Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 217

To zig or to zag?

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 Dominos (ASX: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 increased underlying profits by 102% but the result missed expectations thanks to surging energy costs (see my Cuffelinks article on plunging clean energy prices here). 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, 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/ASX200 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.

[Register for our free weekly newsletter and receive our latest ebook, Cuffelinks Showcase]

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. This article is for general information only and does not consider the circumstances of any individual.

12 Comments
Bruce
September 06, 2017

Regarding Roger’s comment on Telstra, whilst Cuffelinks is not a stock-picking newsletter given Telstra’s importance to most SMSFs the Board's decision to reduce the dividend and its likely future performance is worth considering. Would we be better investing the money in a bank hybrid or staying with a company that has endless years of impotent sales and earnings growth?

I’d be grateful if someone could advise on the projected impact the NBN is likely to have on telecommunication stocks. The large number of NBN resellers, including Telstra, means that none are likely to make any money. At the same time the government will take measures, such as an NBN toll on urban customers, to make the NBN a more attractive company to take to market. Even customers who currently use a cable broadband service will probably have to pay this monthly toll.

The sale price of the NBN also depends on a large number of households signing up. Many potential customers may not be willing to pay for an NBN phone service that does not work during emergencies. If people also need a mobile phone to ensure they have service during blackouts one wonders how many households will sign up. Unless households are using large quantities of data, some may prefer subscribing to a non NBN fixed WIFI point (WiMax, LTE) in their premises and a mobile phone for calls.

If WiMax type technologies can provide a competitive alternative to the NBN cable network in city environs, maybe Telstra can grow its revenues and dividends over time. I would welcome someone who has knowledge of these technologies to comment on whether this is possible or if we should cut our losses with Telstra and move on.

RJM
September 05, 2017

Hi SMSF Trustee: ING is paying 2.87% at call with no fees (pretty close to 3%)

Tony C
September 05, 2017

I invest in Rogers fund for the returns and his ability to hold 30% or more cash if he thinks that is necessary. Why would i go against his professional opinion to hold 30 50 or 100% of the funds money in cash.
I am the opposite of the general feedback hear as i seek out managers who can generally go long short or to cash if they think that is wise

SMSF Trustee
September 06, 2017

Quite a few restrictions on that account RJM. EG you have to have another account with them into which your salary gets paid and which gives you a lot less interest - so much less that their website doesn't even mention an interest rate for that other account.

So that isn't really the same thing as cash in my book, which doesn't have such requirements attached to it.

Besides, that's not available to an SMSF. Their cash account for SMSF's pays 2.4% for the first 6 months for new customers, then it drops to 1.5%.

So try again to convince me that you can get 3% managing cash yourself. When the official cash rate is 1.5% anything that looks like it's paying a lot more than that probably is taking return away from you elsewhere.

Rick
September 04, 2017

I do you use Fund managers with the following characteristics:
Good track record over time after fees and performance fees.
Skin in the game to a significant level
The great performance occurs while holding high cash levels giving what I call "dynamic asset allocation".. my actual cash allocation equals my cash+ cash position of my fund managers..a belts and braces SMSF
insurance policy! OR... buy BBOZ to ease the pain of a ASX correction. Rather than a term deposit, buy AAA, an ETF in $AUS paying quarterly at a better rate.

Adrian
September 02, 2017

Yes agreed James and I do hold a lot of cash as part of my asset allocation. I also do read the PDS, understand the fund manager's approach and track record, and generally try to avoid funds that aren't fully invested (with a few exceptions). If I'm targeting 20% cash in my asset allocation and 80% equities, but my share fund manager decides to hold 40% cash, that means my underyling exposure is 52% cash instead of 20% as intended. So it's a bit of an issue for those of us trying to manage a strategic asset allocation, cognizant of the evidence that suggests market timing is not generally a good idea. It's also an issue for those of us conscious of fees as we are all being told minimizing fees is essential over the long term. I can earn 3% on my own cash. A fund manager might earn 1.5-2% and then subtract fees of 1 to 1.5%, leaves basically nothing.

SMSF Trustee
September 03, 2017

Would love to know where you get 3% on cash, Adrian. If you mean actual cash - ie liquid and funds available immediately. If you mean 1 year term deposits, which is the sort of term that I can find paying that rate, then I don't regard that as cash and I don't think any managed cash fund would have an average maturity that long either.

Graham Hand
September 01, 2017

This week's sale of the '4' NSW number plate for $2.45 million a good example of what Roger calls the "speculative fervour in non-income-producing collectibles".

James
September 01, 2017

I don't pay a fund manager to hold a lot of cash! I can do that myself. Roger goes on about not finding a lot of value in the market yet has missed some good opportunities e.g. WTC, NXT, HSN. Got into RHC late.

Geoff Scott
August 31, 2017

agree with Warren's comment. full time specialists can interpret markets more quickly than the average investor who does have biases. the greatest difficulty I believe is holding questionable stocks purely for yield which is a necessity for most retirees.

Warren Bird
August 31, 2017

Paul makes an interesting point about investor expectations of what active managers will or can do to protect their funds in downturns. Back in my Colonial days I often met with investors who asked me why a particular fund - sometimes equities, sometimes one of my bond funds - didn't just cash up when risks looked high, ahead of a significant fall in asset values/unit prices.

My answer was, 'because the manager isn't prepared to break the law'. Often they'd look at me strangely until I pointed out that the PDS said that there'd never be more than, say, 5% of a share fund in cash and so it would be illegal for the manager of the fund to ''cash up''. Similarly with a bond fund that had, say, a 2 year duration lower limit. It can't go to ''cash'' (negligible duration) without breaking the promise made to investors in the PDS.

I'd say that if you want a fund that can cash up, you need to choose a different product. Clearly Roger's PDS makes it clear that he can load up on cash if that's the best value he can find in the market.

Investors need to know what they've been promised by a fund manager - read the PDS.

Paul
August 31, 2017

Thanks, Roger. Classic problem for any fund manager or even investor of 'the market can remain irrational longer than you can remain solvent'. Anyone who holds a large cash position faces the opportunity cost of a rising market and underperforming those willing to take more risks.

My main issue is a broader one. When I allocate money to an equity manager, I want that money exposed to the equity market. That's my allocation. When they hold 40% cash, I actually have far more in cash than I expected since I've already made that allocation. Accepting that you are protecting the capital of your investors, are you saying you simply can't find anything worth buying for reasonable returns or that it does not reach some high hurdle rate?

 

Leave a Comment:

     

RELATED ARTICLES

Dividends, disruption and star performers in FY21 wrap

Why August company reporting season was poor

August 2018 reporting season: the final verdict

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Latest Updates

Investment strategies

Joe Hockey on the big investment influences on Australia

Former Treasurer Joe Hockey became Australia's Ambassador to the US and he now runs an office in Washington, giving him a unique perspective on geopolitical issues. They have never been so important for investors.

Investment strategies

The tipping point for investing in decarbonisation

Throughout time, transformative technology has changed the course of human history, but it is easy to be lulled into believing new technology will also transform investment returns. Where's the tipping point?

Exchange traded products

The options to gain equity exposure with less risk

Equity investing pays off over long terms but comes with risks in the short term that many people cannot tolerate, especially retirees preserving capital. There are ways to invest in stocks with little downside.

Exchange traded products

8 ways LIC bonus options can benefit investors

Bonus options issued by Listed Investment Companies (LICs) deliver many advantages but there is a potential dilutionary impact if options are exercised well below the share price. This must be factored in.

Retirement

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Investment strategies

Three demographic themes shaping investments for the future

Focussing on companies that will benefit from slow moving, long duration and highly predictable demographic trends can help investors predict future opportunities. Three main themes stand out.

Fixed interest

It's not high return/risk equities versus low return/risk bonds

High-yield bonds carry more risk than investment grade but they offer higher income returns. An allocation to high-yield bonds in a portfolio - alongside equities and other bonds – is worth considering.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.