THINKING OUT LOUD

My year-end investing newsletter

See The Forest For The Trees

December 24, 2014

by Rob Zdravevski

The publishing of our last newsletter, dated October 7, 2014, coincided with an eight month low for the world’s major equity indices and since then (albeit over a very short period), the ASX 200 Index has risen 3%, while the S&P 500 rose 7.4%, Germany’s DAX advance 8.6%, the Nasdaq surged 9.1%

Our main message then was for Australian domiciled investors to invest more of their money in offshore equity markets as we see the risk reward prospects much more favourable in foreign markets than the slowing Australian economy and it’s over-priced equities.

The Australian Dollar seems to be entering a prolonged decline and so our concern is that investors purchasing power will erode. In the short-term, the Aussie Dollar is oversold and due for a bounce but I can’t see any higher than 0.91 in the next 6 months (and this is an extreme bet) for the AUD is in a new long term bearish trend.

Furthermore, our anecdotal amongst local investors suggests that they are convinced that the dividends of Australian equities can’t and won’t be reduced (see my blog post – Don’t Be A Yield Pig) and a steadfastness that housing prices can’t decline.

Interestingly, several folks have asked me for advice about whether its a “good idea” to borrow some more money against their already mortgaged house in order to buy another, so that the newly acquired property can rise in value too, and help pay off the first home mortgage. Offering advice against this sort of asset and strategy isn’t my bag, but I think you can guess what I think.

In keeping with our October 2014 view, we are still bullish but we are preparing for the frustrating zigzag where the market is just messing with ya for a few months into the 2nd quarter of 2015 before giving us cheaper prices.

Tailwinds in Equities:

The continued capital flow into government bonds coupled with countries taking a rotational lead in their quantitative easing efforts still supports the investing case for equities.

If you take into account that capital continues to flow into lowly yielding bonds, the equity market recovery of the past 4 years has occurred with relatively light volume and cash balances are at levels considered by many pension funds and institutions to be “under-invested”, the direction where markets could move in order to do the most damage seems to be higher.

Volatility & Overreactions:

Oil falls 40% in 2 month based on a lot of news we already knew. Russian sanctions, OPEC keeping a production status quo and rising U.S. Shale production & reserves. Some oil stocks and others related securities have halved in price.
Tactically, we have advised clients to buy shares in selected oil exposure or companies that benefit from a lower oil price, but we are wary that although we feel the shares in the companies we have bought are cheap, the Oil price is on the verge of entering a new long-term bearish trend.

Another opportunity occurred in early October when an Ebola case in Dallas sent the S&P 500 to an 8 month low.
Was that threat commensurate to the billions of dollars erased from various companies market capitalisation?

Time and time again, it’s an overreaction by investors who failed to stick to their guns (we didn’t sell our shares in Google),
but “Psst”, don’t tell them though ’cause we need those folks to throw away their assets to the patient ones who are waiting to buy them at cheaper prices.

It’s important to take advantage of volatility.

Paraphrasing one of my favourite investment professionals, Howard Marks; many of the great investments are made when they are trading at the extremes or edges and your better investments are often initiated at moments of great discomfort.

I think the coming year will offer us greater volatility.

I can’t wait.

My Holiday Tip:

Teach your kids about debt & credit.
Watching and understanding the credit (bond) markets will help you with your equity investing.

Presently, there are some warnings in the credit markets.

If you buy 2-year bonds from the governments of Germany, Switzerland, Sweden, Japan, France and the Netherlands, you will receive a negative interest rate. You will lose money holding these bonds until maturity. In other words, you are paying these governments (rather than them paying you) to deposit your money with them. At these sort of levels, betting on interest rates going lower is a marginal bet.

But other metrics tell us that the debt markets haven’t gone pear-shaped yet and instead some instruments are simply trading in a dislocated manner. This may be an investment opportunity, as prices are often mean reverting and it seems logical that rates will rise  but our view is the actual investment opportunity may not lie directly within interest rates but in the 2nd, 3rd or 4th derivative, where rising interest rates may benefit a company and its operational earnings. Perhaps an ungeared utility company ?

Finishing Up:

Amongst our clients portfolios, we have;

made some new investments in the UK and the US,
bought a couple oil related securities (Gazprom, BP & Beach Energy)
took profit in Microsoft, CME & Zoetis,
sold Alumina in Australia,
added to some selected existing portfolio positions (Graincorp, Adelaide Brighton, Zillow & Nielsen)
sold marginal holdings (Syngenta, Realogy & LVMH) where our thesis and basis of investment wasn’t giving us comfort,
and disposed all of our China, Singapore & India exposures,

Seasons Greetings to all.

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