The ONLY certainty next year is VOLATILITY. With the combination of populist political leaders and less “monetary policy morphine” from Central Banks, the ONLY outcome can be volatility.
I think November gave you a taste of things to come in 2017. In November, Donald Trump was elected President of The United States of America and the market implied chances of a 25bp rate hike from the US Federal Reserve moved to 100%. The result was unprecedented short-term volatility and major sector and stock performance divergence.
It’s worth remembering that at one stage in November, US equity index futures were halted limit down (-5%), in fact, the US S&P futures traded in a 9.3% range during the month. Kerb trading kicked in which only happens in periods of extreme duress. I’ve only seen US futures limit down three times in my 23-year career. However, less than 24 hours later, all those losses had been eradicated and capital losses started stacking up in bond markets.
Long bonds, as I have repeatedly warned you, did prove to be “return free capital risk”. Most major long bonds lost -6% in value in November and the total capital lost in bonds in November was $1.7 trillion. However, despite these capital losses, there remains over $10 trillion of bonds in the world still commanding negative interest rates. What this tells me is the bond bubble hasn’t burst yet, but the balloon has been pricked. I remain very cautious on all forms of long bonds.
My funds short position in long bonds were profitable for the month as were our shorts in equity bond proxies (healthcare, REITS, infrastructure). We remain short long bonds and bond proxies feeling that bond yields will continue to head higher over the next year. Along with the rebound in commodity prices, recent wage data out of the US continues to support the view that some inflationary pressures are building into 2017.
Inflationary pressure is bad news for long bonds. It’s as simple as that and inflationary pressure is building in the world’s biggest economy, the USA.
If we then decompose the S&P500 (SPX’s) +3% return since the US election by sector, a clearer picture of the drivers behind the US’s outperformance emerges. Financials have accounted for roughly half of the SPX’s gain since November 8, a far greater proportion than the sector’s 15% weight in the overall index (Chart 2). The 7% gain from industrials, meanwhile, has made up another quarter of the benchmark’s return.
The sizeable rally in financials seems appropriate, at least from a “fair value” perspective, given the significant move in the yield curve. The outperformance from other US sectors, however, is more suspect. The outsized contribution from industrials stocks has been driven primarily by infrastructure specialists (+20% since Nov 8), while copper miners like Freeport have also outperformed (+31%). Both groups have been buoyed by Trump-driven fiscal spending expectations. Yet both industrial stocks as a whole and copper mining shares have historically been negatively affected by a rising dollar. Something’s clearly got to give.
The stock and sector divergence has been stunning both globally and locally.
However, we all need to remember this is a macroeconomic view based rotation to cyclicals from defensives that arguably has gone too far. We are now seeing almost panicked buying of cyclicals and selling of defensive growth stocks.
My very strong view is that investors have moved too hard and too fast on the cyclical stocks, bidding them up, and moved too hard and too fast selling defensive or structural growth stocks as I call them.
For example, in Australia, my fund used price weakness in Aristocrat (ALL), Link (LNK), Star Group (SGR), Treasury Wine Estates (TWE), APN Outdoor (APO) and Ooh Media (OML) to increase our positions. We can see no fundamental change to the earnings outlooks for these companies. In fact, in some we have upgraded our earnings forecasts. All we can see is lower earnings multiples (P/E’s) for those structural earnings growth themes and we have taken advantage of them.
As an investor I must set the portfolio for 12, 18 and 24 months from today. Buying high quality structural growth stocks when they are “on sale” is a great place to start.
Quality is rarely on sale and when it is you need to buy it. Price is what you pay, value is what you get. In all the stocks I mention above you are buying structural earnings growth at what I consider very reasonable prices (PEG ratios for FY17).
Peter Switzer always gets into me for owning “sin” stocks such as gaming, alcohol and casino operators, so today I thought I’d reinforce my very positive view on a “respectable” industry, outdoor advertising.
I am really, really bullish on the Australian outdoor advertising sector for 2017 and beyond. My fund has large investments in the two key players in the sector, APN Outdoor (APN) & Ooh Media (OML).
This is a classic example of an investment idea you can see with your own eyes in everyday life. If you’re like me you check to see which digital and static billboards have “APN” or “OOH” on them. When you do this enough, you realise these companies have a wonderful duopoly and wonderful opportunity to generate strong shareholder returns as they upgrade their signs from static to digital.
Tailwinds in the sector are strong yet the two major players in the sector trade on P/E discounts to the ASX200. That is unwarranted and they will revert back to P/E premiums in the months and years ahead. The February results for both APO and OML should be the trigger for the start of that re-rating process.
It’s worth noting that the outdoor advertising segment is growing at double digits into the lucrative Christmas period. The Outdoor Media Association (OMA) has announced that out-of-home advertising revenue in Australia for November was $84.4m, +12.5% on the pcp. APO and OML are members of the OMA.
For 2016, year-to-date media revenue is $709m, +15.8% vs pcp. Digital penetration of the category continues to increase, accounting for 39.9% of total revenue in 2016 YTD, up from 27.7% in the pcp.
Across all segments, Retail, Lifestyle and Other saw the largest growth in November. The growth in out-of-home advertising will continue. This is structural growth in my view. The outdoor advertising industry will continue to benefit from adoption of digital technologies, presenting new revenue opportunities and increasing returns. The key benefits from digitalisation include increased yield and effectiveness, increased addressable market size, increased consumer engagement interactivity as well as customer growth.
Next time you’re stuck on a motorway, have a look at who owns the digital billboard you’re most likely watching. I am of the view APO and OML will perform strongly in 2017 and I encourage you to consider an investment in both stocks.
Next week I’ll finish the year with a highly speculative trading idea to fill your Xmas stocking with.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.