Bears come out to play

Brokers have caught on. They must be reading MacroBusines. Much of the Australian economy is not in good health, Dutch disease is fast becoming Australian disease, and earnings forecasts in many sectors may be pretty dodgy. As more bearish sentiment starts to grip the market, the question it raises is: is it time to buy on bad news? Probably not. But it is always worth remembering that the best bargains occur when the market thinks that things look bad. And that sentiment is getting stronger. The case for diversifying offshore is looking stronger with the $A high. For the same reason that Australia should establish a sovereign wealth fund, to hedge against the mining boom skewing the entire economy, so investors should think about diversification internationally. There is also another looming question. Should investors just assume that Dutch Disease is semi-permanent, and concentrate on picking value in mining, food and, especially, energy?

Macquarie has a report out that expresses the mood:

The Australian economy has entered an extended period of stress where the ongoing resources boom is crowding out much of the rest.

  • The resulting strong AUD and higher interest rates, together with government policies, which are squeezing the consumer via higher taxes and costs have put substantial downside pressure on industrials earnings. FY11 will see this grouping record negative EPSg for the fourth year in a row, in other words they have missed the cycle entirely.
  • Further substantial earnings downgrades, especially for FY12 beckon as EBITDA margins are continuing to erode. We have this month removed the final domestic cyclical from the portfolio in JBH as that stock is now coming to the end of its buy back period.

The emphasis is going on to defensive stocks:

The ongoing domestic Australian exposures are limited to defensive stocks with earnings certainty a major input.

  • With this in mind, we have added RHC, Australia’s largest private hospital operator, which is generating very strong (15% to 20%) EPSg rates. The stock has recorded consistently strong top line growth over many years with an ROE hovering in the mid teens. Useful starts have been made to building similar exposures in the UK and France.
  • The portfolio remains heavily overweight cyclical exposures to the global economic recovery.
  • Resources, resource services and international manufacturing are all over- represented. This month we have added further to this bias via the addition of MIN, an emerging resource services and iron ore producing company in an extremely strong earnings growth phase with EPSg forecast at 85% in FY11 and 33% in FY12. The company has shown a consistent ability to deliver new projects on time and on budget. The balance sheet is net cash whilst the ROE is over 25% and accelerating to the upside. The valuation is still only modest with prospective PERs at a discount to the market.

Southern Cross is predicting that a lot of the earnings forecasts are looking dubious and has this to say:

I always think the rotation to defensives is the final movement before a broader correction starts. Remember, the only true defensive is cash.”

Very true. Southern Cross is uusally pretty bullish, but it is getting worried:

Let me make one thing VERY clear; I place zero faith in any company guidance for FY12. Interestingly, it seems some people are putting faith in “FY11 guidance being maintained” by certain companies, yet the debate should be FY12 not FY11 with only 1.5 months left to run in FY11.

One of the key reasons I changed our strategy to “take some profits, raise cash, reduce risk” 2 weeks ago was because I am uncertain what comes next economically. I think visibility in the year ahead is the lowest in quite some time, yet many companies carry on giving guidance about the year ahead. They must have a crystall ball that I don’t.”

UBS is making bearish observations about investors getting worried about earnings forecasts:

Conclusions – Demand Still The Key Uncertainty Our analysis suggests that weak demand has been the biggest problem for Australian corporates over the past 12 months and in the absence of a pick-up in key areas (e.g. retail spending, US housing, capital markets activity) it remains the key risk to monitor. The currency has also dragged on earnings but apart from domestic steel stocks it does not appear to represent significant problem for earnings, providing it does not move significantly higher. Cost pressures have been a relatively minor problem in terms of driving industrial downgrades but wages developments bear watching. Our catch-all one-offs category also bears watching given the capacity of areas like mispriced contracts to hit more than once.”

  • The portfolio now has zero exposure to domestic steel, building materials, airline, logistics, media and discretionary retail. Value traps now abound in these sectors. We have also trimmed the exposure to the consumer staple stock WOW, which should feel some headwinds from further interest rate rises.”
  • UBS


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    1. I see JBH is being savaged at the moment. Market buy back or bearishness on retailers?

      When the bears come out to play, goldilocks can steal some nicely priced companies.

    2. is it time to buy on bad news?

      Perhaps, Houses & Holes “triple dip” scenario is the buying opportunity? As soon as Ben announces QE3, it will be all in for a massive risk-on event.

      • That might be the way to go Lorax – a similar replay to the May 2010 flashcrash and subsequent August 2010 announcement of QE2

        Need to watch US GDP quarterly results and unemployment figures to gauge that probability. Amongst 1000 other things.

        This is definitely NOT an investor’s (i.e buy and hold for longer than 1-2 years) market.

        • Does look like there is some scope to make some quick gains if you get things right then stick to your guns and pull out when you are supposed to.

        • Think that could be exactly what we see. I’ve closed many of my stock positions over the last couple of months (sold around 75% of my shares) and now wait to see what comes post June.

          I don’t understand the mentality of those just buying up long term holds at this point. So many different directions things could go over the medium to long term I think there is substantial risk with any set and forget position in todays market.

      • If you guys keep bagging buy-and-hold types you may hurt my feelings 🙂

        I still buy and hold – it’s just in risky/uncertain times your margins of safety need to increase. Which means there ain’t much out there at the moment I’d consider buying. If WOW or REH dropped 15% tomorrow I’d go nuts, but until then it’ll be cash, cash, cash.

        • Hi Q

          I am interested on such bullishness on Reece…

          I have only had a brief look myself, but I see this company having substantially tapered off in the last 5 years in terms of sales growth and returns on incremental capital, and i don’t see profit margins changing for the better either. Even with a 15% drop from current prices I would not get excited as the free cash flow yield would still be low. Combine these numbers with Woolies rolling out Masters, rising interest rates and a slowing property market and I could not get excited about Reece except maybe around the $14 mark.

          I appreciate it is a standout business, but I think it represents $1 that many people have become accustomed to paying $1.50 for. Much like Aussie houses.

          Happy to hear where you disagree.


    3. Mr Market is getting moody. I think he is upset that the QE2 party is about to end…for now??

    4. Just thinking out loud here:
      If we have a case of Dutch Disease then why aren’t we using the vast profits to cushion against the impending burden of boomer pensions?

      Instead the policy response has been to facilitate that generation’s dependence on investment (primarily in real estate) at the expense of other generational cohorts.

      Surely a move to create something akin to Norway’s Oil Fund that would pay the way for the pension and quite possibly the education of our brightest would have been a better move.


      • Tulip Flipper

        The idea of a SWF has been much touted around here, Aaron.

        I think it was discussed that the generational wealth gap with regard to housing was a unintentional effect helping to pay for boomers retiring en masse?

        Things could go quite badly on the second point if prices stagnate for longer. I guess I’m of the differing opinion around here where if prices stagnate for long enough, they will begin to fall quite quickly…

      • Sadly Housing Troll, methinks we missed the boat with a SWF. Truly. I would support such an initiative (whereas I opposed the RSPT as originally presented) – if it was well constructed, non-contaminated by party politics and of generational benefit.

        Can our political honcho’s achieve this. Nope. In the celebrated Australian way, we are short-term focussed, long term myopic.

      • A SWF could have been funded with the transaction costs involved in super: i.e management fees, financial planner commissions and taxation. If these were waved and the funds put directly into Aussie bonds or term deposits (as the majority should be) the returns would exceed 6% a year, not the 3% average. (latest APRA survey)

        Rough back of the envelope – about 20-35% of well over $1.2 trillion over the last 10 years.

        Invest it overseas like the Norwegians did and you’d have over $400 billion by now. And the AUD would have likely be lower as a result too…(hot money going overseas, not circulating here able to borrowed to the hilt to buy overpriced houses)

        All too easy…….

    5. So you experts are waiting for the massive deflation with the banks closing and armeggedon? Or are you waiting to hear the Q E and 3??? Which 1 is it?