Buy Side Brief: What's the most crowded trade?

The ECB has mismanaged the Euro financial system

John Abernethy, Chief Investment Officer, Clime Asset Management

Long European bonds – we do not deal directly here but acknowledge that the ECB has mismanaged the Euro financial system. The delay in undertaking QE and the flagging of the purchase of negative yielding bonds created massive front running. The ultimate result has been a rapid expansion of PERS in European stocks (mainly German) that suggests that our offshore portfolios need to remain underweight to the German equity market. Its recent 8% correction is telling

Caution on the 'offshore earners' 

Tim Hannon, Chief Investment Officer, Freehold Investment Management

Despite our view that a lower Australian dollar will assist in turning around business confidence, the market may already be factoring this in. Investors seems totally enamoured with the ‘offshore earner’ trade and are pricing it richly. We are always concerned when a theme gets its own special name (much like the ‘yield trade’), and it seems to us that the ‘offshore earner’ theme is very crowded and could be subject to a reversal if the Australian dollar does not decline as rapidly as the market appears to be factoring in. Furthermore, investors need to ensure they are discerning as to the type of offshore earning company they invest in. The positive exposure of a falling Australian dollar could well be offset by poor stock specific fundamentals. This risk is further exacerbated if the investor has already paid a hefty multiple for the company. Overall, we suspect if investors want exposure to a falling Australian dollar, they should invest directly offshore, rather than crowding in to what seem very expensive ASX listed ‘offshore earners’

Bearish AUD - Fashionable doesn't mean profitable

David Poppenbeek, Head of Australian Equities, K2 Asset Management

It is currently very fashionable to be bearish the Australian dollar; especially since the Australian dollar has underperformed the US dollar by 17% over the past 9 months. As a result, one of the most crowded trades at present is to be long off shore earners such as CSL, Resmed, Brambles, James Hardie, and Amcor. These 5 stocks have delivered an average total return of 28% since September 2014 whereas the broad market has generated less than 4%. In addition, these 5 companies are currently trading on an average PE of 22x.This is not a place where we want to be positioned. We are mindful that (i) over the past 6 weeks the number of short positions on the A$ has declined by 42% (ii) Chinese economic activity should respond to 3 rate cuts and the wealth effect following a 45% surge in the domestic equity market, and (iii) the price of oil and iron ore are up 41% and 11% from their respective lows in March of this year.

The most crowded trade - short FMG - and why we would not want to be short

John Deniz and Nick Reddaway, Paragon Funds Management

Short FMG. The street has become increasingly bearish on Iron Ore and FMG given its levered balance sheet, with sell side analysts now seemingly competing to downgrade their Iron Ore price forecasts after a 70% fall from its 2013 high. Indeed Iron Ore is an oversupplied market and now in surplus. The Seaborne Iron Ore market is ~1.6btpa, which only recently had annual deficits of ~50mt. As the lowest-cost majors Vale, RIO and BHP continue to materially expand production, the Seaborne market was projected to swing into material surplus’ of ~200mtpa+ by 2016. However if Iron Ore were to fall below recent lows of US$47/t (or hit US$35/t as some pundits were calling for), you would see material supply curtailments and the industry correct itself. In our view Iron Ore bottomed in early April (its price having bounced ~34% off its lows) and FMG bottomed soon after, when it refinanced its near term maturity debt. With FMG liquid, solvent (no debt due til 2019), achieving ongoing cost reductions, a shift from “ongoing major expansion mantra” from the majors, falling China port inventories and China Steel Mill restocking underway, and FMG still being one of the most highly shorted stocks on the ASX (ie. a massive short squeeze candidate), we would not want to be short FMG. In fact we went long at $2.11/sh on the 23 Apr 2015 for these very reasons. More detail can be found here (VIEW LINK)