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Rudi’s View: A Market Of Contradictions

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 | Nov 01 2023

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A Market Of Contradictions

By Rudi Filapek-Vandyck, Editor

This might seem contradictory, but it's simply part of the market being the market: from a technical analysis perspective, the outlook for equities is improving, at the same time as underlying fundamentals are revealing a number of red flags.

Let's start with the good news first.

The performance of the ASX200 in Australia is now negative for the running calendar year, including dividends paid out, and the index is below the level from which global markets bottomed in late 2022.

Over in the trend-leading USA, the S&P500 is now down more than -10% from the year's July peak, with market technical readings flashing equities are currently deep in oversold territory.

A number of technical market analysts are pointing out, whenever markets reached similar levels of being oversold in years past, a bounce, or call it a rally if you like, has always followed. While the exact timing can never be forecast, certainly not with war and bond yields front of mind, more weakness from here onwards will simply put readings below last year's level, and define markets as even more deeply oversold.

Viewed from a different angle, the S&P500 tends to have a -10% "correction" on average every 1.6 years, while 94% of calendar years experience at least one drawdown of at least -5%. The past 24 months have seen the S&P500 drop by at least -10% on four different occasions. The current downward-trending move is number four.

The previous three occasions saw the index retreat by respectively -13.05% over 64 days, -20.83% over 79 days and -16.91% over 57 days. While the current move has the index only down -10.20%, it started in July and is already 88 days old.

The duration rather than the move itself is what is feeding into renewed optimism. In particular since the annual seasonal pattern suggests most calendar years end with a positive move upwards, colloquially labeled the Santa rally.

On some forecasts, this year's end-of-year relief rally could be as powerful as +10%-12%. It sounds as just what the doctor ordered for local share market investors that haven't had a lot of long-lasting joy since the Fed and other central banks started tightening in early 2022.

The ASX200 closed off 2020 with a reading of 6587. Nearly 34 months later the index is trading at 6772.

Price Action Tells The (Other) Tale

Technical readings are, however, not universally positive. The breadth of market moves in the US is narrowing yet again and doubt is yet again creeping into analysts' and investors' minds about genuine growth prospects for US companies in the quarters ahead.

The most obvious signal of this happening comes through price action. While Q3 corporate results on Wall Street are still looking okay, at face value, share price responses have proved cautiously rewarding at best, but mostly sceptical or negative. Underneath the price action, earnings revisions are breaking down into negative territory.

And this time the Big End of the market is being affected too.

Australia doesn't share 100% similar dynamics, but the key characteristics don't seem too different. Analysts forecasts locally continue to slide further downwards, with the consensus FY24 EPS forecast now printing a negative -6% and the recovery in FY25 estimated a positive 5.8%. More forecasts are being downgraded than upgraded (still).

The one advantage the ASX can claim is its average PE ratio is currently below the long term average, albeit not by much (14.35x versus 14.50x). In the US, indices that do not revolve around the so-called Magnificent Seven can make similar claims, including the Russell 1000 and the equal-weighted S&P500.

But, as I explained in last week's edition, when measured against government bonds, share markets, irrespective of their underlying subtleties and polarisations, still look grossly overvalued, unless we see significant acceleration in earnings, or significantly lower bond yields.

It also looks like the RBA may not be done tightening just yet, while the Federal Reserve more likely is. This also creates more headwinds for the local ASX, all else remaining equal.

Story Of Rags And Riches

What should be of more concern, from a market fundamentals perspective, is national home prices in the US are up by some 40% from pre-covid levels with equity indices, led by a small minority of outperformers, up by circa 30%. Those are, within the circumstances, big numbers and they are key to understanding why economies in North America and in Australia have remained relatively resilient up to this point.

In simple terms: the rich and the wealthy have not wavered in their spending as most have seen their wealth, on paper or otherwise, increase further irrespective of inflation, central bank tightening and rising bond yields. Given economies in developed markets are made up more than 50% from consumer spending and the top quintile in the US is responsible for 45% of all spending domestically, the importance of spending by society's top echelon speaks for itself.

One of the reasons as to why the GFC turned into the economic quagmire it became is because both equities and property markets temporarily fell into the abyss, which led to white collar job losses and less spending by society's well-off citizens, research by the IMF concluded in 2014.

That research has been highlighted this week by analysts at Morgan Stanley as they believe the outlook for US house prices is becoming a lot less attractive. Morgan Stanley doesn't think house prices need to fall to make wealthier Americans think twice before they continue to spend. A relatively 'flat' outlook, i.e. no more additional wealth from real estate, might do it.

Anecdotal evidence and detailed analysis from available data both suggest households on middle and lower incomes have been largely responsible for the slowdown in consumer spending, both in the US and in Australia. If higher income spending is about to join in the slowdown, as forecast by Morgan Stanley, the aggregate numbers for total consumer spending will no longer seem as resilient as they have to date.

The broker's research has equally discovered there's a close correlation between share market momentum and the confidence of CEOs steering corporate America. This too can quickly turn into a negative if equities don't start a new, durable uptrend shortly.

The narrative that usually dominates equity markets is that, ultimately, markets will respond to changes in economies and, in extension, in corporate profits, dividends and margins. Morgan Stanley's latest research reminds us — investors — it's a two-way correlation that might be about to start eating into the apparent resilience by economies that have surprised so many throughout 2023.

All this, of course, takes us back to global bond markets where higher-for-longer yields have become the new norm this year. Maybe it's not up to us mere mortals to understand in full details why bond yields are where they are, but it remains plausible, no; likely that higher bond yields continue to leave a negative imprint on businesses' and households' intentions in the quarters ahead.

The fixed income markets have been waiting for a while now for something to 'break', quite literally, and when it does, the outlook for financial markets might yet again become closely correlated with a change in policy at the Federal Reserve (QE instead of QT?).

In the absence of such reversal, it seems a lot is riding on high income earners keeping their jobs and feeling wealthy enough to keep propping up their national economies, while middle and lower income households are being squeezed from multiple sides. Economies, it turns out, are as polarised around a small group of outperformers as are share market indices.

Steve Johnson, Portfolio manager at Forager, pointed out on Monday more than 25% of the ASX200 closed at a 52-week low on the day, including the likes of Ansell ((ANN)), CSL ((CSL)), Ebos Group ((EBO)), IPH Ltd ((IPH)), Macquarie Group ((MQG)), Nanosonics ((NAN)), Nufarm ((NUF)), Pinnacle Investment Management ((PNI)) and a whole battery of A-REITs.

A Good Clean Is Healthy

Should we focus on the next technical relief rally or on the erosion in share markets' underlying fundamentals that might keep a firm lid on what is plausible once markets have left their oversold status behind?

Decisions to make all boil down to our personal level of risk appetite and what our specific strategy is. I would not get too excited just yet until we have a more conclusive answer whether economies are still facing recessions next? The next six months or so look very vulnerable to such an outcome.

Apart from keeping a healthy level of cash on the sidelines (enough to guarantee you sleep at night), I tend to recommend investors upgrade their portfolios by selling lower quality disappointments and start adding higher quality companies that are more likely to perform positively over a (much) longer time frame.

As the saying goes, investors are most likely to reap the best rewards during bear markets, but they'll only realise it when the next bull market unfolds.

For good measure: we are nowhere near the next bull market. Caution remains appropriate.

Further reading:

-Last week's:

-Week prior:

-Three weeks ago:

-To Sell Or Not To Sell:

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(This story was written on Monday, 30th October, 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).

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