Rudi: It’s the healthiest bull market we’ve seen in years

James Marlay:

Hello and welcome to another Livewire exclusive reporting season interview. My name's James Marlay, I'm a co-founder of Livewire Markets and I'd like to extend a warm welcome to all of our subscribers, readers, and viewers on this video. I'm joined by Rudi Filapek-Vandyck who's the editor at FNArena. Rudi, it's great to have you back. As I said, it's becoming a bit of a tradition at the start of each reporting season. And it's great to see you, so welcome to the video.

Rudi Filapek-Vandyck:

James, I'm happy to be back and I'm also happy to now see the inside of your house, which usually I don't get the chance to see that one.

James Marlay:

A few books collecting some dust. Now Rudi, last time we spoke in February, you said we were entering a new bull market and value is back. Since that time, the All Ords has rallied about 11% which is a good return. My opening question to you is do you think the bull market is healthy and where will the leadership come from if we're to continue to see a bull market from here?

Rudi Filapek-Vandyck:

As per always, there's always a context to things. Conclusion number one is financial markets never ask where you came from. They ask where you're going to. And all the reasons why I said we are in a bull market now, is despite all the bad news that we had last year of COVID pandemics, profit forecasts falling off the cliff, dividends being cut, capital raisings being necessary, et cetera, is that the truth of the matter is that the quick recovery, we don't have to go too much into detail there, but we've had an incredibly quick recovery in economies, which has fueled an incredibly quick recovery in profits and in dividends for corporate Australia, as well.

But it also has created a completely new dynamic for corporate Australia, and while we look at reporting season and COVID results, it's incredibly visible in those corporate results in how they compare towards market expectations, that there's a complete new dynamic in corporate Australia. And probably the easiest way to illustrate this is in late 2019, that was probably in August, and post August, that was probably the worst time of corporate Australia in all the years that I've been in Australia, which is more than two decades.

And according to some analysts that have data that go back to the 1980s, those data were worse than the 1980s. There's probably amongst the worst time for corporate Australia was the second half of 2019. That's even before the pandemic appeared, and what we saw back then is companies not being able to meet even relatively low expectations. We all forget this, but the banks started cutting their dividends back down. As did the energy companies and some other cyclicals.

And then the pandemic came along, and of course everything falls off a cliff. But that experience now and the subsequent recovery, and the fact that companies have used that experience to strengthen their balance sheet, to streamline the operations, et cetera, has now created a completely different dynamic. And now what we're seeing is that profit growth is surprising to the upside. You won't see it if you just look at the share price or the index, but forecasts in Australia are now rising for 11 months uninterrupted. That almost never happens.

That has created a completely new dynamic. Dividends in Australia are recovering at a speed which is probably never witnessed, and is the number one in the world now, in terms of recovery. And we're seeing that with the early indications, as well. The banks have already announced they're going to do some share buybacks. Those dividends are not quite back to where they were, but they are on their way, and we already had Rio Tinto paying out probably as much cash as they ever have done in the history of the company, including a bonus dividend with a promise of more to come in the second half.

I think one of the words we can use here is a super cycle in dividends, which is right here happening in Australia at this point in time. If you combine all of that, it should be no surprise that people like myself have now been talking about a new bull market that's started. If you basically say that the old one stopped in late '19 or early '20, otherwise it's just a continuation of, but this is a much more profitable, much more enjoyable, much stronger up turn to be part of as an investor.

Because the other one was pretty much crawling through the mud and you really had to be careful in which stocks you had in your portfolio. That is still the case now, but I'm sure we'll get there with some of your other questions.

James Marlay:

Before we get into the nitty gritty, we will talk about dividends and earnings in a bit more detail. I just want to briefly touch on the backdrop which is the bond market. Because when we spoke in February, we were seeing a peak, a rise in bond yields and effectively it's rolled off since then. I guess I'd be interested in your take on that. Does that mean that value trade that we saw ignited by inflation expectations is now over?

Rudi Filapek-Vandyck:

Again, context, very important, but just before I forget to mention that later in the interview, I do believe that the value trade needs the bond market to ignite it and to support it. And that gives you already the answer of why the value trade has basically deflated from about late March. No doubt about it, the bond market has pretty much surprised just about everyone and that includes myself, as well. Did I expect the bond market would go to 2% and just continue going up? No, definitely not.

But I also did not expect it would go this close to 1% back again, basically. We can all have lively discussions about what's happened in the bond market. I actually think there's probably a lot of sense to it. One of the reasons I believe is the relativity between bonds in Europe and bonds elsewhere. I think this is also a very new concept for investors, for most investors are constantly trained of judging and making a valuation call on assets on their own. And I think in the modern day environment, we have to make assessments on the relative basis.

In the share market, that's the relative basis between let's say for example, between Commonwealth Bank and the other banks, or between Afterpay and the competition. In the bond market, the same thing happens. It's having to make a relative call between low yields in the US but they are still positive, and low yields in Europe, which are becoming lower. And I think that's one of the reasons why the bond market has gone where it has gone, and it has had a massive impact on equities.

I've never been a believer that the value trade is ... That we are entering a new era of the value trade, but I'm sure, again, we'll talk about this later. I do believe we'll go through periods when the value trade is everything that happens in the share market and then it disappears again. We've seen so far that every time the value trade becomes popular again, it lasts about 4-5 months and then it sort of peters out. So far, that's basically the maximum that the value trade has been able to do.

James Marlay:

Rudi, I'm going to dive into your reporting season themes. Now, you've touched on a couple of them already. Two of the ones that you've touched on are surging corporate profits and dividends. I'm going to start with one that we haven't touched on so far, which is rising costs, and pressures. Could you talk me through why that's something that you think is interesting to watch? And maybe call out where you think it is most likely to pop up?

Rudi Filapek-Vandyck:

This bull market is very, very strong. Has been very, very strong, but it doesn't make people comfortable. You see that on many, many metrics, and with the data that we have at FNArena, as well, people always worry that the share market has gone too far. But what we see with the data that we watch for example, the difference between share prices and price targets, the difference between buy, hold, and sell ratings in the market, for example, this market is very reluctant in pricing it into the maximum.

There's a lot of question marks around this market, so we've now had the V recovery, V shaped recovery. Very strong, but we're very hesitant to go beyond this year, because we don't know what's coming beyond 2021. And you see that on many, many, many, many levels. Now, one of the reasons I believe is because we have this factor this year of transitory inflation. Now, central bankers talk about it all the time, there's a whole discussion of backgrounds happening.

What is transitory inflation? Is that the one that sticks around, or is that the one that goes up once and then stays there? Now, central bankers say it's the second part but it means we're not going to see a roaring forward of 2% inflation increase every year. They see it's transitory, and for that reason bond yields can stay low. We don't have to act as central bankers and the share market, all else being equal, should do quite well. However, if you have a rise in prices which are essentially input prices, like commodities and rent and other elements, companies are consumers of those commodities and they are paying rents, as well, et cetera.

One of the reasons I believe why the share market in a broad sense has been very reluctant in continuing to price in and continuing to forecast that those strong recoveries will simply continue, is because while the sales level might go up, the margins might come under pressure. Because as I just said, inflation has to go into somewhere. If it doesn't go into the margins at the companies, then it will come out of the companies. And traditionally one of the profitable investments in the share market is when a company enjoys rising margins.

Because your profit and growth accelerates. But obviously the opposite happens when your margins come under pressure. And the obvious questions that the share market's asking is for a lot of industrial companies. I mean, the likes of Amcor, Ansell, Orora you name it, because they all have to buy in commodities and then make a product out of it. But what we are learning as well, and this is the trick also, is that investors should not automatically assume that the producers of commodities are immune from this. And because we will see price pressure equally for the likes of Fortescue, BHP, Incitec Pivot, Orica, and you name it.

Ultimately it's universal. And where you will see it less happening is in those typical IT companies, services companies, software companies. Because they don't have to buy in oil, for example. As a crude example. That is one of the question marks that hangs over this reporting season, is investors will be watching this very, very closely and it's not that companies can't buy in product at a higher prices. They have to be able to pass it on. Again, that brings you again to quality companies that are market leaders in their sector, they have an ability to pass on price increases. If they have none of those three, they might end up in trouble at some point, and investors will be on the lookout for that.

James Marlay:

That's probably something for people to keep a really close eye on. You've touched on the strength of earnings. I guess just in terms of the dividends, you've touched on the headline dividend payers, banks, the miners, which are spinning out a lot of cash at the moment. Are there any areas where you think people might not be fully anticipating the dividends that are about to come out? Are there any under the radar dividend opportunities?

Rudi Filapek-Vandyck:

I think in the general terms, I mean, I've just looked across the market, I think most companies are all increasing their dividends. It's quite broadly carried where people can expect some specials from companies. Some companies are selling assets, as well, and have already sort of indicated they're going to pass at least half of it or more to shareholders. You have to think about the likes of Telstra, Insurance Australia Group, IAG. Iress is selling. Commonwealth Bank is selling, and they're definitely going to do something, as well.

BHP probably. We have Ampol, formerly known as Caltex Australia. We even have some REITs that are selling assets. Waypoint REIT, for example. On top of the fact that the cash flows are coming back, the profits are recovering, there's also asset sales happening. Special dividends, a lot. The term super cycle dividends is not easily applied here, and it will apply. It's almost a once in a lifetime experience that we have in 2021, because of course, I mean, this is not going to be repeating in every subsequent year. But this can potentially get a repeat again in February next year. I mean, it started in February. It's going to continue now in August and there will be a lot coming into the investor's coffers.

James Marlay:

This is your opportunity to draw on the database that FNArena puts together, which tracks the beats and misses of corporate earnings and I know you've just done a bit of an update on those companies that reported between February and where we are now. I guess the question is are expectations likely to be exceeded on average this reporting season? What's your assessment of the temperature? Do you think investors are likely to be surprised or expectations very poor?

Rudi Filapek-Vandyck:

That's an interesting one. I think the general context is changing, but we have to ... Like, to what extent it's changing. I think what we've seen over the past 6-9 months or so is that in the numbers are absolutely blown out of the park numbers. We usually don't see in Australia the same numbers as we see in the United States, where business leaders are very well trained to make sure they beat expectations in the market basically. This second quarter, for example, the number of companies in the United States that beats expectations is close to 90%, which is 89% something.

We never see those numbers in Australia. Like, absolutely never. I'm now doing this for 20 years. Australia is lucky if it beats by 40% or so. But what we are seeing over the past nine months is that we are operating at much higher levels. That's obviously you come from a low level, analysts are a little bit ... Don't want to go too positive, and we analyse from the outside, we don't go with what business are doing from the inside, plus the recovery has been much, much, much, much quicker.

What we've seen is that usually on an average, we have about 33, 34, 35, maybe 37% of companies that beat expectations in the reporting season. In the last reporting season which we just closed off on, the percentage was 55. Now, that gives you an idea about how much those numbers are well above average. Now, what are we going to expect for August? Because we now are in the 11th month of rising forecasts and now of course the question becomes will we see a reversal in February?

Because February, the reporting season was fantastic, but obviously expectations were much lower, because we came out of that recovery. Now expectations are quite high. We are all expecting a big announcement from BHP. We will not be happy if Telstra doesn't do something special. Expectations are high. One of the indications I think that maybe has gone unnoticed this time around, and you would know this as well, James, is that usually when we have a reporting season, what comes first is the confession season.

I remember in 2019 and 2018, confession seasons, that was something you would almost like be a little bit afraid of. You would hope that you were not in the market the months before the reporting season, because share price could tank by 30% or more. I think the best indication here is that have you noticed any confession season? I haven't. February didn't have one. So, I think the fact that the confession season has pretty much gone away, has gone really, really quiet, maybe that in itself is a very strong indicator of what we should expect from August.

Maybe this August season is too early yet to see reversal in that strong uptrend. Doesn't mean that we can't see it in six months' time, but maybe now it's too early yet. I'm not expecting that we are going to have a results season that is going to be 55% beats again. But I'm thinking it might still be higher than average, and the lack of confession season I think sort of indicates that we might actually be still for a very positive experience in August overall, I think.

James Marlay:

Very interesting observation. Now Rudi, this is your time to shine. You are the manager of the All Weather Portfolio. You don't need to go through each of them, but I thought I'd ask you to bring along a couple of stocks that you're going to be watching closely in reporting season. And maybe pick a few that you think could surprise on the upside and a couple that might surprise on the downside.

Rudi Filapek-Vandyck:

On the downside, yeah. It's always the left field one, isn't there? There's one thing I want to throw in first, because I realised I should actually emphasise this. You know when we spoke about dividends earlier? Just I think to illustrate the magnitude of what's happening this year is that if you look at the six months announcement from Rio Tinto, they paid out more in six months than they did last year, and the year before, over 12 months. Actually, you can combine those two years together and they will stay pay out more dividends this year.

That gives you something like an indication of how much that is coming from a company like Rio Tinto. I mean, the yield is more than 5% in six months. I mean, BHP is going to pay out something like three and a half, four percent, in six months, yeah? You're going to get that from the banks after 12 months. These guys are paying that out over six months. That gives you an idea of the magnitude of what's coming towards Australian investors. And of course, it's not going to be sustainable. One of the reasons why it's happening now is because nobody believes it's sustainable. That's why the share price is where it is.

Coming back to the reporting season itself, as people would know, I'm not the kind of guy who looks for beaten down stocks that are forgotten by everyone and that are only for six months in the hope that someone else comes along and gives me a big price for it, or it sort of revives itself and then I think I'm this big gun investor. I happen to concentrate on what I believe are high quality companies. There are some fast growers in there. And I actually recently noticed that quite a number of the stocks I own are near or at an all time high, which shows you that they've obviously done well.

I mean, that's the long and the short with it. Those companies in particular are going to have my attention. The likes of a ResMed and REA Corp, because I need to remain confident that those companies can continue performing and actually there are companies in there, like for example Pro Medicus which I still believe is one of the prime growth stories on the Australian Stock Exchange. But I recently sold it because the share price was very close to $60 and I thought you probably can't justify that. That's just too high.

With pain in my heart, I actually sold my shares. I remain on the lookout for a company like Pro Medicus, and if I would have to wish for this year, I would say well hopefully Pro Medicus comes out and people get a big scare and they sell off the share price, and then I can become a shareholder again. And that obviously goes as well for the likes of some of the other ones I've missed out on. There are companies on the smaller end that have my attention and that could potentially become something like a Pro Medicus in the years to come, and one of them I believe is Audinate Group and the company code is AD8.

I also owned that one. I've done really, really well. But out of portfolio management, I do not longer own that stock, but I would still be looking for that one. And that is a stock that could potentially do very, very well in years to come, but it is a small-cap stock, it's not profitable yet, and bond yields will have a big impact, if bond yields move at some stage. Which is probably equally important as well. We spoke a little bit about bonds, but what we saw last year in November is a very strong switch between value and growth, and growth stocks were sold off quite heavily and value was bought quite heavily.

I think in the second half the chances are that we might get a similar repeat of that, for the simple reason that the whole value trade has deflated so much, and bond yields are so important for that trade. Investors should be mindful of the fact that it's not all about corporate results and dividends. Post August, the bond market can have a big say again, and then stocks like a Pro Medicus or an Audinate, or an REA, they've all benefited now from the fact that the bond yields have gone the other way. They might get punished very harshly if the bond market decides to go up again, and there's quite a few people that expect that to happen.

Paying attention to companies in reporting season, it's not just out of the individual cases. You have to do it from a portfolio perspective, I believe. And in 2020, there's no better advice than to have a diversified portfolio that if bond yields move, that not your whole portfolio gets squashed, because you're on the wrong side of the trade. You have to take these things into account, as well. Other than that, I actually have very few stocks as it happens, who are a little bit of a market laggard.

But if I had to nominate two of them, I would nominate Amcor and I would nominate NextDC. And obviously again, I think it's up to NextDC again to prove the doubters wrong, and there's a lot of doubters out there. And Amcor, it's a bit of a strange animal. It gets thrown in with the growth companies when bond yields move and that's a bit strange of course, but I'm a big Amcor fan. I believe it's defensive growth at very high quality and dependability and predictability is something you do want to have in your portfolio. Especially when the tough times arrive, and it's a nice dividend. No franking, though.

James Marlay:

Final point, Rudi. I did happen to go and have a look at the CSL share price before our call, because I know it's a bellwether stock and something that you've followed for a long time. I know quietly crept its way the $250 level up towards $300. Give us a quick view on CSL.

Rudi Filapek-Vandyck:

Well, luckily you mentioned, I didn't want to mention it, because people think I always talk about CSL. Essentially the share price was sideways. I mean, it's $293 or $292 or whatever, along those lines again now. I mean, it has been above $300. It's very simple. CSL is one of those high quality companies, but its business has been impacted by COVID. And bad policies in the US. That is still the case and the market will want to see some indications. Like, how's that ... When is that going to be resolved? Et cetera. How's that impacted? When was the price increased? How is the virus operation performing given that AstraZeneca has unfortunately got a lot of bad press in Australia?

I mean, sometimes those companies go sideways. I see CSL is in a sideways pattern. But I still own it. It's still one of my largest holdings and I'm not too unhappy about things. If it wasn't CSL, the share price would have been clobbered, if something similar would have happened to one of the lesser quality companies. But I think sometimes people just have to be patient and I think in this case, one shouldn't expect miracles. It's very telling as well, that when analysts have to nominate their potential risks and surprises for the upcoming season, that CSL is mentioned on both sides.

And that's I think it's very typical, as well. A few other companies like that. Lendlease is like that. I think Lendlease is no longer quality, by the way. Seek is mentioned in that same, as well, so we'll have to see of course what reporting season brings. But it's funny that some people will mention those companies with conviction, like, "Oh, they're going to disappoint" and other people go, "No, no, I can see potential for an upside surprise" and that's interesting I think, at the very least.

In general terms, when people nominate potential disappointers for the reporting season, they usually are proven wrong because companies when they do have to announce bad news, they often can mix it with some positive news. Like, "We throw in an extra dividend" or, "We're going to restructure. We're going to lay off people." Often the news doesn't end up that badly, and in the past you have the perennial disappointers. You had QBE Insurance, for example, that was always disappointing for the reporting season. And you had Telstra which always disappointed for the reporting season. I actually think both now are probably going to surprise to the upside, and that too gives us an indication that the dynamics in Australia really, really are different from the past.

James Marlay:

Good stuff. Well, Rudi, that's a comprehensive download of your views ahead of reporting season. As always, great to catch up and thanks for jumping on the video.

Rudi Filapek-Vandyck:

Thanks for giving the opportunity.

James Marlay:

No worries. To all of those Livewire readers, I can recommend a great resource throughout reporting season which is the FNArena reporting season monitor. It's going to go up on Livewire every Friday afternoon throughout reporting season. It's a great way to find out which stocks beat and miss expectations. Great way to stay on top of your own companies, and I'll put a link to Rudi's profile at the bottom of this article so you can go and follow Rudi and that'll be the best way to stay in touch with the reporting season monitor. Rudi, thanks again for your time.

Rudi Filapek-Vandyck:

Sounds like a plan.