Market Matters Report / Market Matters Weekend Report Sunday 21st October 2018

By Market Matters 21 October 18

Market Matters Weekend Report Sunday 21st October 2018

Market Matters Weekend Report Sunday 21st October 2018

Last week the local market found a little independence from its global peers on a performance basis, by Fridays close the ASX200 was up +0.7% while the S&P finished unchanged, amazingly to the point. Our battered banking sector added some much needed back bone to the local index and as we often say “the market won’t go down without the banks” – the influential big 4 banks make up over 20% of the ASX200 and take up 4 of the top 6 spots for Australian stocks by market capitalisation / index weight. Generally the market was pretty mixed but some large cap resources remain “heavy” with BHP, South32 and Fortescue all down over -2% for week.

You could almost hear a collective sigh of relief that global stocks hadn’t continued their plunge of the previous week, although I reiterate my preference remains that another leg lower by US stocks is likely over coming weeks. Usually when a panic / aggressive sell-off is exhausted we get V-style bottom after which indices are at least a few % higher within the week - this was the case for the US S&P500 in February 2018, early 2016, July 2011, July 2010 and June 2009. On Friday the Russell 2000, small cap index, which has led the US stocks decline closed only 0.8% above the previous weeks low, implying strongly to us that our targeted area 5-6% lower remains very much “in play”.

During chaotic markets it’s important to stand back and consider the bigger picture and your objectives plus most importantly of all don’t get caught up in the day to day emotional roller-coaster that can detrimentally influence investors best thought out longer term plans – this is the prime reason MM writes its main report when markets are closed, it removes any temptation to keep casting an eye on the price ticker – I’m sure we have all been guilty of this habit!

At MM we regard ourselves as an active discretionary investor i.e. we combine both fundamental & technical analysis. As the word discretion comes into play its imperative that we revise our interpretation as markets evolve and new facts come into play – a mistake that many investors often commit is re-interpreting facts to fit their theory = extremely dangerous.

Over the last week both our short-term and medium-term outlooks have not waivered but we must remain open-minded to any potential deviations from the anticipated path:

1 - On a short-term perspective we remain bearish Global World Equities with an initial target ~5% lower.

This coincides with our opinion that US stocks will fall another 5-6% and the ASX200 will again test below 5800, only ~3% lower.

2 – Over the Medium-term our preference is that stocks should regain their bullish characteristic into early 2019.

However, we are very open to the risks that we may have already seen the top of the longest bull market in history – there are lots of arguments for both sides of the fence but fund managers are bearish and sitting on cash hence the path of most pain here is actually up to fresh all-time highs in early 2019.

People are becoming extremely bearish the US into next year, before we even contemplate domestic issues like tumbling Australian housing prices e.g. two thirds of American business believes the US will be in recession by 2020 and to be specific JP Morgan believes there’s a 28% chance of a recession in 2019 and 60% by the end of 2020.

We question where these bears were hiding before the GFC, its easy to be negative today (just read the press) but MM prefers to just remain open-minded.

The MSCI World Index Chart

A great example of utilising fresh information occurred on Friday when China flexed its muscles around stock market declines, we felt this was just a matter of time as was mentioned in Friday mornings very timely report.

A cascading Shanghai Composite will damage the Chinese economy on many levels but the coordinated comments, not action, by the country’s vice-premier, central bank governor and financial regulatory institutions was enough to send their market up strongly +4% from its intra-day low. Investing against the Chinese government is a very dangerous occupation, just ask George Soros after his huge losses in 1998 when he took on China / Hong Kong – as the legendary hedge fund trader discovered beating Malaysia and Thailand is not China - perhaps a lesson for President Trump if he feels brazen after wins with Mexico and Canada.

Not surprisingly following Fridays comments we remain more comfortable with our view that emerging markets will outperform US stocks into 2019 i.e. China makes up ~25% of the iShares Emerging Markets ETF.

NB Markets that decouple usually recouple relatively quickly – MM is long Emerging Markets and short US stocks via ETF’s in our Platinum Portfolio.

US S&P500 v Emerging Markets Chart

Moving onto the local ASX200 which has been a touch firmer than we anticipated this time last week when we stated:

1 – The ASX200 looks set to rotate between 5775 and 5900 next week

2 – Over the next few weeks, into November, we anticipate another attempt at fresh lows probably down towards 5700.

Last week felt like a market slowly gaining confidence as a few brave investors started putting funds to work but the relatively tight trading range / small volumes implied most investors and fund managers are still more comfortable sitting on their hands.

Note the market has simply mean reverted back to its average 12m forward valuation going back to 2005 i.e. the market was far too expensive but importantly it’s not yet cheap. Another 3-5% lower and this dynamic would most certainly change and we feel there’s enough risks around at the moment like US – China trade war, rising bond yields and the next step of European implosion through Italy to almost “expect” an opportunity to buy the general market cheaply in the coming weeks – that’s before we even consider the negative sentiment which is engulfing asset prices today.

We remain mildly bearish the ASX200 over coming weeks but believe the worst from an acceleration context is behind us at this stage.

We feel fund managers / investors currently  feel more comfortable to miss out on some upside as oppose to trying to explain how they got caught before an “obvious” major correction in stocks - another fascinating example of market psychology, only 8-weeks ago before the 9% fall people were suffering from distinct “FOMO” (fear of missing out) as stocks made fresh decade highs – as we often say normal human psychology, centred around “Fear & Greed”, is an awful liability for the investor.

We are still contemplating an aggressive Christmas rally from lower / current levels = exciting!

ASX200 Index Chart

1 US & Overseas stocks.

This week we must again pay particular attention to US stocks as they were the leader / main catalyst for recent declines by global stock markets – no great surprise to MM with fund managers more than 20% overweight US stocks and in our opinion they’ve been used as a quasi-bond / safe haven = very dangerous concept to MM as subscribers know.

Our favourite of the many US indices over recent weeks from a clarity perspective has been the Russell 2000, the small cap index – it lead the US rally in 2018 and topped out on average a month before the S&P500, NASDAQ & Dow before leading the decline, over 12% to-date. By definition its likely to bottom first and ideally for us below 1500, or well over 5% lower.

We remain bearish US stocks targeting ~1450 for the Russell 2000, or around 8% lower.

NB We may consider taking profit on our BBUS ETF (short US stocks) around 1500 basis the Russell 2000 because of the risks of significant moves when a bottom is put in.

Russell 2000 Chart

Interestingly when we quickly look at the Australian Small All Ords it’s also in theory a relatively clear picture.

Technically the  index now looks poised to correct another ~2-3% but from a risk / reward perspective it represents a good buying opportunity.

Australian Small Cap Index Chart

Now moving onto the bigger picture for US stocks and after a very quiet week our view remains largely the same  i.e. lower before a potential rally.

The tech. based NASDAQ looks positioned for a year, or 2, of large sideways consolidation with an ultimate further ~10% downside a very distinct possibility.

NASDAQ Chart

Now lets turn our attention to European markets to see if we can find any glimmers of optimism. When we look at the different time perspectives for Europe hopefully subscribers can understand why MM may appear to be slightly “on the fence”, especially compared to our usual committed opinion:

Medium term the German DAX is within 2% of our targeted buy zone which has been in place for most of 2018 and would represent an almost 17% correction from Januarys high i.e. very close to turning bullish.

Longer term the French CAC is very close to suggesting a 20% correction is about commence.

On top of this we have BREXIT where a second referendum would not surprise, polls are now suggesting the voters have started to realise the true pain of the “Leave vote” – indications are suggesting the “Remain vote” is now over 15% ahead – watch this space.

Our position in Janus Henderson has been a real thorn in our side but its extremely hard to sell such a cheap stock that would probably surge ~15-20% on confirmation of a new BREXIT vote.

German DAX Chart

French CAC Chart

2 Continue to avoid the high valuation / growth theme.

Last week the market witnessed the savaging of another high growth story as Afterpay (APT) plunged on the news of a senate inquiry into their business model – the only question is how damaging will it be, not if!

As we’ve been repeating for the second half of 2018 “when stocks are priced for perfection the downside can be far greater than many comprehend”. This is a dangerous stage of the economic / stock market cycle for the high growth sector and we caution any investors in the area who have no got the stomach for rising volatility.

Afterpay Touch (APT) Chart

Lets just consider the high growth, but blue chip, stocks that MM holds in its Platinum Portfolio having bought into their respective corrections:

1 Aristocrat (ALL) – ALL has corrected 18.5% and trades on an estimated P/E for 2018 of 24.8x.

2 Cochlear (COH) – COH has corrected 17.4% and trades on an estimated P/E for 2019 of 38.5x.

3 CSL Ltd (CSL) - CSL has corrected 21.3% and trades on an estimated P/E for 2019 of 31x.

All 3 clearly illustrate what happens when the optimism elastic band stretches too tight and finally snaps.

We think its no surprise that last week both Cochlear and CSL fell while ALL rallied over 6%, simply this clean out wave of the higher valuation, “very owned” stocks is not over.

CSL Ltd (CSL) Chart

3 We believe banks are closer to the end of their correction than the beginning.

This title shouldn’t surprise many as CBA’s corrected over 30% from its 2015 making this hardly a brave call.

However with over 20% of the ASX200 being made up of the big 4 banks it’s always an important topic for over 90% of our subscribers.

After adding to our Westpac (WBC) position into recent weakness we hold 30% of our Platinum Portfolio in the local banking sector which is now clearly overweight but we continue to like our holdings at current levels.

Commonwealth Bank (CBA) Chart

The below chart illustrates perfectly the dependency on the share price of our banks to Australian housing.

If you found a positive note this week in any press around the local housing market you are certainly reading different papers / articles to me e.g. two on Saturday alone:

1 – “20% fall in property now likely” – Shane Oliver, AMP Capital

2 – “Property investor losses soar” – Australian Financial Review (AFR).

Owning property is in Australians DNA and while I don’t think many will argue that prices had rallied way too far I do feel that unless interest rates and / or unemployment increases strongly that many are getting too pessimistic. The pent up quality buying is percolating below the surface and it wont take much for the buyers to start meeting the vendors offer – our “gut feel” is ~10% may hold it as the banks / government who engineered this cooling off have absolutely zero interest in it gaining momentum from here.

The unemployment numbers were solid last week and when they’re eventually followed up with a few positive weeks of house auctions we reckon the banks will pop at least 5% quick smart, hence we read Domain news very carefully!

Australian Financial Sector v Housing Auction Clearance Rates Chart

4 The resources are coming to us slowly.

Just a quack note on the resources as it hasn’t changed much over the last 3-4 weeks, we are looking to buy weakness and the markets slowly coming to us, 3 of our potential purchases:

1 BHP Billiton (BHP) $33.10 – MM sold out of BHP back in mid-May at $34. The stock is closed around $32.70 in the US but still ~8% above our $30 target area.

2 Fortescue Metals (FMG) $3.88 – Iron ore has rallied 23% since March but FMG has fallen, we don’t believe this will continue, our targeted entry remains below $3.50 but the stocks cheap in our opinion at todays price.

3 Western Areas (WSA) $2.33 – Nickel producer WSA has been approaching our buy zone as it tracks the underlying nickel price in an exaggerated way lower, MM is looking to buy WSA below $2.20.

Western Areas (WSA) Chart

Conclusion

MM will be looking to massage our portfolio in line with the above views, until further notice we are buyers of decent weakness and definite sellers of reasonable strength until the markets clearly show their hand.

We are looking to buy resources into weakness with some of our underperformers potentially on the proverbial “chopping block” e.g. Healthscope (HSO).

Also we may look to take profit on our BBUS ETF (short US equities) into further decent weakness.

Buy (s) of the week.

We have 2 stocks that we like today that can be taken on as both investments or trades depending on a subscribers use of stops / leverage.

1 Invocare (IVC) $12.36

After being bearish and correct the funeral home operator for a long time we are now bullish targeting 15-20% upside.

We are bullish at todays price and for traders in particular we advocate stops under $11.70.

Invocare (IVC) Chart

2 Graincorp (GNC) $8.36

Another stock we have been watching for a while looking to gain exposure to Australian farming into the drought depressed prices.

We are bullish at today’s price and for traders in particular we advocate stops under $7.50.

Graincorp (GNC) Chart

Chart of the week.

A slightly negative offering but this lends hope to our lower targeted buy prices in the resources sector.

We are bearish the diversified metals / mining company targeting the sub $3.50, or over 7% lower.

South (S32) Chart

Our Holdings

Our positions as of Friday. All past activity can also be viewed on the website through this link

Weekend Chart Pack

The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.

Enjoy your Sunday

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 20/10/2018

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