Lose The Losers, Back The Winners

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Dear time-poor reader: irrational herd behaviour is dominating the share market. Below is the best strategy to deal with it (late 2018 revisited)

Lose The Losers, Back The Winners

By Rudi Filapek-Vandyck, Editor FNArena

Right now, the main thing to fear is fear itself.

Those among you who have a knack for history will recognise the implicit reference to Franklin D Roosevelt's first inauguration speech as the 32nd President of the United States, delivered on Saturday March 4, 1933. There was no facebook at the time, and no twitter, but otherwise the basic ingredients remain the same.

For financial markets, the question has quickly shifted from "should we be worried about this?" to "How long should we worry, and how many bad things might happen in the meantime?"

Never before has the ASX200 fallen from its all-time record high in a comparable magnitude in such a short time. We all collectively blinked and -10% had gone with the wind, and that's just the market average. Some stocks are down -30-40% in a flash.

At face value, this is all about a virus for which we don't have a cure and containing it from spreading into more countries seems almost wishful thinking. But if we pause and look at the facts and details for a few moments, we might realise we are talking about something that is a little stronger than the seasonal flu, does not attack small children and has a low mortality rate, even among the most vulnerable; elderly with a pre-existing condition.

But you wouldn't know it by reading media stories about shoppers hoarding non-perishable essentials as if WW III is but a few weeks away. On Friday, an Italian waiter in close contact with his family back home informed me people in the streets of Italy are physically attacking others of Chinese appearance. This includes Italians from Chinese origin who've never visited China.

Investment experts like to point at computer programmed algorithms or the rapidly increased market share of passive instruments like ETFs when share markets go through rapid turmoil like we are experiencing, but I tend to simply think "humans". This is what we do best. We cannot see any danger for downside near the peak, and we cannot help but feel that the world is about to end when share prices keep falling.

It is upsetting. Too much to bear for most.

Another anecdote from the week past: someone jumps in an Uber and is asked by the driver if it's ok to park the car briefly near the side of the road. The explanation? Share markets are falling. Need to sell my shares.

Because of all the biases, it is difficult to get a good grip on what is happening and what should be our most appropriate response. To those who had been complaining (in some cases for years) about how expensive asset values had become, this is the Day of Reckoning. I've already noticed some have started talking next bear market.

Others are proud they are sitting 100% in cash.

There is also a large group who likes to point out the current cycle has a lot more left, still, and thus cheaper shares are offering better opportunities to get on board.

I have been surprised by how quickly the mood darkened and self-perpetuated into a downward spiral. Now economists are talking coordinated stimulus from the world's central bankers. On Monday, National Australia Bank revised its forecasts to two RBA rate cuts in response to the coronavirus-inspired turmoil.

One cut on Tuesday and again in April will take the official cash rate to the central bank's self-imposed floor of 0.25%. The next step will include Quantitative Easing (QE); pumping liquidity in the system though additional credit for banks, and through buying of bonds, corporate credit, and mortgage-backed securities. Economists at UBS already reported recent movements in Australian bonds are implicitly suggesting QE is coming.

To think that long term US bond yields sank to new all-time lows last week, while three-quarters of the commentariat, globally, was calling for an end to the bond bull market three years ago is, simply put, astonishing. If ever anyone wanted evidence that financial market forecasters are no better than the worst weather expert, simply look up bonds, yields, and forecasts. Make sure you have lots of nibbles and alcohol in the fridge.

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My own view is that it is too early to start preparing for the next bear market. As such I believe the broad, indiscriminate share market selling behind the global headlines is offering level-headed investors a great opportunity to re-calibrate their portfolios. For those who like to jump on and off targeted equities, the focus will most likely shift towards stocks that have been absolutely trashed, as these will -at some point- offer the highest recovery potential.

But for those who like to think of themselves as an investor with a long-term horizon, the best opportunities are unlikely to be among the heaviest falls. On the contrary, the best opportunities might be in stocks that offer less risk and robust, higher quality growth, that possibly have fallen less than others. Stocks you always wanted to own, but never offered a genuine pull-back opportunity.

This now is your chance to strengthen and de-risk the portfolio.

Back in October 2018 I wrote a story titled "Out With The Garbage", which essentially outlined the same strategy. If one is not carrying enough cash to jump on newly created opportunities, the logical step is to sell out of misfits, disappointments, and everything that hasn't lived up to expectations. I would even argue, you do this anyway, irrespective of what is available in cash.

You'll thank yourself for it in a while from now.

Here is a direct link to the story from October 2018: https://www.fnarena.com/index.php/2018/10/17/out-with-the-garbage/

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For Australian investors, the timing of this sell-off could have hardly been more beneficial. Most listed companies released financial reports in February and their share prices sold down regardless. This now offers the unique opportunity to buy into strong and healthy performers whose share price would otherwise have risen a lot higher.

For good measure: the February reporting season was not a good one. On FNArena's preliminary assessment, some 30% of reporters beat expectations versus 26% disappointing, which at face value is not out of whack with most seasons from the past, but underneath the bonnet, hiding in the finer details, there is a lot of bad news on top of disappointing trends to consider.

For example, contrary to some of the more positive expectations pre-February, EPS forecasts on average have taken yet another step down, to circa 2% growth. With covid-19 weighing on corporate outlooks, it's probable that by August there won't be any average growth left for the ASX200. That'll be the second year in succession. Dividends on average disappointed  in February, and for once large resources companies were part of the general disappointment.

For the first time FNArena has split its assessment for the ASX50, the top200 and all of the 300-plus reporters under coverage. Now consider that for the ASX50, total "misses" outnumbered "beats" 14 against 11. For the ASX200 the outcome was not different: 47 misses against 43 beats.

On Monday, analysts at Goldman Sachs labeled February "the weakest earnings season since the GFC, with further downgrades to come". Before February, Goldman Sachs had declared August last year the weakest post-GFC. Corporate Australia is not in good nick.

The key question investors have to consider is whether it is better to stick with companies that showed weakness and disappointment in February, in the hope they might get it right by August, or whether it is time to increase the overall quality level, with reduced risk?

You already know my answer to that question. The FNArena-Vested Equities All-Weather Model Portfolio in February waved goodbye to Link Administration ((LNK)) and Nearmap ((NEA)) and instead we added Pro Medicus ((PME)) while topping up on stocks we like to own more of, including Altium ((ALU)), Atlas Arteria ((ALX)), Goodman Group ((GMG)), Macquarie Group ((MQG)), ResMed ((RMD)) and Xero ((XRO)).

We will continue to monitor further developments, and make adjustments accordingly.

In the meantime, there are a few particular groups of stocks investors might want to focus on post February; those who are simply better-than-the-rest and those who might be staging a successful come-back. I'll write a proper reporting season assessment by early next week, but scanning through 300-plus corporate assessments from February has generated the following three baskets of stocks:

Basket: Simply Better-Than-Most
Companies whose history of performances makes one jealous, but only if they are not in your portfolio. High quality, robust performers with a long history include a2 Milk ((A2M)), Accent Group ((AX1)), Breville Group ((BRG)), Charter Hall ((CHC)), CSL ((CSL)), IDP Education ((IEL)), JB Hi-Fi ((JBH)), Goodman Group, and ResMed.

Basket: Tomorrow Is Looking Better
Companies whose performances in February have fueled expectations for better times ahead, including Cleanaway Waste Management ((CWY)), Freedom Foods ((FNP)), InfoMedia ((IFM)), Integral Diagnostics ((IDX)), James Hardie ((JHX)), Nick Scali ((NCK)), Pinnacle Investment ((PNI)), and Super Retail ((SUL)).

Basket: Tomorrow's Future With Less Risk
The February reporting season has marked the end of the easy trend for technology stocks that offer the promise of new innovative business models and old economy disruption. Companies that are increasingly distinguishing themselves in a positive manner include Afterpay ((APT)), Altium, Appen ((APX)), Bravura Solutions ((BVS)), Data#3 ((DTL)), and NextDC ((NXT)).

Other companies that stood out in their own specific way: Adairs ((ADH)), AUB Group ((AUB)), Austal ((ASB)), Australian Finance Group ((AFG)), City Chic ((CCX)), CommBank ((CBA)), Fineos Corp ((FCL)), Magellan Financial Group ((MFG)), and People Infrastructure ((PPE)).

No doubt, there is more to be learned from the past four weeks of corporate reporting, which is why the FNArena Corporate Results Monitor can be quite the valuable asset: https://www.fnarena.com/index.php/reporting_season/

(This story was written on Monday 3rd March, 2020. It was published on the day in the form of an email to paying subscribers, 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?)
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