Originally published by Cuffelinks
Reporting season has delivered a mixed set of results which has again failed to move the dial much in either direction for the broad market. As investors move on from local company annual reports, what are the big picture issues that could drive either downside volatility or justification for optimism? There is a plethora.
Some notable underperformers
Disappointments during reporting included Domino’s (AX:DMP), which achieved same store sales growth well below guidance in Australia, Japan and Europe and missed its own previous guidance for profit. It reported NPAT of $118.5m which was 3.7% below consensus and lowered guidance for FY18 to 12% below consensus. The company’s PE has now ‘de-rated’ by more than 60% since its 2016 calendar year peak. In the past, the company was trading on lower multiples (mid teens) and generating greater than 30% growth.
Elsewhere, Bluescope (AX:BSL) increased underlying profits by 102% but the result missed expectations thanks to surging energy costs. Bluescope also revealed the unanticipated departure of its Chief Executive of over 10 years, and to complete the trifecta, the ACCC is investigating potential cartel behaviour in steel in 2013-14.
And Telstra (AX:TLS), that darling of yield huggers over the age of 55, not only delivered another entirely predictable year of impotent sales and earnings growth but, also predictably, announced a cut to its dividends, which was the raison d’être for the stock being owned by almost every baby boomer with an SMSF.
With the majority of the largest companies paying the bulk of their earnings out as dividends, rather than reinvesting for growth, and with bank loan volume growth flattening, listed builders at peak levels of activity, retailers of homewares likely peaking and an end to asset revaluations for REITs, it is no wonder the S&P/ASX 200 is still at the same level as at the beginning of the year. The price index is well below its level of 1 September 2007, a full decade ago. So much for the joys of investing for the long term in an Australian index fund.
That’s the past, what about the future?
The end of reporting season may be a blessed relief to many equity investors but are they out of the woods? A temporary lull in the influence of idiosyncratic factors on equity prices is not the end of potential increases in volatility for investor returns.
Bullish investors are betting on an acceleration in global economic growth evidenced by higher resource prices including copper and iron ore. These global ‘reflationists’ are also looking to recent hawkish comments by central bankers to support their case. Across the world we have:
- Australia’s RBA Governor Phillip Lowe in February 2017 effectively ruled out further rate cuts, voicing concerns about, “how much extra fragility [it would] create in the economy” by encouraging further growth in household debt.
- More recently, US Fed Chair Janet Yellen in June noted, “We do have a strengthening economy with policy accommodative, all that we’re doing in raising rates is removing a bit of accommodation heading toward a neutral pace.”
- And in Europe, ECB President Mario Draghi said that reflationary pressures have replaced deflationary ones as the Eurozone’s recovery progresses.
- Meanwhile, Bank of Canada Governor Stephen Poloz observed, “It does look as though those cuts have done their job.”
- And finally, Bank of England Chief Economist Clive Haldane admitted he believed “that the balance of risks associated with tightening too early, on the one hand, and too late, on the other, has swung materially towards the latter in the past six to nine months” adding, “Certainly, I think a tightening is likely to be needed well ahead of current market expectations.”
In the bearish camp sit some of the world’s most lauded hedge fund managers who believe stretched equity valuations, record low levels of volatility, the concentration of funds flowing into a narrowing group of tech stocks and speculative fervour in non-income-producing collectibles are all signs that raised cash levels are sensible.
What the big global investors are saying
Ray Dalio, founder of Bridgewater Associates LP, the world’s largest hedge fund with more than $150 billion under management, believes the magnitude of the next downturn will be epic. He said recently:
“We fear that whatever the magnitude of the downturn that eventually comes, whenever it eventually comes, it will likely produce much greater social and political conflict than currently exists.”
Bill Gross, founder of PIMCO LLC and now Portfolio Manager at Janus Henderson, cites the highest risk levels since 2008: “Investors are paying a high price for the chances they’re taking.”
‘Bond King’ and CEO of DoubleLine Capital Jeff Gundlach advised, “Moving toward the exits”, telling Bloomberg, “If you’re waiting for the catalyst to show itself, you’re going to be selling at lower prices.”
Oaktree Capital’s founder Howard Marks, in his latest letter to investors, summarised present circumstances thus:
“The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.”
“In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.”
“Asset prices are high across the board. Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.”
“Pro-risk [behaviour] is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.”
Finally, Appaloosa Management’s David Tepper recently warned investors to stockpile some cash and says he’s “on guard.”
Choosing your cognitive biases
The above collection of comments from fund managers and central bankers is evidence that investors can easily amass a collection of views that reflect their own. This is the stuff cognitive biases are made off.
With the end of reporting season fast approaching there is no doubt investors will turn their attention to more disparate considerations.
Irrespective of what camp Montgomery is in, our process isn’t revealing large amounts of value among the quality names we like. As a result, cash is the safest alternative and our largest position by far, varying between the Montgomery Fund with 27% cash to the Montgomery [Private] Fund at 43% cash. The Australian market is 17% weighted to materials (compared with 2.9% in the US) and it will snub its nose at our apparent conservatism and make our process look dumb. As Howard Marks noted, ‘Currently, the optimists are winning’.
So which camp are you in? I'd be delighted to hear your thoughts in the comments section.
Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management.