?

If you are sceptical about the strong bounce in global equities post Christmas, you are far from the only one.

Apart from -quite literally- a whole army of technical traders and analysts sticking with a negative outlook, share market strategists at Morgan Stanley added their fundamental analysis to general market scepticism.

Economic recession. We hear commentators, economists and strategists talk about it a lot these days, usually followed by the add-on "we don't think there is one on the horizon for the US this year".

But last year's pull back might be less about the potential for US GDP growth to turn negative by year's end, as it is more about forecasts for US corporate earnings needing a significant re-set to much lower levels. In the latter case, the industry lingo talks about an "earnings recession".

The last time global equities were confronted with such an earnings recession was in 2015-early 2016 and share prices trended south for the better part of a full year. Until the US Federal Reserve backed down from its tightening schedule, which hasn't as yet happened in the same fashion since 2019 may not be as much about the Fed funds rate as it is about reducing the Fed's balance sheet.

Were the Federal Reserve to unequivocally communicate it's done/on pause with lifting interest rates and running down debt on its balance sheet, this would be seen as a game-changer by strategists at Morgan Stanley.

But in the meantime, their observation is that market expectations in the US are falling, but they remain too high still, based upon Morgan Stanley research and assessments. This almost by definition means the share market will have to move lower again, and potentially testing the lows from December – all else remaining equal.

In Australia, a similar process is taking place. Earnings estimates are falling and companies are issuing profit warnings. The result is for lower valuations and price targets. This is why the February reporting season will be pivotal.

How much of an "earnings recession" has been incorporated into forecasts and into (lower) share prices; and has it been enough?

If you're siding with Morgan Stanley's conviction, you keep your enthousiasm contained, and prepare for the next leg downwards.

(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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