Rudi’s View: Dealing With Risk

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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).

I reminded myself of the dangers of such high-risk strategies when I looked up the share price of Tyro Payments ((TYR)) last week. Having mostly fluctuated between $3 and $4 during the first two years after listing, the Tyro share price has since trended south and rarely breaches the $1 level on the upside these days.

Imagine you’d be throwing more money at it on the relentless trend downwards. That, in a nutshell, is how you turn $400k into $50k, with very little prospect of regaining those heavy losses too.

Better to take a broad portfolio perspective that allows you not to get obsessed with any singular disappointments. Your next allocation should go where your investment instinct tells you the highest return is likely to be achieved. This might not be in the share price that just got clobbered.

My personal experiences tell me it is rather unlikely that the share price that just got punished will be the next stellar performer in your portfolio. Or as one smart cookie declared a while ago on social media: if simply putting more money into a falling share price was all we needed to do as investors, we’d all be rich in no time.

For good measure: there never is a 100% certainty, but there are ways to assess whether it is worth holding on after disappointment has struck; maybe we might even buy some extra shares. Not to pull the average purchase price down, but to take advantage from a lower entry price once we have concluded there still remains a healthy investment thesis beyond the short-term clouds.

Two things come to mind:

The motto from legendary investor Peter Lynch: Know what you own, and why you own it. Advice from a recent social media post: “Don’t marry your stocks, but date them long enough to get to know them really, really well”.

The message is the same: make sure you know more about the companies you own than simply their share price. When disappointment strikes, this should help you with your assessment about what to do.

Post The Share Price Punishment

The easiest assessment should be when market sentiment temporarily depresses a share price.

Current examples are supermarket operators Coles Group ((COL)) and Woolworths Group ((WOW)). Both are under public scrutiny (and worse) from regulators, politicians and shrinking household budgets, but only that last factor should be seriously considered as it is rather unlikely this industry will be carved-up and handcuffed, with no more growth avenues left.

As one smart investor once said: worst case scenarios have a habit of, in most cases, not materialising.

Another almost perfect example was seen in WiseTech Global ((WTC)) shares earlier this month, leading to its share price falling from $139 in September to below $100 as the public humiliation of founder/CEO Richard White unfolded.

White, for those who haven’t paid attention, has essentially been unmasked as your typical self-made billionaire; a bullying control freak with too much taste for female companionship (pre-marriage). White’s social life quickly turned into a public scandal, with lots of juicy details to devour, putting a lot of pressure on the share price.

The real question for investors hadn’t changed, however: is this company still on schedule to keep growing at big numbers in the years ahead?

FNArena’s consensus forecasts are projecting 48.8% in EPS growth this year and 38.5% next year. If nothing happens to these projections, what are the chances the market is exaggerating in its response?

I think we all know the answer. On Friday, when the announcement came White has stepped back as CEO and director and taken up a function within the company as ‘consultant’, the share price instantly rallied to $113. Equally unsurprising, both Bell Potter and Citi upgraded to Buy on the day, as did RBC Capital, as did Goldman Sachs.

Of course, there still is some remnant risk White has done something legally wrong, like maybe misappropriating money that belongs to the shareholders, or this month’s C-suite upheaval does have an impact on the day-to-day operations. For this reason the share price should trade at a discount for a while until more certainty has been achieved.

This is why the consensus price target has pulled back to $118.77 from $121.95 pre-scandal. The real question, of course, is whether any of this has changed the longer-term growth trajectory that to date has made WiseTech Global one of the largest companies on the ASX.

Some critics might argue White’s punishment for bad behaviour is too light. He remains on the same salary package. The flipside is WiseTech Global without him would bring about a lot more uncertainties, most definitely in the short term, and investors would not like it.

That same argument applies to Mineral Resources ((MIN)) where billionarire founder and MD Chris Ellison is being linked to an alleged tax evasion scheme. This is a much more serious scandal and could ultimately land him in criminal court. MinRes is itself investigating the matter and will release findings next Monday.

I am a lot less confident in how this matter will be resolved at MinRes, with the share price equally weighed down by balance sheet matters (too much debt) and the cyclicality of the business.

Another company where my personal risk assessment has deteriorated this month is Audinate Group ((AD8)) with today’s share price less than half of what it was in March this year when the financial result in February literally put a rocket under the share price.

What has followed next are two profit warnings, and now a lot of uncertainty about what possibly follows next.

What we do know is customers are not buying Audinate products; or at least they are not doing it in the amounts management would like them to. There’s no indication this might change anytime soon.

I think this now makes owning shares in this small cap company (annual sales less than $100m) a much higher risk proposition and investors who own the shares should question whether this suits their own strategy and risk appetite.

Equally important: such assessment needs to be made irrespective of when the shares were bought and at what price.

Making such decisions is never easy, but if we decide the risks are simply too high, we need to follow-through and sell the shares, and move on.

In the first year of the FNArena-Vested Equities All-Weather Model Portfolio a similar crisis situation had emerged at Slater & Gordon ((SGH)), up until that point one of the best performing inclusions in the portfolio. From memory, I think the portfolio sold at a loss of something like -15%.

That crisis would ultimately break the firm and the share price would end up losing -96% of its value. This is why one of my credos is: it’s never too late to sell.

Nothing of the above makes investing any easier, but knowing our companies’ fundamentals and making the right risk assessments can get us a long way.

All-Weather Model Portfolio

FY24 review for the All-Weather Model Portfolio:
https://www.fnarena.com/index.php/download-article/?n=DE2A4552-E2C7-4DC7-0A896CE5CF68ACD8

Prior years:

FY23: https://www.fnarena.com/index.php/download-article/?n=DFC11150-CB36-C777-1AA3EDA640E2F5BF

FY22: https://www.fnarena.com/index.php/download-article/?n=DFE7241B-9CD8-61F1-1602C581A8E539C4

FY21: https://www.fnarena.com/index.php/download-article/?n=DFF82691-E53E-3CF5-17A2337D72CDB54F

Video: Why FNArena & All-Weather Stocks

I’ve used my participation to the InvestmentMarkets’ conference in July to explain how/why FNArena started & what investors get out of it, including research in All-Weathers and Gen.Ai

The video: https://bit.ly/3A1pLuz

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (21 since 2006); examples below.

(This story was written on Monday, 28th October, 2024. 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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