Rudi’s View: Dealing With Risk

Rudi's View | Oct 30 2024

Dealing With Risk

By Rudi Filapek-Vandyck, Editor

It's roughly one more week before Americans vote in person on who will be their next President, but don't hold your breath, it's more than just likely the world won't know the definitive outcome until days after the event.

And that's assuming Kamala doesn't win and team Trump starts its carefully constructed strategy to contest the election outcome.

Markets usually don't like uncertainty. I doubt whether they will like such an outcome, at least in the initial phase.

Of course, Trump might win and then the next question becomes: what about Congress?

Either president with a divided Congress is usually the market's preferred outcome as it limits the room for dramatic changes. If Trump wins, investors will have to weigh up the future benefits from lower taxes and less regulation (as promised) against the negative impacts from import tariffs (as promised too).

In direct conflict with common economic theory, Trump has made it clear he loves tariffs, and not only for cheap Chinese products. Is it possible bond yields rising this month can be partially explained by investors hedging their risks? The answer is probably 'yes' but both candidates are likely to further increase budget deficits, and that probably requires higher bond yields as well.

Nothing is 100% straightforward this year. The opposition in Queensland has just achieved a landslide victory while in Japan the Liberal Democratic/Komeito coalition has lost its majority in parliament for the first time since 2009. Before the election on the weekend, such an outcome had only been given a 35% probability, but it has happened regardless.

Common logic and history suggest high inflation and elongated pressure on household budgets make it a lot harder for government incumbents to get re-elected. In the example of Japan, the ruling party had also been damaged by a scandal about a secret slush fund that facilitated party members misappropriating funds from supporters.

It's not a great celebration for democracy when that same LDP/Komeito coalition might now align with other conservative parties and still form the next government, albeit likely with a new prime minister.

Everybody makes her/his own choices when faced with short-term uncertainty. Whatever is right or wrong often only becomes apparent when looking back in hindsight. To those that like to take some risk off the table or otherwise make portfolio adjustment: there's still time.

The other key events pre-election next week will be US corporate results with the likes of PayPal, McDonald's, Pfizer, Alphabet, AMD, Meta, Microsoft, Apple, Amazon, Exxon Mobil and Chevron scheduled to report, among many others. US corporate earnings are the essential ingredient to keep equities on an upward sloping trajectory over the year(s) ahead.

For what it's worth, US analysts at RBC Capital have dubbed the US quarterly reporting season thus far as "mildly disappointing".

One factor that is all too often overlooked when markets have a stellar year and valuations are well above average is how key characteristics for the underlying companies have changed over time. The graphic below is just one such example.



The Australian Experience

Over in Australia, the seasonal AGM period of October and November has effectively been transformed into a mini-results season for ASX-listed companies. This is the outcome from more companies being dual-listed on foreign bourses, as well as the increasingly common feature of updating investors and shareholders on a quarterly basis.

The latter is also closely intertwined with the fact the ASX now counts significantly more small cap technology companies.

Add most banks, retailers, and your standard out-of-season cyclicals such as GrainCorp, Incitec Pivot, Nufarm, Orica and Elders, plus the fact most company boards nowadays feel compelled to at least update on fresh trading insights thus far and there's a lot more to digest in between August and February for Australian investors.

More transparency and timely insights should be welcomed, of course, but during times of ongoing pressures and challenges this also means a lot more disappointments are being communicated that negatively impact on share prices.

October thus far has seen a large number of disappointing updates, ranging from Audinate Group ((AD8)) and Chrysos Corp ((C79)), to Newmont Corp ((NEM)) and Paladin Energy ((PDN)), to Flight Centre ((FLT)) and Web Travel Group ((WEB)), Brambles ((BXB)), Metcash ((MTS)), and a number of others.

Not all market updates by definition turn into a negative event, as also yet again proven by ResMed's ((RMD)) release of September quarter financials on Friday morning. The shares are up by more than 55% since January 1st and last week's Weekly Insights reported ResMed is still Australia's most highly rated by local analysts and model portfolio stockpickers.

Yet another better-than-forecast quarterly performance has vindicated why. Three of four brokers that have updated by Monday morning lifted their price targets above $40, as did Wilsons.

This might no longer look an attractive proposition after 55% in gains and with the share price approaching $39, but at least ResMed did not issue a profit warning or disappoint otherwise, unlike numerous others, plus there remains more growth on the horizon for this multi-decades long growth story.

A timely reminder for local investors: most parts of the ASX are struggling without extra stimulus or support and this is reflected in consensus forecasts that have low-to-negative growth penciled in for the majority of sectors and companies on the local bourse over the twelve months ahead.

Sectors including Insurance, Technology, Engineering and Contractors, and Healthcare are standing head and shoulders above the crowd, often offering the prospect for double-digit growth as well as robust increases in dividends, a la ResMed.

More stimulus from China might close the gap for today's share market laggards, as might lower taxes in the US and rate cuts from the RBA, but none of these factors is currently in place. Looking at the precedents from corporate Australia thus far in October, it's hard not to conclude the short-term risk for individual companies looks biased to the downside.

This means, assuming we all have a portfolio of 10-25 individual stocks, we are likely to see at least one of our exposures taking a dive this or next month. The key characteristic of an unexpected disappointment is that it is impossible to predict with an 100% certainty, so let's focus on what to do next instead.

How should one respond to the market announcement that drags the share price to a (much) lower price level?

What Not To Do

My personal modus operandi dictates to never sell when others are selling in large numbers, just like I never join-in on a rallying share price. Taking away the impulsive urge to react when negative news hits the portfolio is the right strategy under most circumstances.

Let the market do whatever it needs to. Better to let the news sink in and assess with a calmer mindset. History shows bad news often impacts over 2-3 days, with shares often recovering from that initial punishment.

The next step is trying to assess the importance and impact from what just happened. The most difficult task at hand is making this assessment without letting the share price doing all the talking.

On my observation, most investors focus too much on what happens to the share price. If the share price is all you care about, you'll always be led by present momentum and miss out on the opportunities that are mis-priced, under-appreciated and temporarily out of fashion.

If all you care about is the share price, you are also likely to sell out too soon, or you start adopting high-risk strategies such as dollar-cost averaging into falling share prices in order to bring your average purchasing price down.

Throwing more money at a failed investment doesn't improve the fundamentals underneath your investment. What it does achieve is it increases your exposure to one concentrated, single, painfully failed purchase. Years ago, I spoke to an investor who'd managed to turn $400,000 into $50,000.

His strategy?

Dollar-cost averaging in order to improve the optics (which is essentially what you're trying to do: to make it look less ugly for your own perception).