The ASX200 was up over 100pts last week, adding 1.85%. Banks recovered 4% (though still down 4% for the calendar year) ahead of “round 2” of the Royal Commission and Telco continued it’s slide, down 6%, pretty much caused a further fall in the market value of Telstra (TLS, -6.6%) – resultant from earnings downgrades post the strategy day. The top 20 stocks significantly outperformed the rest of 200, adding 2.45%.
If you are wondering what’s driving markets higher, it’s all about the USD. Below is a chart of the USD per AUD FX rate with the ASX200 over the past 12 months (daily). As you can see, the correlation is pretty solid and the out-performance of the ASX20 last week is further proof that this latest jump in prices is a result of foreign investment in our market.
Foreign money often flows into larger, more liquid names and comes in directly but also, indirectly via passive investment funds (ETF’s). The value or appeal for foreign investors is the same reason a strong AUD makes you think about going on holidays to New York. Buying power!
My thesis here is that international yield investors don’t want to own bonds as the prices have been, and look likely to further contract (yields going up) and they want some protection from potential capital loses as inflation rises in the US. It therefore makes sense that they start investing in stocks (which benefit from inflation) and the stock market with the highest dividend yield is Australia. The rising USD just makes those yield stocks even MORE attractive.
I’m still of the view the currency has another 5-10% to fall. Why? It’s pretty simple. Capital flows to where returns are greatest.
For near on 30 years, Australian bonds has offered a premium to the US bonds to attract capital. That changed recently, the US is now offering a premium to Australia and surprise surprise, the USD has rallied against the AUD.
The continued decline of the AUD, whilst supportive of some of our company earnings (CSL, AMC, Miners, ALL, RMD, SYD, QBE come to mind) it doesn’t necessarily mean our market will go higher. As always, it’s more nuanced than simply, “this happened, so therefore this must happen.” It’s about rates of change (as always!)
The Poker Table
This week, the University of California-Davis released a report on 35,000 poker players and high-stakes decision making. There’s a lot of parallels we can draw between poker and investing, though one finding really caught my eye:
Researchers said “People think poker players have a sixth sense or innate ability to detect people’s bluffs, but really it is just a combination of processing information to make better decisions.”
This is exactly the same in financial markets. People think that professional investors, fund managers, suits in the paper, famous hedge fund gurus… you think they have some knack. Some special ability or talent. THEY think they have some special ability or talent (in some cases.)
Reality is: They don’t.
Poker players, according the study, succeed because:
1. They accept uncertainty
Successful players (only 10-15% of players are profitable) realise the opponents cards are unknowable and regardless of the size of their bet, their facial expression or your knowledge of their prior behavior, you’ll never know for sure what cards they hold.
In markets, this is the same as accepting you don’t know what the share price will be tomorrow or the day after that. It’s understanding that you are never going to be sure, never going to be certain. Anyone who says they are is foolish or lying. This however doesn’t mean the best players don’t still have an advantage… that advantage is….
2. Process over Outcomes
The study finds that the best players are process-orientated over outcome-orientated as “outcomes and decisions are very loosely linked”. A good poker player can play a good hand perfectly well and still lose, a poor player and play a good hand poorly and still win.
I see this ALL THE TIME in the stock market. Investors confusing luck & skill, fooled by the charlatan promises of past performance. It’s the first question I get asked by new or prospective clients “what were your returns like last year?”. NEVER has client walked through the door and asked how I choose companies to invest in, never has a client asked to work through a case study with me.
You suck at investing because you don’t have a process. If you’ve made money, it was by chance. They only reason you still haven’t lost is because you haven’t made enough bets or played enough games or invested in enough companies or played for long enough yet to lose to those players with a process. This doesn’t even speak to those people who have a process and don’t follow it or have a rubbish process unsupported by adequate data.
[Challenge: If you have an adviser currently, ask them to walk you through the thought process around a recent stock recommendation. If the first thing they do is pull out a research note they didn’t write and point to the “buy” recommendation and a price target, you know they are a spud. If you want to play the game with me, feel free to give me a call (03) 8639 1601 is my direct line.]
Great investors and poker players are empathetic to their competitors plight. They realise that your opponent doesn’t know what you are thinking or what cards you hold. I try to understand why you’d want to sell the stock that I want to buy, my favourite question to ask myself/colleagues is “how could you/I be wrong?” What would this situation/stock price look like if the next most likely scenario plays out? Why would you want to sell this stock at these prices? What’s the opposing thesis or point of view? Like in debating, winning requires you to see both side of the argument.
Revisiting Seneca Quant
Speaking of process, I ran a little quant screen back in late-September and was tracking returns from 1 October. It’s a pretty basic algorithm that looks for quality stocks with earnings momentum. If you remember the portfolio was equal weighted across 5 stocks that were (CAR, CHC, GWA, PDL and REH). It ended up outperforming over 4 or so months by c.12%.
I thought I’d check in and see how the portfolio is tracking now AND WOW! Up 29% in absolute terms and outperforming the ASX200 by 17%. That is significant in just under 9 months.
This sort of process is exactly how we are selecting stocks today. We are looking for companies that can demonstrate certain characteristics, that we can observe are likely to be mispriced by others. We look to buy those stocks at a time when it’s likely that this pricing error will be corrected within our investment time horizon, so we incur minimal opportunity cost.
Again, the process here is key. If you’d only picked one company from the list of 5, and selected say, BT Investment Managers (PDL) you’d have under-performed, losing 5% of your capital.
If you’d selected GWA Group also under-performed for the first 5 months, before adding 48% from February to its peak in May.
All I’m saying is, don’t evaluate advice on 12 months and certainly don’t evaluate someone else’s advice if you don’t take 100% of it.
A few big moves this week
Blue Sky Alternatives bounced (not that it will help shareholders out too much at this stage) whilst Nearmap (NEA) continues on it’s merry way. Canaccord upgraded it’s price target today and Morgan Stanley are still bullish. Kathmandu upgraded earnings guidance this morning, APO under takeover, IDP Education (IEL) seems to have a stranglehold on english language testing whilst HT&E (HT1) seem to have come to agreeable terms with Ooh! Media (OML) to sell Adshel for $570m.
Hansen (HSN) gave up 9 months of share price gains in 1 day on Friday on margin pressure, a key customer loss and weak guidance. I’m very aware of how quickly IT services businesses can accelerate and decelerate and hesitant to pay overs for growth opportunities. Similar to mining services or other contractors, you just need to be careful with the price you pay for the growth you assume.
Ramsay (RHC) also had a minor downgrade which confirmed the suspicions of some in the market about hospital volumes and growth. RHC’s history of delivering fantastic shareholder returns and the defensive nature of the health sector has resulted in a pretty high ‘steady state’ PE for RHC (median 21x with 16% yoy growth).
Over the last 5 years, RHC has been growing slower than in the past and next years earnings are only forecast to be 5% higher than this year. This has resulted in a de-rate of the valuation, back to more ‘market multiple’ type areas. RHC still a high quality business but just a good example of what can happen to a share price when growth slows.
Have a good week,
The information contained in this email is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.