Rudi: It’s a new bull market and Value stocks are back
It has been one way traffic for nearly a decade in the value vs growth debate, and betting against those growth darlings has been a painful, frustrating and costly experience. Rudi Filapek-Vandyck is a keen observer of share market trends, having set up FNArena in the early 2000s, he has dedicated two decades towards analysing the plethora of sell side research that gets pumped out each year.
As recently as last August, Rudi told me that frustrated value investors should expect to remain just that for the foreseeable future. So when I spoke with him earlier this week I was interested to learn that he had changed his view, at least for the rest of 2021. Rudi says that the early signs are pointing to one of the best reporting seasons we are likely to have seen for a long time. Dividends are back in a big way and value stocks should continue to enjoy the recent time in the sun. He is also of the view that the pullback experienced in 2020 has kickstarted a new bull market.
In this interview, Rudi talks me through his initial observations for reporting season, why he has turned bullish on value, and some of the stocks he will be following closely as reports start to drop.
- Why this reporting season will be unusual
- Rudi explains why he thinks a new bull market has started
- How he is thinking about current valuations and what that means for finding opportunities
- The headwinds that are blowing against 'market darlings' as bond yields rise
- The stocks Rudi is following closely this reporting season
- An incredible statistic for Livewire readers
Click on the player to watch the interview or read the edited transcript below.
Well Rudi, let's get straight on into it. What are some of the most important things investors need to be aware of as we head into reporting season?
This is going to be a very unusual one. We’ve got some very high perceived valuations for equities globally. On some traditional metrics, stock valuations have probably never been this high, not for at least 100 years.
And on the other end, we had a very brief but very sharp recession in 2020, and the market is positioning for a very sharp recovery this year. And for that reason, we’re probably headed into one of the best reporting seasons Australian investors will have ever seen.
The irony here is that prior to the events from 2020, the pandemic and the recession, corporate Australia was actually cycling some of the worst reporting seasons that we at FNArena have ever recorded. And they were definitely among the worst reporting seasons post-GFC.
So, it’s ironic that we might have forgotten – living in Australia, where we hadn't had a recession since the early 90s – but a recession is actually quite good for the so-called value aspect of the market. And it actually triggers a new bull market. And we are in the middle of a bull market here.
From the depths of March 2020 to where we are now, you think a new bull market has been kick-started?
Yes, that definitely appears to be the case. And what is very, very important here is that some of the trends that we saw pre-March 2020, for example a decline in dividends in Australia, in 2019 corporate Australia was one of the few countries where dividends had started to decline. And that decline obviously accelerated in 2020. But that's one of the major reversals we’re about to experience this month, and again in August.
From a dividend perspective, 2020 will be a bonanza. We will have the return of dividends for a lot of companies that had to wipe them away last year. Those who had to cut their dividends last year will see them increase. In one example, comparing back to last year, bank dividend yields from current share prices should almost be back to where they were pre-pandemic, and that is quite a remarkable turnaround.
After the RBA announcement last week, rates have been effectively pegged at 0.1% for the next three years, with more stimulus in the pipeline. How do you reconcile that backdrop against what you're saying is a new bull market? It doesn't sound like we're in the healthiest economic environment and therefore conducive of corporate profits and bull markets.
If you look at corporate profits, a completely different picture is emerging, one that’s very similar to what we saw after the bear market of 2008. Basically, analysts’ forecasts are too low. P/E ratios don’t tell the whole story, and companies are more likely than not to surprise to the upside with their financial performances, including everything on top of this, like dividends.
This will keep the positive momentum going for global equities. In January, for example, it looks like markets were getting bit overheated, and it might actually be time for a correction. But as this corporate reporting season draws closer – and in the US, of course it's ongoing – the numbers are absolutely staggering. The end of February will be staggering, I believe. And that's why I say this is going to be probably the best reporting season we, any of us, have experienced in our lifetimes. And that's apart from the valuations, which should keep positive momentum under the markets.
You said earlier that markets look expensive. Are there any specific sectors where you think there's likely to be big opportunities to the upside?
On valuations themselves, I hope investors are by now aware that low interest rates basically create higher valuations for equities. This is particularly true for the Growth and Quality segments, not so much for Value.
The other element is that we have to understand how price-to-earnings ratios actually work, if we’re going to understand why markets look as expensive as they do today. And I think the best example to use for that is the experience of BHP Limited (ASX: BHP) in 2015 and 2016. You see, when the BHP share price tanked to $13 briefly in early 2016, the P/E ratio rose to 80. That's a very high P/E ratio.
Initially, that doesn't make much sense. Because BHP had to give up their progressive dividends, the market was really punishing it, and commodity prices kept on dropping. So, both profits and dividends would be cut quite dramatically.
But the reason why the PE ratio rose so high is because the market correctly assumed this situation wouldn’t forever, that a recovery lay on the horizon. And of course, in hindsight, we've all seen that the recovery arrived, and BHP has now tripled its share price. And the profits and dividends, of course, have gone the same way.
More broadly, the share market is in a similar position now. We had the drop in 2020, and we are now banking on the recovery of 2021. And that's why, by definition, P/E ratios have to be high, and that's why they look as high as they are today.
The main danger is that the recovery isn’t as strong or as quick as markets are currently pricing in. Reeling back to the reporting seasons we've now seen in Europe, the United States, and now ongoing here in Australia, they’re all suggesting that these P/E ratios, these valuations are not too high for equities, and that they are justified. This is because corporate results are presenting as better than expected, and analysts will have to recalibrate their forecasts higher.
It's all about sustainability. Later in the year, we’ll also have to figure out whether it's sustainable on the back of that economic recovery that should be ongoing.
Can you name some of the stocks where you think the sell-side is most bullish or bearish, or where you think the biggest adjustments are needed?
This remains a polarised market, and the irony is that in the background you have bond yields, which are affecting the market's behaviour and the overall dynamic. The 2021 reporting seasons will continuously evolve against a background of the bond market, whatever's happening there. And the fact that bond yields have been rising for around the last half-year has created an upside-down dynamic in the share market.
By this, I mean that yesterday's winners, the super-performers – Quality stocks, the technology stocks, the structural growers – they are now facing headwinds. This is because bond yields have moved higher, and those stocks that couldn't catch a bid previously, including the banks, resources and mining service companies – the cyclical industrials – they are very much in favour this year. Bond yields are a key reason for that.
Now, when you asked me about certain segments of the markets, there's two interesting elements to note here. The numbers that have come through from European corporate profits and from the US look very, very high. In terms like in Europe, it's about 65% of businesses have done better than expected. In the US it's around 80%, which is quite high. Now where it gets interesting is that the reporting season we had in Australia after August before this one, it doesn't get much airplay, but there are companies reporting in that season, that already gives us a little bit of an insight in how February can be. The number of beats, so to speak, is considerably higher than the average of all the reports, well based on every reporting season we have recorded so far. On our calculation, 49% of all businesses that have reported between September and December beat market expectations.
I'll give you a statistic so far, because the February reporting season is quite young, but we've already seen a number of companies reporting.
The number of companies that have reported better than analysts’ expectations so far in February is 70% in Australia. In all the years I've done this I've never seen a reporting season starting off this high.
So if those numbers correspond with what we've seen overseas, that's why I said at the very beginning of this interview, we might be at the very early stage of a tremendous reporting season, where most companies, if it's not two thirds, it might be close to it, will basically force analysts to revalue their businesses and to rethink the valuations for those businesses, and that all else being equal, bond yields et cetera, should keep a positive sentiment in the market.
However, and here is where the polarisation comes in, already from early observations in this season, I've noticed for example, that ResMed or Amcor that have both have done better than expectations have not been treated in a similar fashion as has been in REA Group or James Hardie or as Credit Corp and Pinnacle Investment Management. So and Macquarie, which I found very, very remarkable, when Macquarie reported this week that in the United States, out of all the COVID winners, 82% has beaten market expectations over there, but they have on average not performed that well, and out of the COVID losers, so basically the banks, the cyclicals, only 50% have beaten market expectations over there, but they have in majority being treated better by the market.
And I think that's the message for investors here. The likes of ResMed, CSL, Carsales, all the winners from last year, they have to work harder, potentially for a lesser return in 2021. Of course those long secular trends will not go away. It's just that for the time being the market is very much focused on the losers from last year and potentially seeking protection from higher bond yields.
You told us last year that Value investors’ frustration would continue, which for most of last year was right. Of course, the last quarter we saw that rotation into Value. Have you now changed your view?
Yes, they're definitely having their moment in the sun right now. And I think it is plausible this will stretch to longer than a moment. I'm still a believer that bond yields will remain lower for longer and that we will have predominantly low inflation. And I definitely do not see the disappearance of the structural trends we saw before the end of this year. But, for the time being, all those considerations are in the background, and the market's focus is somewhere quite different.
The market never runs in straight lines. Last year, I also said that the gap between Value and the Growth and Quality part of the market had never been as high. And such a large gap, I think, was always going to correct. It can't just go in one direction.
We are now seeing a normalisation in the relationship between Value and Growth.
What stands out, from some of the recent research you’ve been reading, as being particularly useful or insightful for our readers and viewers?
It's very important for investors to understand that you don't have to perform incredibly well to still get a big reward this year – that’s whether you’re James Hardie, Incitec Pivot, Emeco Holdings or an Imdex. The market is on your side.
But if you are ResMed this year, or you are Amcor or CSL, you have to work really, really hard, and you may not get the same reward as those companies I just mentioned. That's what Macquarie picked up from the recent corporate results out of the United States. And I’ve already observed this in the early stages of this reporting season.
Investors need to understand that there’s not necessarily anything wrong with the Growth companies in their portfolios. But for the time being, the market's focus is literally on a different spot.
What companies are you following really closely, where you have very high or low expectations?
It's no secret that some parts of the markets are really going through a very strong operational momentum. For example, the buy now pay later sector. Discretionary retailers are another one, along with housing-related exposures, both on the side of Domain and REA as well as James Hardie, CSR, and Brickworks.
It’s the very large core of companies most leveraged to consumer spending that I’m watching. And that varies from a Bapcor on one side to Super Retail Group, Harvey Norman and even the Woollies and various other retailers. Those are the companies tipped to do very well this year, on top of the usual candidates including the banks and mining stocks, who are facing some very high expectations.
Iron ore producers are still swimming in cash. And for the first time in a very long time, energy producers are too. But I emphasise that I'm a firm believer that the energy sector is now facing a structural decline in the decade, but this situation now signifies that the market often lives in the moment. And for now, the prospects and the expectations for the energy sector are positive. It doesn't mean that a stock like Woodside or Santos will in 10 years’ time be where they are now. But the chances are very high that in six months, they might be at a higher level.
And I'm very much focused of course on stocks that I own. And those stocks include, for example, IDP Education, which to my surprise has started rallying quite strongly. This is probably also because it was mentioned by some stockbrokers as a prime candidate to perform in this season. And I've structurally moved away some of the money I manage from yesterday's winners into what I think might be this year's winners, and that includes stocks like Aristocrat Leisure and Super Retail.
But also, for the first time in a long time, I'm back on board with Telstra. I actually believe that is an example of how a structurally challenged industrial firm, where they just can't make it work, can still drive shareholder value by essentially “selling off the farm”. And you will remember that last year, I published a story on Livewire where I predicted that both AMP and Telstra would not see out the next decade in their current structures.
Well, AMP has now basically been rescued by selling the farm, putting themselves up for sale. And Telstra has now decided that that's the way to go as well.
It shows that, especially for dividend investors, if those dividend stocks have no growth under their belt, they face quite severe headwinds from rising bond yields. So, you have to think about your usual yield that only has a little bit of growth. You might get a 6% yield, but you might also face a 6% fall in share price. You're actually on a zero operation there, at least for this year. If you are looking for yield or income, my advice since January has been to look at industrials that pay dividends, and that have more growth under their belt. Financials may also be included here, of course, so Telstra and the banks are back in focus this year.
Rudi, our readers love following a good statistic. And given we are talking about reporting season, and that is one specialty of FNArena, could you share an incredible stat about reporting season that's caught your attention?
I mentioned earlier the 70% of companies that so far in the season are beating expectations, that is a tremendous figure in Australian context. We never do as well as the United States that regard.
Another number is that, so far, average price targets for those companies are up by 9.5% this month. In aggregate, they're actually up by more than 13%.
It has never been higher than 7%, that came during the most fantastic reporting seasons we’ve had since the GFC. This one goes well beyond that, further fuelling the sentiment that we are facing a very, very favourable February.
3.5% is yet another statistic. Because we’ve had so many dividend cuts, that’s the average dividend yields decline for the ASX 200 this year.
That figure used to be 4.5%, or 4% when markets got a little hot under the collar. On current forecasts, we may not get back to 4% until next year, not even this year.
There's a long way to go until we return to the levels of 2019, but that won't stop the share market from taking the positive instead of the negatives. And it means we are growing, and that's everything the share market needs to know at the moment.
Right, well thanks, Rudi. I'm going to have a quick go at summarising some of the views you've given us.
Number one, you think we're in a new bull market.
Number two, broker earnings expectations, the analysts need to upgrade those that haven't been upgraded yet, so you think that's going to be a generally positive for reporting season.
Bond yields in the background are having a big impact so the winners of yesteryear might have to work harder for returns. And you think that that value trade has got a little bit more to go in it.
And from across the board, what you've seen, you've seen the highest level of beats versus misses than you've seen in quite some time. So, you think overall with rising dividends, low expectations and consistent beats, things are looking pretty rosy.
And it will be a very polarised market in the end.
Rudi, thanks for jumping on the call. For Livewire readers every Friday on our website, we're going to be publishing a great bit of analysis that Rudi does where he summarises the stocks they've reported over the past week, whether they beat, missed or came inline with analyst expectations. That'll be up under Rudi's profile on the website every Friday throughout reporting season. He covers more than 300 stocks so it's an amazing resource. If you enjoyed this video, subscribe to the channel, we've got lots more great content coming up and give it a like. Rudi, thanks again.
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