##{"id":60700,"date":"2012-10-10T10:06:41","date_gmt":"2012-10-09T23:06:41","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2012\/10\/10\/investing-under-challenging-circumstances\/"},"modified":"2012-10-10T10:06:41","modified_gmt":"2012-10-09T23:06:41","slug":"investing-under-challenging-circumstances","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2012\/10\/10\/investing-under-challenging-circumstances\/","title":{"rendered":"Investing Under Challenging Circumstances"},"content":{"rendered":"

\n\tBy Rudi Filapek-Vandyck<\/span>, Editor FNArena<\/span><\/p>\n

\tThis may not have caught the attention of most among you, readers of my Weekly Insights, but the Australian share market has now been in an uptrend since late September last year, so give or take one full year by now.<\/p>\n

\tAs everyone can see on the chart below, overall volatility in uptrends and down-movements has subsided significantly. Whereas we saw a rally of no less than 58% post the March 2009 bottom, next thing on the agenda was one sharp sell-off, followed by an equally sharp rally back to square at 5000, after which we yet again witnessed a correction to the tune of 21%.<\/p>\n

\tSince September last year, when the major indices in Australia yet again sank below the 4000 level, any movements up or down have been much smaller in nature. Throughout the reducing volatility the ASX200<\/span> has managed to book a net gain of just under 15%.<\/p>\n

\tNot bad for a market that, on widely carried perception, has largely remained moribund throughout the period, frustrating many active traders and investors.<\/p>\n

\tThat frustration, of course, stems from the fact that many household names until today have failed to properly participate in these gains. Shares in BHP<\/span> Billiton<\/span> ((BHP<\/span>)), to name the obvious point of reference, are still down from $37 last year to circa $33 today.<\/p>\n

\tInstead, all those index gains have been carried by that same group of market outperformers<\/span>: defensives, dividend payers and companies with a solid balance sheet and an all-season's business model, otherwise known as the "All-Weather Performers"^{(*)<\/sup>.<\/p>\n}

\t $\"\"$ <\/p>\n

\tToday's outperformers<\/span> look stretched and one wonders how much further they can push this share market without better contribution from the resources and the industrial cyclicals<\/span>. On the other hand that long awaited switch into these underperformers<\/span> doesn't seem to be forthcoming as yet. If today's retail investors and managers of their own Self Managed Super Funds (SMSF<\/span>) believe this share market is one tough nut to crack, then imagine the conundrum at hand for hedge funds and professional funds managers. They cannot be seen as missing out on the upswing, but at the same time nobody wants to be exposed when that pull back finally arrives, if and when it does.<\/p>\n

\tRecent global industry updates and client surveys suggest these professional market participants have responded by significantly shortening their horizon. Previously, the average period behind new market positions was for some two months into the future. In recent time this has been reduced to between two days and two weeks. In other words: overall confidence remains low and risks are still perceived as uncomfortably high, but market participation is seen as obligatory. There are reputations and jobs on the line and important client relationships.<\/p>\n

\tThe industry's conundrum was once again highlighted through the fact that local funds managers are now Overweight Australian banks, mainly through exposure to the Big Four. This has been the right move over the past year, with the sector significantly outperforming but it doesn't change the fact that Australian banks are still operating under a lot of pressure and their outlook remains for low growth only. The reasons as to why local funds managers were happy to load up on banking shares was because the major banks' dividends remain safe and supported by plenty of cash flow, plus most of the vulnerable cyclicals<\/span> remain in profits downgrade mode which turns the Big Four in Australia, on a relative basis, into high quality safe havens.<\/p>\n

\tThe dangers of investing outside the safety of the proven market outperformers<\/span> was again highlighted on Friday when regional lender Bank of Queensland ((BOQ<\/span>)) was forced to issue yet another bad debts inspired profit warning. The shares lost some 10% in two days.<\/p>\n

\tYet, it seems the economic tide in Australia is turning and it is only logical investors will increasingly start paying attention. Amidst wide-spread concerns that phase two of the Commodities Super Cycle will finish sooner with potentially serious ramifications for the Australian economy, the Reserve Bank of Australia last week sliced another 25bp<\/span> off the official cash rate. The banks will pass on most of it.<\/p>\n

\tEconomists are expecting more cuts, if not on Melbourne Cup Day in November, than in December and\/or in 2013. The reasoning behind these expectations is that interest rate cuts take time to filter their way into higher economic activity. With resources capex<\/span> projected to peak next year, the RBA<\/span> is worried about what comes next for Australia, thus lower interest rates must help to secure a rebalancing in the Australian economy. Even if investors were to remain sceptical<\/span> about what changes will take place in consumers' spending behaviour<\/span>, forecasts are the Australian dollar is now on a path to below USD-parity (exact timing unknown) and there's already anticipation the local housing market will see some kind of a revival.<\/p>\n

\tThe latter certainly is supported by anecdotal evidence that positive sentiment towards property in Australia is making a come-back.<\/p>\n

\tMost of these changes will come gradually and that means positioning for a better FY14<\/span>. For example, shares in New Zealand's prime builder Fletcher Building ((FBU<\/span>)) don't look very attractive on the current outlook for FY13<\/span>, with the Price-Earnings Ratio above 15 (dividend yield 4.5%) but on current market projections for FY14<\/span> the PE drops to 11.2 and the yield to 5.4%, suggesting healthy gains for investors who own the shares on a two-year horizon.<\/p>\n

\tWhile the projected 30% growth for FY14<\/span> (in original currency) looks pretty ambitious, investors have to appreciate this would only take earnings per share back to levels of 2005 and 2006 but still substantially below the boom year that was 2007.<\/p>\n

\tThe same logic can be applied to other stocks that have been in the doldrums because of Australia's multi-speed economy. Names that come to mind include Leighton Holdings ((LEI)), Lend Lease ((LLC)), GWA<\/span> Group ((GWT<\/span>)) and Arrium<\/span> ((ARI)). There are no guarantees these companies will meet current market expectations in two years' time, but if they do today's share prices will look like a bargain in hindsight. This explains why Arrium<\/span> is now targeted by an overseas consortium.<\/p>\n

\tAnd… if current economists' expectations prove correct, these beaten down strugglers now have the support from the RBA<\/span> whereas previously they were victims of RBA<\/span> policy aimed at balancing out the strength of the resources spoils.<\/p>\n

\tIn the meantime, investment strategists at major stockbrokerages and investment bankers are refusing to give up on the high quality theme that has served investors so well post-2008. It's just that many of these stocks look temporarily overvalued due to their solid dividend outlook or perceived defensive characteristics. It is for this reason that UBS, for example, no longer likes names such as Cochlear ((COH<\/span>)), Woolworths ((WOW)) and Computershare<\/span> ((CPU)); current PE valuations seem out of line with projected growth in EPS. A burden that is not necessarily carried by the strong and defensive only as UBS also no longer likes James Hardie<\/span> ((JHX<\/span>)) and the Australian Securities Exchange ((ASX<\/span>)) for that very same reason.<\/p>\n

\tUBS strategists' favourite<\/span> theme remains "Growth At A Reasonable Price", shortcut GARP<\/span> and according to the strategists' updated assessments Seek ((SEK<\/span>)), Orica<\/span> ((ORI<\/span>)) and News Corp ((NWS)) presently offer the best value\/risk proposition in the Australian share market.<\/p>\n

\tEven if investors take a two year view, one of the key questions that remains when attempting to pick tomorrow's investment successes is whether structural changes are negatively impacting on potential growth. UBS has serious questions about whether this is the case for the ASX<\/span> and for Sonic Healthcare ((SHL<\/span>)). Logical sectors to add include the traditional media companies, bricks and mortar retailers and resources services providers.<\/p>\n

\tWhat about resources companies themselves?<\/p>\n

\tWith China now on top of the worry list for global funds managers and institutional investors, it remains possible the long anticipated switch into the sector will remain on hold for longer. Two key questions remain unresolved for the sector:<\/p>\n

\t1.) how will changes in China's growth composition and pace impact on supply-demand balances and thus on prices?
\n\t2.) can increased production volumes compensate for weaker prices and if so, for how long?<\/p>\n

\tAt this point in time, I am tempted to add resources producers to the list above of structurally challenged sectors. Ironically, with BHP<\/span> Billiton<\/span> now poised to report a decline in profits for the second year in a row (first time since 2002\/03) it can be argued investors have already adopted a two-year view on the company's shares. BHP's<\/span> PE on FY13<\/span> estimates is higher than 12, which is above its historical average of less than 11. On FY14<\/span> estimates, on the other hand, the PE on current AUD\/USD values, is only 10.4.<\/p>\n

\n\tThis, however, doesn't mean there won't be any opportunities among miners and energy companies on a shorter horizon. Witness, for example, the renaissance taking place among gold miners across the world post QE3<\/span> ("QEternity<\/span>").<\/p>\n

\tImportantly, many a strategist around the world has in recent times grabbed the opportunity to reiterate the structural attractiveness to investors in equities for "quality growth" and for "reliable yield". While both themes appear a bit long in the tooth, global economies remain challenged, central bank policies accommodative but as yet unproven and overall risks remain elevated. The latter now includes China. Add to this cocktail the fact that growth prospects remain subdued, in particular for corporate earnings, while interest rates seem poised to remain low for a while longer.<\/p>\n

\tAnalysts at BA-Merrill Lynch have taken the "quality" theme into Australia's small caps stocks. While earnings prospects for the smaller companies in the market seem to be plateauing<\/span> after relentless cutting by analysts earlier this year, BAML<\/span> advises investors stick with "quality" and "growth" and make sure they don't overpay for the combination. On this basis, the analysts like ROC Oil ((ROC)), Telecom New Zealand ((TEL)), Ainsworth Game Technology ((AGI)) and Flightcentre<\/span> ((FLT<\/span>)).<\/p>\n

\tAt the same time, BAML<\/span> analysts note it has become increasingly difficult to spot companies that can grow their profits for shareholders at double-digit annual speed while generating strong free cash flows. Technology One ((TNE<\/span>)), Virgin Airlines ((VAH<\/span>)), Reckon ((RKN<\/span>)) and Ainsworth Game Technology are all considered members of the increasingly exclusive club of "rare gems" in corporate Australia.<\/p>\n

\tThis in itself can serve as justification as to why "high quality growth" and "reliable dividends" are going to dominate investors' equity investment strategies for longer.<\/p>\n

\t(This story was written on Monday, 8th<\/span> October 2012. It was published on that day in the form of an email to paying subscribers).<\/p>\n

\t^{(*)<\/sup> I am currently preparing an e-booklet on All-Weather Performers. Once finished, this e-booklet will remain exclusive for paying subscribers at FNArena<\/span>. It will be published before Xmas this year.<\/em><\/p>\n}

\t(Do note that, in line with all my analyses<\/span>, 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.) <\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

By Rudi Filapek-Vandyck, Editor FNArena This may not have caught the attention of most among you, readers of my Weekly…<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[85],"tags":[48],"acf":[],"_links":{"self":[{"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/posts\/60700"}],"collection":[{"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/comments?post=60700"}],"version-history":[{"count":0,"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/posts\/60700\/revisions"}],"wp:attachment":[{"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/media?parent=60700"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/categories?post=60700"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/staging.fnarena.com\/index.php\/wp-json\/wp\/v2\/tags?post=60700"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}