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Rudi’s View: Investing In 2021 – The World Upside Down

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Mar 25 2021

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

In this week's Weekly Insights:

-Banks: Bonds & Yields Versus Targets & Valuations
-Investing In 2021: The World Upside Down
-Pharma & Biotechs in February
-FNArena Talks
-Conviction Calls

By Rudi Filapek-Vandyck, Editor FNArena

Banks: Bonds & Yields Versus Targets & Valuations

My update on Australian banks last week elicited a few questions from subscribers which can be split in two:

-why are banks back in favour when their businesses haven't genuinely changed much?
-are banks truly 'expensive', even if we ignore the fact that analysts' price targets can move higher later in the year?

My combined responses to these questions:

It does make a humongous difference whether banks are facing a recessionary environment or, as is the case in 2021, the tailwinds of an economic recovery.

In addition, the pricing of the bond market makes it infinitely easier for banks to lift their profit margin on loans. Specifically, when short-dated bond yields are near zero and longer-dated bonds are rising, approaching 2%, this makes making money from lending money a lot easier than when everything is priced within a narrow range.

Not surprisingly, rising bond yields have triggered a repricing of equities. Banks, previously "cheaply" priced being local and international share market laggards, have thus benefited from a re-rating. History shows cyclicals, including banks, enjoy their moment in the sun when the economic recession is in the rearview mirror.

This is because share markets are always forward looking. They don't care where profits and dividends come from (low base?) but focus solely on where both are heading. Markets also do not necessarily care about what comes next. Though it would appear the sector locally can now potentially look forward to 2-3 years of unexpected buoyancy after 5.5 years of (mostly) hardship.

It is the latter prospect that currently feeds into forecasts of higher dividends, plus extras, for the years ahead. Admittedly, if banks do not use this period to restructure and re-align with the many challenges that lay ahead, as I am sure many companies are not, then they will be facing the same quagmire all over again in a few years' time.

Thus far, however, one can only conclude banks in Australia are trying to reinvent themselves to stay relevant in the New Age of disruption and technology. Witness how they are all selling off low yielding operations (asset management, insurance, etc) while investing in areas such as BNPL, while also seeking out younger and more flexible partners in business.

On top of all of the above comes the sharp difference in property market dynamics throughout Australia today, which cannot be underestimated in terms of how beneficial this is for the banks (and other parts of the Australian economy).

Inside a general context of rising bond yields and -potentially- an environment of higher inflation, it makes perfect sense for Australian banks to regain favour with investors. Financial reports and quarterly updates from the sector in February have vindicated the market's newfound obsession.

With so many SMSFs and retirees continuing on the lookout for yield and income, it must also be noted forward dividend yields are again approaching 5% (4.5% for Commbank ((CBA)); this remains attractive for many.

But, as per always, banks are not without risk. Any interruption or slowing down in the economic healing process will weigh down share prices. And, of course, banks are still being penalised for breaching laws and all kinds of malpractices, while local authorities are no doubt working towards taming the animal spirits that currently push up house prices throughout Australia.

When it comes to putting a "valuation" on the sector…

While forward looking price-earnings ratios (PEs) might occasionally prove too optimistic, in particular at negative turning points, backward looking PEs don't tell you anything about the future.

Pick your poison.

In the current context in which banking operations are recovering from last year's short though deep recession, I'd easily say last year's PEs are next to useless. You wouldn't calculate dividend yield from last year's payout, so why do it for EPS growth?

As I always try to emphasise: context is important.

Historically, a sector PE range of between 9x and 15x has long been a reliable guide, with 9x the bottom during recessions and bear markets and 15x the top during the boom years.

Boom years usually see PE ratios between 13-15x. Bear markets are characterised by 9-11x. This places the long term average at around 12.5x with the added observation that banks very, very seldom trade on the long term average PE.

Firstly, to avoid all miscommunication, these PEs are forward looking, not backwards. In the current set-up, three of the Big Four are trading within the historical range while CommBank, traditionally at a sector premium, is trading outside of the range.

An important factor to add here is the PE range does not account for the relative yield the sector offers compared with REITs, other yield providers, and bond market yields. Forward looking, three banks are back on implied dividends of 5%-ish (plus franking) while the market average is circa 4.5%, with CommBank shares trading around the average.

These yields, however, do not account for the additional cash that will probably flow into shareholders coffers in the two years forthcoming.

I think the above suggests that on ex-yield measurement, banks look fairly fully valued. In line with this assessment, bank share prices have been retreating for the past week or so. Measured by the yield, however, it can be argued banks are merely fairly valued, but certainly not overly expensive looking.

My market sentiment indicator (see last week's Weekly Insights) is based upon share prices versus price targets, which in essence measures bank share prices with where sector analysts believe they should be in 6-12 months from today. On this basis, share prices seem due for a pause, at the very least, and this too feeds into the retreat in prices we are witnessing.

I do think banks have the ability to report strong financials during the upcoming bank sector reporting season, which might lead to increased valuations and thus higher price targets, maybe even higher dividend forecasts. The latter, however, is still multiple weeks away, and in the meantime market sentiment is all about economic data and bond market movements.

One additional consideration is that inside the traditional 9-15x PE range it was usually the case that CommBank, the sector leader, would reach the top of the range, maybe slightly exceed it, with the others following at a distance. In the current context, two of the three other major banks are near the top of the PE range, while CommBank shares are trading well outside of the range.

This in itself suggests a higher sector valuation than traditionally has been the case, which also translates into fuller rather than fairer valuations for local bank shares. Share prices in general are trading on higher valuations during times of low bond yields and low inflation. At present, the banks are not an exception. Also note, share prices still are below the levels seen pre-covid. They are well off from the peak reached in April 2015.

In general terms, I would conclude banks seem well-priced in the short term, but they should be able to rise to higher share price levels over the medium term.

The importance of the above is dependent on one's horizon and specific strategy.

For more insights on the outlook for local banks, I strongly recommend:

Investing In 2021: The World Upside Down

Last week I presented to members of Gold Coast Retirees on how much market dynamics have changed for investors in 2021. We can all blame (or thank) the bond market for that.

Paying subscribers can access and download the Powerpoint slides I used via the SPECIAL REPORTS section on the website, which also includes the bonus reports that come with a paid subscription (6 or 12 months). A video recording is available via FNArena Talks (see also further below).

Below is a brief summation of the key topics I touched upon, with the occasional slide included.

One of the stand-out observations that preceded late last year's global recovery momentum switch in equities is that the relative valuation gap between Winners and Laggards had never been as wide as during the emergence of covid.

Pre-pandemic it had already become widespread public knowledge that investors had fallen in love with the New Economy growth stocks, which also included local healthcare stocks such as CSL, ResMed and Nanosonics, but when the covid bear market arrived that relative gap between loved and unloved parts of the market simply blew out further to a level probably never before witnessed in the history of share markets.

Data analysis by Morgan Stanley (see chart above) takes the gap between Value (Laggards) and Growth (popular Winners) to an extreme that puts the dotcom era of the late 1990s deep in the shade. This situation had to correct -sometime, somehow, somewhere- and markets found a trigger with the arrival of vaccines, foreboding the ability to revert back to "normal" (sort of), while bond markets soon followed as the logical back-up for market optimism about a better future ahead.

It is not too difficult to see why your typical value-investor gets extremely excited when looking at this type of research. Imagine the further potential for value-laggards to outperform were this gap to revert back to its historical equilibrium!

The offsetting, alternative view remains that economies will continue to transform over the decade(s) ahead and the current five-month long resurgence of cyclicals and many an old economy stock is simply a correction in a trend that had overstretched itself too far. Fact remains, the bond market is likely to decide for how long this trend-correction might last, potentially also how far this trend might correct.

But relying on the bond market is a two-edged sword: if bonds keep selling off, and thus yields continue to rise, this will eventually trigger a major correction for equities in general. Under such a scenario it may well be this relative gap closes further as banks and cyclicals weaken less than growth stocks trading on higher valuations, but that's not exactly considered an ideal scenario by most.

For good measure: bond yields can rise to higher levels, of course, and they've at times done exactly that, but it cannot happen at breakneck speed. As I always say: compare with crude oil markets. Too strong too fast triggers a recession, and the impact from a fast running bond market will be equally pronounced.

When it comes to picking Winners and Losers from rising bond yields, most research, backed up by historical data analysis, shows financials (not just banks) in various shapes and forms are the key Winners, as well as Energy companies. While the technology sector (again: in various variations) can be reliably identified as the prime loser.

Gold is a major loser too, though it is virtually never mentioned in this context (except, increasingly, this year), probably because history shows multiple drivers and it is not always easy to establish which driver outweighs others or loses its influence, temporarily or otherwise.

Comparing banks versus technology stocks over the past thirty or so years provides us with a rather fascinating insight; one that suggests by mid-last year market momentum had swung too far in favour of technology, but this situation has been corrected in a brutal and violent manner, with the momentum monitor below (compiled by Longview Economics) now suggesting momentum in favour of banks has, for the time being, swung too far.

Incidentally, the effects from the swing in market momentum out of last year's Winners has nowhere been as strong and pronounced as on the ASX. We can all create our own little narrative around why this is the case, but holding on to technology, staples and healthcare stocks has been multiple times more damaging than in overseas markets, including Emerging Markets.

Another intriguing observation is the large gap between central bank statements and policies and what bond markets are pricing in. There is no grey zone here. Either central banks will change course, or bonds must give up part of what has been gained over the past half year. My five cents is that bond markets are running ahead of themselves, and I am far from the only one with this view, but supply chains the world around have been disrupted and businesses cannot source sufficient materials to satisfy consumer demand.

Inflation is coming.

The global debate is not whether this is the case or not. It's about whether the coming spike in inflation will prove nothing but a temporary phenomenon, see supply chains and unexpected strong consumer demand, or whether we truly are experiencing the start of a new era in which inflation makes a come-back when governments and central banks are still stimulating economies.

Most of us are too young to remember what investing was like in the 1970s and the early 1980s. This, by no means, implies we should start treating the pre-Volcker years as the natural reference period for the years ahead. On contrary, the global economy has changed dramatically since then. Economics is not an exact science. We are still trying to understand why exactly inflation has been as low as it has been in years past. It remains possible, of course, inflation might make a come-back and it surprises us all, including financial markets and central bankers, but that's not a scenario most of us are pining for.

No, seriously, we most definitely are not.

Other identifiable dividers for the share market this year are the strong Aussie dollar, benefiting domestic oriented cyclicals rather than international success stories, and the prospect of re-opening borders which keeps a bid under travel and leisure-oriented franchises rather than covid-beneficiaries, including Fisher & Paykel Healthcare, Goodman Group, and Woolworths.

One straightforward reason as to why share price movements have been so erratic and unpredictable, even seemingly illogical in the first three months of calendar year 2021 is because all of the above mentioned influences do not necessarily move in tandem. On some days the AUD might weaken while bond yields strengthen. On other days a third wave is announced while the currency firms along with the price of oil.

One observation has remained intact and that is asset prices are far from cheaply priced. While history suggests this is what one should expect, given the broader context of low yields and low inflation, there is always at least a little bit of doubt in every investor's mind: what if this truly is a bubble, and we cannot see it because we're in the middle of it?

-Powerpoint slides: see Special Reports on the website
-Video: see FNArena Talks on the website

Pharma & Biotechs in February

With apologies for the delay as IIR's latest sector update was supposed to be included in last week's Weekly Insights. Instead, the full report can be downloaded this week:

FNArena Talks

As mentioned above, last week I presented views and insights about bonds, equity markets and investing to Gold Coast Retirees.

That presentation is now available to everyone with an appetite for circa 50 minutes of graphics and slides with the occasional quip in between:

Conviction Calls

Bond yields continue to focus on higher levels and in the share market this means investors will continue to favour Value over Growth, with an emphasis on companies that benefit from higher inflation.

Stockpickers at Wilsons have specifically crunched the numbers to find beneficiaries outside the ASX50, while also providing investors with one stern warning: avoid bad quality.

After adding in factors such as recent changes in market forecasts, analyst recommendations and short positions, Wilsons' short list of stocks to benefit from current market momentum includes Adairs ((ADH)), Champion Iron ((CIA)), Nick Scali ((NCK)), Sky City Entertainment ((SKC)), Super Retail ((SUL)), Pact Group ((PGH)), and oOh!media ((OML)).


While bond market volatility is disconcerting, the move up in (depressed) bond yields is a positive signal around economic growth, which is ultimately positive for markets, assures stockbroker Morgans.

Recent updates on Model Portfolios revealed a strong performance by Cleanaway Waste Management ((CWY)) has led to the Balanced Model Portfolio waving goodbye and instead loading up on Suncorp ((SUN)).

The Growth Model Portfolio, on the other hand, has sold out of Orica ((ORI)) following more disappointment from the company and instead decided to buy Hub24 ((HUB)) and more of ALS Ltd ((ALQ)).

(This story was written on Monday 22nd March, 2021. 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: 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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