Rudi’s View: The Year Of Shame (Part 2)

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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

Byron Wien's Ten Surprises For 2019

Every year Saxo Bank draws up a list of potential surprises that might happen in the year ahead, and when they do their impact will be significant if not devastating for investment strategies and portfolios, but the chances of each of them happening are actually quite small, a feature readily acknowledged by the analysts themselves.

The Saxo Bank list is usually widely published and re-published, including by FNArena.

There is an alternative which is likely to have a much larger impact on investment returns in the year ahead, if only because events listed have a much higher chance of happening. For the 34rd year in a row Byron R. Wien, Vice Chairman in the Private Wealth Solutions group at Blackstone, released his Top Ten of probable surprises at the end of last year.

With each "surprise" given a higher than 50% chance to actually take place this year (which make them a "probable" event) investors might want to pay a little more attention to what Byron Wien has lined up for calendar 2019.

Byron's Ten Surprises for 2019 are as follows

1. The weakening world economy encourages the Federal Reserve to stop raising the federal funds rate during the year. Inflation remains subdued and the 10-year Treasury yield stays below 3.5%. The yield curve remains positive. 

2. Partly because of no further rate increases by the Federal Reserve and more attractive valuations as a result of the market decline at the end of 2018, the S&P 500 gains 15% for the year. Rallies and corrections occur but improved earnings enable equities to move higher in a reasonably benign interest rate environment.

3. Traditional drivers of GDP growth, capital spending and housing, make only modest gains in 2019. The expansion continues, however, because of consumer and government spending. A recession before 2021 seems unlikely.

4. The better tone in the financial markets discourages precious metal investors. Gold drops to US$1,000 as the equity markets in the United States and elsewhere improve.

5. The profit outlook for emerging markets brightens and investor interest intensifies because the price earnings ratio is attractive compared to developed markets and historical levels. Continuous expansion of the middle class in the emerging markets provides the consumer buying thrust for earnings growth. China leads and the Shanghai composite rises 25%. The Brazil equity market also comes to life under the country’s new conservative leadership.

6. March 29 comes and goes and there is no Brexit deal. Parliament fails to approve one and Theresa May, arguing that a change in leadership won’t help the situation, remains in office. A second referendum is held and the U.K. votes to remain.

7. The dollar stabilizes at year-end 2018 levels and stays there throughout the year. Because of concern about the economy, the Federal Reserve stops shrinking its balance sheet, which is interpreted negatively by currency traders. The flow of foreign capital into United States assets slows because of a softer monetary policy and a lack of need for new capital for business expansion.

8. The Mueller investigation results in indictments against members of the Trump Organization closest to the president but the evidence doesn’t support any direct action against Trump himself. Nevertheless, an exodus of Trump’s most trusted advisors results in a crisis in confidence that the administration has the people and the process to accomplish important goals.

9. Congress, however, with a Democratic majority, gets more done than expected, particularly on trade policy. Progress is made in preserving important parts of the Affordable Care Act and immigration policy. A federal infrastructure program to be implemented in 2020 is announced.

10. Growth stocks continue to provide leadership in the U.S. equity market. Technology and biotech do well as a result of continued strong earnings. Value stocks other than energy-related businesses disappoint because of the slowing economy.

Every year there are always a few Surprises that do not make the Ten because either Wien does not think they are as relevant as those on the basic list or he is not comfortable with the idea that they are “probable.”

This year's less probable forecasts are:

11. Geopolitical tensions increase. Iran continues to destabilize the Middle East and Kim Jong Un fails to live up to his North Korea denuclearization promises. Secretary of State Pompeo and National Security Advisor Bolton make statements indicating the United States may take pre-emptive action in both places, thereby causing one of several sharp market sell-offs. But in spite of hostile rhetoric, the United States does not go to war with anyone as we approach the 2020 election. Trump’s tough talk on some issues like trade works, however, and leads to successful diplomatic negotiations on national security.

12. In desperation China engages in ambitious infrastructure programs to bolster its economy. China grows at 6.5% real, but the increased debt causes concern around the world and has a negative impact on the renminbi.

13. China announces, “We want to be the world leaders in free trade.” It sends envoys around the globe to negotiate better bilateral trade terms in order to offset the losses from the ongoing U.S. disagreements. Joint ventures in which foreign companies control the majority share are initiated in all sectors, from industrials and autos to raw materials. As China’s influence around the world becomes greater, the U.S. further isolates itself.

14. The European Central Bank is forced to restart quantitative easing in response to a defiant Italy, a weakening Germany and Brexit. Thwarting expectations that Brexit would bring the rest of Europe closer together, Italy realizes that it can break all fiscal rules without any fear of punishment from the E.U. As a result, the Italian economy falls into recession, debt spreads surge and the ECB is forced to liquefy the system again.

For good measure, the following were Byron's Ten Surprises for 2018:

1. China finally decides that a nuclear capability in the hands of an unpredictable leader on its border is not tolerable even though North Korea is a communist buffer between itself and democratic South Korea. China cuts off all fuel and food shipments to North Korea, which agrees to suspend its nuclear development program but not give up its current weapons arsenal.

2. Populism, tribalism and anarchy spread around the world. In the United Kingdom Jeremy Corbyn becomes the next Prime Minister. In spite of repressive action by the Spanish government, Catalonia remains turbulent. Despite the adverse economic consequences of the Brexit vote, the unintended positive consequence is that it brings continental Europe closer together with more economic cooperation and faster growth.

3. The dollar finally comes to life. Real growth exceeds 3% in the United States, which, coupled with the implementation of some components of the Trump pro-business agenda, renews investor interest in owning dollar-denominated assets, and the euro drops to 1.10 and the yen to 120 against the dollar. Repatriation of foreign profits held abroad by U.S. companies helps. 

4. The U.S. economy has a better year than 2017, but speculation reaches an extreme and ultimately the S&P 500 has a 10% correction. The index drops toward 2300, partly because of higher interest rates, but ends the year above 3000 since earnings continue to expand and economic growth heads toward 4%.

5. The price of West Texas Intermediate Crude moves above US$80/bbl. The price rises because of continued world growth and unexpected demand from developing markets, together with disappointing hydraulic fracking production, diminished inventories, OPEC discipline and only modest production increases from Russia, Nigeria, Venezuela, Iraq and Iran.

6. Inflation becomes an issue of concern. Continued world GDP growth puts pressure on commodity prices. Tight labor markets in the industrialized countries create wage increases. In the United States, average hourly earnings gains approach 4% and the Consumer Price Index pushes above 3%.

7. With higher inflation, interest rates begin to rise. The Federal Reserve increases short-term rates four times in 2018 and the 10-year U.S. Treasury yield moves toward 4%, but the Fed shrinks its balance sheet only modestly because of the potential impact on the financial markets. High yield spreads widen, causing concern in the equity market.

8. Both NAFTA and the Iran agreement endure in spite of Trump railing against them. Too many American jobs would be lost if NAFTA ended, and our allies universally support continuing the Iran agreement. Trump begins to think that not signing on to the Trans-Pacific Partnership was a mistake as he sees the rise of China’s influence around the world.  He presses for more bilateral trade deals in Asia.

9. The Republicans lose control of both the Senate and the House of Representatives in the November election. Voters feel disappointed that many promises made during Trump’s presidential campaign were not implemented in legislation and there is a growing negative reaction to his endless Tweets. The mid-term election turns out to be a referendum on the Trump Presidency.

10. Xi Jinping, having broadened his authority at the 19th Party Congress in October, focuses on China’s credit problems and decides to limit business borrowing even if it means slowing the economy down and creating fewer jobs. Real GDP growth drops to 5.5%, with only minor implications for world growth. Xi proclaims this move will ensure the sustainability of China’s growth over the long term.

The following predictions were seen as less probable:

11. Investors recognize that the earnings of companies in Europe, the Far East and the emerging markets are growing faster than those in the United States while the price earnings ratios in those regions are lower than those in America. Global investments become more broadly represented in institutional portfolios.

12. The Mueller investigation of the 2016 presidential election fails to implicate any members of the Trump family in collusion with Russian operatives.

13. Artificial intelligence gains visible momentum. Service sector jobs are automated, particularly clerks in legal and finance professions, as well as workers in fast food outlets and healthcare. Economists begin to question the unemployment data because the rate drops below 4% while so many people still appear to be out of work and seeking government assistance.

14. Cyber attacks become more prevalent and begin to affect consumer confidence. A major money center bank suspends deposits or withdrawals for three days because its system is penetrated. Numerous retail organizations report that customer personal information has been obtained by hackers. Those invading corporate information systems appear to be smarter and more innovative than the internal employees protecting the computer data, suggesting that the systems themselves need to be upgraded.

15. The regulatory authorities in Europe and the United States finally get concerned about the creative destruction of Internet-related businesses.  As a result of pressure from retailers and traditional media companies, they begin an investigation of anti-competitive practices at Amazon, Facebook and Google. The public begins to think these companies have too much power.

16. The risks in Bitcoin are so great that regulatory authorities restrict trading. Among their concerns are: no regulatory oversight; no safety and soundness measures; no recourse in the event of mistaken or miscalculated transactions; high cyber risk; no deposit insurance.

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, 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/

Waiting For February

The importance of avoiding bomb shells in the Australian share market has once again become apparent this month with small cap infrastructure and buildings materials company Wagners Holding ((WGN)) issuing another profit warning this week one day after scrap trader Sims Metal Management ((SGM)) had done the same.

February is now less than two weeks away, but stockbroking analysts are only now genuinely getting back to work, so I guess we'll have to wait a little while longer before being inundated with all kinds of previews and predictions regarding potential beats and misses throughout the February reporting season.

One team already released the results of its own set of predictions but the news from JP Morgan is not looking great; the analysts see more potential for downside than upward surprises. If correct, this could potentially translate in a lot more disappointment for investors hoping for a better experience as the February reporting season unfolds.

Among the potential candidates for a negative surprise next month feature National Storage ((NSR)), but also Aurizon Holdings ((AZJ)), Healthscope ((HSO)), Tabcorp ((TAH)), Vocus ((VOC)), Wesfarmers ((WES)), BWP Trust ((BWP)), Carsales ((CAR)), Downer EDI ((DOW)), and Woodside Petroleum ((WPL)).

Stocks that are believed to carry an elevated level of upside surprise risk include Village Roadshow ((VRL)) and Charter Hall Long Wale ((CLW)). JP Morgan's research also suggests Telstra ((TLS)) might finally surprise in a positive sense, as might LendLease ((LLC)), Qube ((QUB)), ERM Power ((EPW)), Credit Corp ((CCP)), Ramsay Health Care ((RHC)), Reliance Worldwide ((RWC)), Seek ((SEK)), and Super Retail ((SUL)).

On my own observation, earnings estimates are falling, not only in Australia, but around the world, which makes the upcoming reporting season in February doubly important as it should provide answers to questions such as have share prices fallen deeply enough, not enough, or way too far to more properly account for a more subdued outlook?

Within this context I note indiscriminate selling has pushed down share prices for companies that can be linked to falling sales for new automotive vehicles, both in Australia and abroad, as well as to discretionary consumer spending. As such, I believe investors have overlooked the resilience that should be embedded for companies such as Bapcor ((BAP)), ARB Corp ((ARB)), and GUD Holdings ((GUD)).

Carsales ((CAR)) might have a few niggles here and there in some of its marginal side-operations (such as car financing) but its core operations too should remain relatively resilient.

But as said, all should be revealed in February.

Paying subscribers should note you have exclusive access to a dedicated section on All-Weather Performers on the website. Data have been updated recently to show share price performances during the final four months of last year, and into January.

P.S. ResMed ((RMD)) and TechnologyOne ((TNE)) set new all-time highs this week.

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/

(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. 

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