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Rudi Interviewed: 2021 Dynamics Are Different

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 | Aug 13 2021

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FNArena Editor Rudi Filapek-Vandyck was recently interviewed by LiveWire Markets’ James Marlay about what to expect from the August reporting season in Australia.

The video of the interview, including a transcript, was published under the heading ‘Rudi: It’s the healthiest bull market we’ve seen in years’ (link at bottom of this story).

Below is an edited version of that transcript, correcting spoken grammar and misheard expressions for more to-the-point and easier reading.

James Marlay:

Rudi, last time we spoke in February, you said we were entering a new bull market and value is back. Since that time, the All Ords has rallied about 11% which is a good return. My opening question to you is: do you think the bull market is healthy and where will the leadership come from if we're to continue to see a bull market from here?

Rudi Filapek-Vandyck:

As per always, there's a context to things. Conclusion number one is financial markets never ask where you came from. They ask where you're going.

Despite all the bad news that we had last year of the covid pandemic, profit forecasts falling off the cliff, dividends being cut, capital raisings being necessary, et cetera, the truth of the matter is we've had an incredibly quick recovery in economies, we don't have to go too much into detail, but this has fueled an incredibly quick recovery in profits and in dividends for corporate Australia.

It also has created a completely new dynamic for corporate Australia. While we [here at FNArena] look at reporting season and corporate results, it's incredibly visible in how those corporate results compare towards market expectations, and that there's a completely new dynamic in corporate Australia.

Probably the easiest way to illustrate this is: August and late 2019 was probably the worst time for corporate Australia in all the years that I've been in Australia, which is more than two decades.

And according to some analysts that have data that go back to the 1980s, those 2019 data were worse than the 1980s.

That's even before the pandemic appeared. What we saw back then was companies not being able to meet even relatively low expectations. We all forget this, but the banks started cutting their dividends back then, as did energy companies and some other cyclicals.

Then the pandemic came along and, of course, everything falls off a cliff. But that experience now and the subsequent recovery, and the fact that companies have used that experience to strengthen their balance sheet, to streamline the operations, et cetera, has now created a completely different dynamic.

Now what we're seeing is that profit growth is surprising to the upside. You won't see it if you just look at the share price or the index, but forecasts in Australia are now rising for 11 months uninterrupted. That almost never happens.

This has created a completely new dynamic. Dividends in Australia are recovering at a speed which is probably never witnessed, Australia is the number one in the world now in terms of recovery in dividends.

We're seeing all of that with the early indications. The banks have already announced they're going to conduct share buybacks. Those dividends are not quite back to where they were, but they are on their way.

We already had Rio Tinto ((RIO)) paying out probably as much cash as they ever have done in the history of the company, including a bonus dividend, with a promise of more to come in the second half.

I think one of the words we can use here is a Super Cycle in Dividends, which is right here happening in Australia at this point in time.

If you combine all of that, it should be no surprise that people like myself have now been talking about a new bull market that's started. That is if you assume that the old one stopped in late '19 or early '20, otherwise it's just a continuation of, but today’s phase is a much more profitable, much more enjoyable, much stronger upturn to be part of as an investor.

Because the older bull market was pretty much crawling through the mud and you really had to be careful in which stocks you had in your portfolio. That is still the case now, but I'm sure we'll get there with some of your other questions.

James Marlay:

Before we get into the nitty gritty, we will talk about dividends and earnings in a bit more detail. I just want to briefly touch on the backdrop which is the bond market.

When we spoke in February, we were seeing a peak, a rise in bond yields and effectively it's rolled off since then.

I guess I'd be interested in your take on that. Does this mean the value trade that we saw ignited by inflation expectations is now over?

Rudi Filapek-Vandyck:

Again, context, very important, but just before I forget to mention this later in the interview, I do believe that the value trade needs the bond market to ignite it and to support it.

And that gives you already the answer of why the value trade has basically deflated from about late March.

No doubt about it, the bond market has pretty much surprised just about everyone and that includes myself. Did I expect the bond market would go to 2% and just continue going up? No, definitely not.

But I also did not expect it would go back this close to 1% again. We can all have lively discussions about what's happened in the bond market. I actually think there's probably a lot of sense to it.

One of the reasons, I believe, is the relativity between bonds in Europe and bonds elsewhere.

I think this also touches upon a new concept for investors, for most investors are trained to judge and to calculate a valuation for assets on their own, while in the modern-day environment, we have to make assessments on a relative basis.

In the share market, this shows up, for example, between Commonwealth Bank ((CBA)) and the other banks, or between Afterpay ((APT)) and the competition.

In the bond market, the same relative comparison applies. It's about having to make a relative call between low yields in the US, still positive, and low yields in Europe, which are turning even lower.

I think that's one of the reasons why the bond market has gone where it has gone, and it has had a massive impact on equities.

I've never been a believer in that we are entering a new era of the value trade. I do believe we'll go through periods when the value trade is everything that happens in the share market, and then it disappears again.

We've seen so far that every time the value trade becomes popular, it lasts about 4-5 months and then it, sort of, peters out. So far, that's basically the maximum the value trade has been able to achieve.

James Marlay:

Rudi, I'm going to dive into your reporting season themes. You've touched on a couple of them already.

Two of the ones that you've touched on are surging corporate profits and dividends. I'm going to start with one that we haven't touched on so far, which is rising costs, and pressures.

Could you talk me through why that's something that you think is interesting to watch? And maybe call out where you think it is most likely to pop up?

Rudi Filapek-Vandyck:

This bull market is very, very strong. Has been very, very strong, but it doesn't make people comfortable. You see this on many metrics, and in the data that we collect at FNArena.

People always worry that the share market has gone too far. But what we see with the data that we watch -for example the difference between share prices and price targets, the difference between buy, hold, and sell ratings in the market- is this market is very reluctant in pricing in the maximum.

There are a lot of question marks around this market, so we've now had the V-shaped recovery; very strong, but we're very hesitant because we don't know what's coming beyond 2021.

And you see that on many, many levels. One of the reasons, I believe, is because we have transitory inflation. Central bankers talk about it all the time, there's a whole discussion about it in the background happening.

What is transitory inflation? Is that the one that sticks around, or is that the one that goes up once and then stays there? Central bankers say it's the second; it means we're not going to see 2% inflation increases year upon year in the years ahead.

Central bankers see it as transitory, and for that reason bond yields can stay low. They don't have to act and the share market, all else being equal, should do quite well.

However, if you have a rise in prices which are essentially input prices, like commodities and rent and other elements; companies are consumers of those commodities and they are paying rent, et cetera.

One of the reasons I believe why the share market in a broad sense has been very reluctant in continuing to price in and continuing to forecast that those strong recoveries will simply continue, is because the sales level might go up, but corporate margins might come under pressure.

Inflation has to go somewhere.

Traditionally, one of the most profitable investments in the share market is when a company enjoys rising margins – because profit and growth accelerate.

But the opposite happens when margins come under pressure. The obvious questions the share market is asking are directed at industrial companies. The likes of Amcor ((AMC)), Ansell ((ANN)), Orora ((ORA)), you name it, they all have to buy in commodities and then make a product out of it.

But investors should not automatically assume that the producers of commodities are immune. We will see price pressure equally for the likes of Fortescue Metals ((FMG)), BHP Group ((BHP)), Incitec Pivot ((IPL)), Orica ((ORI)), you name it.

Ultimately, it's universal. Where you will see it less happening is in typical IT companies, services companies, software companies. They don't have to buy in oil, for example.

This is one of the question marks that hangs over this reporting season, and investors will be watching this very, very closely. It's not that companies can't buy in product at a higher price; they have to be able to pass it on.

Again, this takes us to quality companies, that are market leaders in their sector, and that have an ability to pass on price increases. If they have none of those three characteristics, they might end up in trouble at some point, and investors will be on the lookout for this.

James Marlay:

You've touched on the strength of earnings. I guess just in terms of the dividends, you've touched on the headline dividend payers, banks, the miners, which are spinning out a lot of cash at the moment.

Are there any areas where you think people might not be fully anticipating the dividends that are about to come out? Are there any under the radar dividend opportunities?

Rudi Filapek-Vandyck:

Most companies are increasing their dividends.

Some companies are selling assets, and have already, sort of, indicated they're going to pass on at least half of it or more to shareholders.

You have to think about the likes of Telstra ((TLS)), Insurance Australia Group ((IAG)), Iress ((IRE)), Commonwealth Bank, BHP too, probably.

We have Ampol ((ALD)), formerly known as Caltex Australia. We even have some REITs that are selling assets. Waypoint REIT ((WPR)), for example.

The term super cycle dividends is not easily applied here, but it will apply. It's almost a once in a lifetime experience that we have in 2021.

Of course, this is not going to be repeating in every subsequent year. But this can potentially still get a repeat in February next year.

This started in February. It's going to continue now in August and there will be a lot of cash coming into investors’ coffers.

James Marlay:

This is your opportunity to draw on the database that FNArena puts together, which tracks the beats and misses of corporate earnings and I know you've just done a bit of an update on those companies that reported between February and where we are now.

I guess the question is: are expectations likely to be exceeded on average this reporting season? What's your assessment of the temperature? Do you think investors are likely to be surprised?

Rudi Filapek-Vandyck:

What we've seen over the past 6-9 months or so is that the numbers are absolutely ‘blown out of the park’-numbers.

We usually don't see in Australia the same numbers as we see in the United States, where business leaders are very well trained to make sure they beat market expectations. This second quarter, for example, the number of companies in the United States that have beat expectations is close to 90%.

We never see those numbers in Australia, absolutely never. I've been doing this for 20 years. Australia is lucky if ‘beats’ reach 40% or so.

What we've seen is that, usually, on average, we have about 33%, 34%, 35%, maybe 37% of companies beating expectations in reporting season.

In the last reporting season, which we just closed off on, the percentage was 55%. Now, that gives you an idea about how much that number is above average.

What can we expect for August? We now are in the 11th month of rising forecasts and the question thus becomes: will we see a reversal from February?

The February reporting season was fantastic, but expectations were much lower. Today expectations are quite high.

We are all expecting a big announcement from BHP. We will not be happy if Telstra doesn't do something special.

One indication that maybe has gone unnoticed this time around is that usually when we have a reporting season, what comes first is the "confession season".

I remember in 2019 and 2018, confession season; that was something you would be a little bit afraid of. You would almost hope you were not in the market the month before reporting season, because share price could tank by -30% or more.

I think the best indication today is: have you noticed any confession season? I haven't. February didn't have one either.

So, I think the fact that the confession season has pretty much gone quiet, maybe that in itself is a very strong indicator of what we should expect from August.

Maybe this August season is too early yet to see a reversal in the strong uptrend. It doesn't mean we can't see it happening in six months' time, but maybe now it's too early yet.

I'm not expecting that we are going to have a results season that generates 55% in beats again. But I'm thinking it might still be higher than average.

The lack of confession season indicates we might still be in for a very positive experience in August, overall.

James Marlay:

Very interesting observation. Now Rudi, this is your time to shine. You are the manager of the All-Weather Portfolio.

You don't need to go through each of them, but I thought I'd ask you to bring along a couple of stocks that you're going to be watching closely in reporting season.

And maybe pick a few that you think could surprise on the upside and a couple that might surprise on the downside.

Rudi Filapek-Vandyck:

On the downside; there’s always the left field one, isn't there?

There's one thing I want to throw in first, to illustrate the magnitude of what's happening this year. If you look at the six months announcement from Rio Tinto, they paid out more in six months than they did last year, and the year before, over 12 months.

Actually, you can combine those two years together and Rio Tinto will still pay out more dividends this year.

The yield on the Rio Tinto dividend is more than 5% over six months. BHP is going to pay out something like three and a half, four percent, over six months. You're going to get that from the banks after 12 months. These companies are paying that out over six months.

This provides us with an idea of the magnitude of what's coming towards Australian investors. Of course, it's not sustainable. One of the reasons why it's happening now is because nobody believes it's sustainable. That's why the share price is where it is.

Coming back to the reporting season itself, as people would know, I'm not the kind of guy who looks for beaten down stocks that are forgotten by everyone and that I can buy and hold for six months in the hope that someone else comes along and gives me a big price for it.

I happen to concentrate on what I believe are high quality companies. There are some fast growers in there. I recently noticed quite a number of the stocks I own are near or at an all-time high, which shows you they've obviously done well.

Those companies in particular have my attention. The likes of a ResMed ((RMD)) and REA Group ((REA)), because I need to remain confident those companies can continue performing.

There is also Pro Medicus ((PME)), which I still believe is one of the prime growth stories on the Australian Stock Exchange. I recently sold it because the share price was very close to $60 and I thought you probably can't justify that. That's just too high.

With pain in my heart, I sold my shares. I remain on the lookout for a company like Pro Medicus, and if I would have one wish for this year, I would say, well, hopefully Pro Medicus comes out and people get a big scare and they sell off the share price, and then I can become a shareholder again.

There are companies at the smaller end that have my attention that could potentially become something like a Pro Medicus in the years to come. One of those, I believe, is Audinate Group ((AD8)).

I also owned that one. I've done really, really well out of it. But out of portfolio management, I no longer own that stock, but I will still be watching it.

Audinate Group is a stock that could potentially do very, very well in years to come, but it is a small-cap stock, it's not profitable yet, and bond yields will have a big impact, if bond yields move higher at some stage.

This is probably equally important. We spoke earlier about bonds. What we saw in November last year was a very strong switch between value and growth, and growth stocks were sold off quite heavily while value was bought heavily.

I think for the second half, the chances are we might witness a similar repeat of that experience, for the simple reason that the whole value trade has deflated so much, and bond yields are so important for that trade.

Investors should be mindful of the fact that it's not all about corporate results and dividends. Post August, the bond market can have a big say again, and then stocks like a Pro Medicus, or an Audinate, or an REA, who've all benefited from bond yields going the opposite direction, they might get punished very harshly if the bond market decides to push up yields again. There are quite a few people that expect this to happen.

Paying attention to companies in reporting season; it's not just about the individual cases. You have to do it from a portfolio perspective. And in 2021, there's no better advice than to have a diversified portfolio so that if bond yields move, it doesn’t mean your whole portfolio gets squashed, because you're on the wrong side of the trade.

Other than that, I actually own only few stocks that are a bit of a market laggard.

If I had to nominate two of them, I would nominate Amcor and I would nominate NextDC ((NXT)).

I think it's up to NextDC again to prove the doubters wrong, and there are a lot of doubters out there.

Amcor, it's a bit of a strange animal. It gets thrown in with the growth companies when bond yields move and that's a bit strange, of course.

I remain a big Amcor fan. I believe it's defensive growth at very high quality and dependability and predictability is something you do want to have in your portfolio. Especially when the tough times arrive, plus it's a nice dividend. No franking, though.

James Marlay:

Final point, Rudi. I did happen to go and have a look at the CSL ((CSL)) share price before our call, because I know it's a bellwether stock and something that you've followed for a long time.

It quietly crept its way from the $250 level up towards $300. Give us a quick view on CSL.

Rudi Filapek-Vandyck:

Well, luckily you mention CSL, I didn't want to because people think I always talk about CSL.

Essentially, the share price is moving sideways. It's at $293 or $292, or whatever. It has been above $300.

CSL is one of Australia’s high-quality companies, but its business has been impacted by covid, and by bad policies in the US.

That is still the case and the market will want to see some indications: when is that going to be resolved?

I see CSL as in a sideways pattern, but I still own it. It's still one of my largest holdings and I'm not too unhappy about things.

The share price would have been clobbered if something similar would have happened to one of the lesser quality companies. I think sometimes people just have to be patient and I think in this case, one shouldn't expect miracles.

It's very telling as well, that when analysts have to nominate their potential risks and surprises for the upcoming season, that CSL is mentioned on both sides.

A few other companies are like that. Lendlease is. I think Lendlease is no longer quality, by the way. Seek ((SEK)) is mentioned in the same manner.

We'll have to see what reporting season brings, but it's funny that people will mention those companies with conviction, like, "Oh, they're going to disappoint" and other people go, "No, no, I can see potential for an upside surprise" and that's interesting.

In general terms, when people nominate potential disappointers for the reporting season, they usually are proven wrong because companies that do have to announce bad news, they often can mix it with positive news.

Like, "We throw in an extra dividend" or, "We're going to restructure. We're going to lay off people."

In the past, we had perennial disappointers. QBE Insurance ((QBE)), for example, and Telstra which always disappointed.

I actually think both now are probably going to surprise to the upside, and that too gives us an indication that the dynamics in Australia really are different from the past.


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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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