Rudi's View | Apr 05 2023
This story features CANNINDAH RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: CAE
In this week's Weekly Insights:
-Don't Be Hoodwinked
-Consensus Targets, And Other Consequences
-Webinar on Copper
By Rudi Filapek-Vandyck, Editor
Don't Be Hoodwinked
It is easy to be flummoxed by financial markets. At times prices go down on good news, other times they rally on what looks like a negative impact.
Not making matters any easier: the way we, the humans observing these moves, interpret what is happening is mostly an extension of our own bias and predilection.
Hence, it's not difficult to identify the optimists in today's market. They'll tell you 2023 is poised for good news, because indices have refused to revisit the lows set last year. Inflation is coming down, albeit in a gradual manner, and central bankers are readying for a pause, followed by rate cuts later in the year.
Bitcoin and China are leading the rest of the world and financial markets. History shows the third year in the US presidential cycle is always a positive experience. Charlie Aitken at Bell Potter has already declared we are in the early stages of a fresh bull market.
That groaning you hear in the background is that of revered and well-respected investment experts a la Jeremy Grantham and John Hussman who keep warning global equities remain in an epic bubble. The Day of Reckoning, whenever it arrives, might well pull down markets by -50% (from today's level, not from last year's starting point).
Leaving the debate on today's asset prices aside, the most cited counter-argument by experts who do not share the bullish view at this point in time is that the true impact from more than 15 months of central bank tightening is yet to be felt in economies around the world.
The prime example of this in Australia is the so-called Mortgage Cliff that is only starting to genuinely gain traction this month (April). I was reminded recently that even on the RBA's own assessment, to date less than half (45%) of all RBA rate hikes put in place since early last year have been passed on by local banks to mortgage holders in Australia.
That RBA assessment includes both fixed interest and floating rates, though it is the first category that is usually referred to with the Mortgage Cliff term.
We can all speculate how much of an impact exactly this year's reset in mortgage costs will exert on household spending and housing markets, and there's always a chance things won't be as bad as one fears, but completely without impact it will not be.
As a cautious investor myself, it doesn't seem appropriate to make firm bullish calls on today's asset prices before we receive at least an early insight as to how this process is unfolding.
Admittedly, economic data to date can serve both bull and bear forecasters, and the long-anticipated slowing in economic activity certainly has remained a patience-testing experience.
But there are plenty of anecdotal insights suggesting the pressure on the economy locally is building, and cracks are starting to reveal themselves.
Yet equity markets, both locally and elsewhere, are rallying higher in what can easily be read as a message of 'the worst is over, let's move on'.
Markets are forward-looking, it's the most cited justification among today's optimists, but markets also live 'in the moment' which is why they move up and down on new input or the absence thereof.
Today's renewed upward momentum is not by default a positive assessment of what lays ahead for the remaining nine months of calendar year 2023. As a matter of fact, it makes a lot more sense when we look over our shoulder to what happened in March.
Signs of emerging banking stresses in the USA and in Europe have been quickly backstopped by governments and regulators, avoiding an all-out international fallout a la Lehman Bros back in late 2008. This is great news. Nobody wants a repeat of the GFC.
But very few sector experts are as naive to think there won't be any further consequences.
Similar to the aforementioned Mortgage Cliff, there are no concrete signals of what those consequences might look like, or when exactly they might show up, or where exactly. Markets don't have patience. If bad news is set to arrive in, say, three months' time, they'll deal with it then.
Right now, the threat of an imminent global banking crisis has been averted and thus it makes sense to price-out what was previously priced-in (i.e. to push share prices higher).
Life is never simply that straightforward, of course, and after seven consecutive weeks of falls, the lower starting point looks more attractive, on top of positive readings of 'technicals'. The way our human brains are wired, rising share prices improve our mood and act as an invitation to join in.
Plus there's always more in positives to look forward to… like a forthcoming pause in central bank tightening, or the fall in bond yields, or the prospect of possible rate cuts later in the year, or in 2024.
Similar to the example of last month's emerging banking crisis, these oft-cited 'positives' are only positives in the short term.
A pause in central bank tightening won't stop the lagged impact from all those rate hikes up until now. Falling bond yields are a reflection of bond investors' conviction an economic recession is coming. Central bankers won't be cutting rates until things become dire first.
I think one obvious mistake to make today is to assume the likes of Charlie Aitken are correct simply because share prices are moving up. Remember the (misplaced) general euphoria in January?
None of the above means today's optimists cannot be proven right later in the year, but surrendering to their view very much feels like a gamble right now that is guided by the wrong interpretation of what is actually happening, and why.
Banks & Historical Precedents
My interpretation of recent events has been corroborated by research conducted by analysts at Canaccord Genuity into historical precedents and typical market behaviour.
On their analysis, every time banks sell off on signs of a fresh crisis, this then triggers a broader market rally from oversold levels on general relief the worst case outcome has been avoided.
On some occasions both the drop and the relief rally can be extremely violent (20%-plus). In all cases since 1998, which nowadays is referred to as the LTCM crisis, that subsequent relief rally proved misguided.
Because the worst outcome looked unlikely on each occasion, but the crisis itself was not yet over.
Canaccord Genuity's research identified 1998, 2002 (post dotcom bust), the GFC in 2008, the European debt crisis in 2011 and the global pandemic in 2020.
In each case, report the analysts, a drop in the banks led to a relief rally that did not create a sustainable rise in the broader market, only a knee-jerk response to a temporarily oversold situation.
"We believe such sharp BKX weakness [index representing US banks] leads to an initial oversold bounce in the hopes the crisis is past, while the move back to the low is the realization it may not be due to less availability of money and its negative impact on economic growth outlook."
In today's context, any impartial assessment would consider the risks for an economic recession in the US have grown on the back of already tight lending standards that have simply become tighter as regional lenders in the US focus on liquidity, their balance sheets and on staying in business.
Canaccord research also shows the S&P500 has, post-1957, never made "the low" before the economic recession was actually in place.
A Pivot Is Positive?
In similar vein, speculators salivating over a Fed pivot later in the year might equally be singing from the wrong hymn sheet.
History suggests the reason as to why the Federal Reserve starts cutting the cash rate is the negative that pulls down equity markets after the first rate cut.
The graphic below was published late last year by Elliott Wave International.
It's not the first rate cut that historically rings the bell to announce the next bull market for equities, it's the final rate cut instead.
Imminent Test For US Forecasts
It's always an open question how far exactly the current relief bounce might take share prices and indices.
If there is a temporary Risk On move, this might provide the more active, cautious investors with an opportunity to reduce exposure to more speculative and cyclical parts of the market (if there is any exposure) and instead strengthen exposure to solid defensives and high quality growth companies.
At some stage, whether it'll be fast, severe, slow or mild, but share markets will pay attention and succumb to deteriorating momentum, suggesting the oft anticipated recession is (finally) approaching. At this point, however, the exact timing remains uncertain.
It won't be long before eyes turn to US corporate profits and margins with the next quarterly results season less than two weeks away.
In the run-up, analysts are still cutting forecasts. But the more important data to pay attention to is what happens to projections for the quarters ahead.
As things stand right now, economists believe the US economy will trough in Q3 (calendar year) and start improving again in the final months of this year. Forecasts for corporate America are suggesting the trough in earnings will have occurred in Q1, ahead of the US economic trajectory.
That latter assumption is about to be put to the test.
If somehow the US economy manages to avoid recession this year, it would imply all the traditional indicators that usually point towards it, have been wrong.
Always possible, of course, but is it probable?
In reference to that third year in the US presidential cycle, a recent historical study has clarified most gains supporting that thesis occur in the first few months, not later on.
This suggests those gains have been made between October and January already.
(Details do matter).
Plus Conviction Calls and Best Ideas:
Consensus Targets, And Other Consequences
FNArena recently made the decision to no longer include Credit Suisse in its core stockbroker coverage of the Australian stock exchange.
Instead we now include Bell Potter and Shaw and Partners, which previously only featured via the Broker Call *Extra* updates.
These changes have noticeable impact on everything we do. From updating the daily Australian Broker Call Report to the calculation of consensus forecasts and targets, and other tools and services on the website.
For example, post these changes, the total percentage of Buy ratings has jumped above 58%, with 33% on Hold/Neutral and only 8% on Sell. One look at the "Broker Recommendation Breakup" below highlights the 'why'.
Retail investor-focused local stockbrokerages by definition carry a larger skew towards Buy-ratings. It's not different at Morgans or Ord Minnett.
Another change that is having a large impact is Ord Minnett's decision to swap JP Morgan research for Morningstar as the latter uses mostly a more conservative valuation than the others.
If one looks up the three largest companies on the ASX via Stock Analysis, Morningstar has the lowest or the second-lowest valuation for each, which depresses the consensus price target as a higher input (JP Morgan) has been replaced with a lower one.
For BHP, CBA and CSL the impact remains benign. For some of the smaller companies the target with or without Morningstar (Ord Minnett) can be quite significant, as does the inclusion of Bell Potter and Shaw for some of the smaller companies. More voices sometimes means greater diversion.
So what to make of all of this?
FNArena does not simply offer consensus targets and forecasts. We also provide the details behind the calculations we publish on our website and inside our graphics and stories.
This means anyone who likes to use these pieces of information and input can do so with a degree of intelligence and flexibility.
Don't like the fact a certain broker doesn't want to join the others with a higher/lower valuation? You can always exclude them and make up your own assessment. The info is there.
Webinar on Copper
On April 19, 4pm, Peak Asset Management & FNArena are hosting a webinar on copper's role in achieving the world's zero carbon ambition.
Registrations via https://us02web.zoom.us/webinar/register/WN_O-lXPaubSyCp70dPVbprzQ
(This story was written on Monday, 3rd April, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday 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: contact us via the direct messaging system on the website).
A paid subscription to FNArena comes with numerous bonus publications and data on more than 1200 ASX-listed companies. Subscriptions cost $480 for 12 months and $265 for 6 months and can be tax deductible (ask your accountant about it).