Welcome to April edition of the Burrell Blog for 2016!
Platinum Brisbane Presentation
Platinum Asset Management lead by Kerr Neilson and Andrew Clifford gave their regular six monthly presentation in Brisbane on Tuesday 26 April 2016.
The speakers noted that negative interest rates are now present in both Japan and Europe and that investors and markets need to adapt to interest rates being lower for longer. A graph was shown after extreme events in the 1930s and 1890s, interest rates stayed low for 20/25 years. A precedent was seen in the Japanese lower interest environment because Japan has experienced low interest rates for most of the last 15 years. The Platinum Japan fund has performed well over the period and the speakers draw the following lessons from the Japanese experiences:
↗ In low interest rate environments, the market will price growth stocks highly. However chasing growth stocks to extremely high valuations did not work. Rather the Platinum team sought stocks in the sweet spot with growth of 7% and price earning valuations around 20x. Stocks in this sweet spot had out performed.
↗ Secondly, stocks with strong yields performed in low interest rate environments as investors preferred higher divided paying stocks.
Thus growth at reasonable price (garp) and the dividend yield driver are likely key features in selecting portfolios. Other observations were as follows:
↗ In an overseas environment of low and negative interest rates, it is likely Australian interest rates will go lower.
↗ The USA stock market is the least attractive major market to be invested. On normalised earnings, Platinum calculate the USA stock market to be on 26x earnings and historically, the market has fallen from such valuations. The earnings per share (EPS) in the USA has been falling for the last 6 months and Platinum doesn’t see this recovering easily.
↗ While Platinum International and other Platinum funds carry some weighting to USA technology and some industrial stocks having attractive valuations, the majority of the portfolio is invested in Asia (42%) and Europe (23%). While the theme in the USA is technology leaders, the theme in Europe is banking, pharmaceuticals and consumer and in Asia, the consumer in China, Indian infrastructure and Japan self-help.
↗ In adopting a realistic view on China, not a sentiment view the Platinum portfolio managers are pursuing a strategy which is somewhat contrarian but based on valuation in investing in China and other Asian markets which are currently out of favour with investors. For example, the number of cars per 100 people is 9 in China as compared to 45 and 52 in Taiwan and South Korea, indicating growth in areas such as insurance.
↗ Globally, selected European banks have recapitalised and are forecast to pay high dividends. Again this seems to be a play which is contrarian but based on valuation as stocks are unlikely to trade at current levels if the dividend yields continue to improve in a low interest rate environment.
↗ Re the $A:US exchange rate, whilst the rate has moved up from 70 to 78 cents in the short term, Platinum see this reversing and going much lower in the medium term as the Australian economy continues to feel the tailwinds from the decline in resources.
↗ Negative interest rates and declining currencies are a positive for gold as investors carry gold exposure in their portfolios as a hedge.
↗ In respect to the oil market, the Arab nations are close to maximum production. US production has already declined from 10MMBL to 9MMBL per day. Platinum see oil recovering to US $65 and have been buying 1 or 2 stocks in the sector. They also note that despite all the exploration, the major US producers have not increased production over the past decade. Demand is continuing to increase particularly in Asia and so a more positive view of the oil price can be taken in the medium term.
The Platinum presentation was confirmatory on several aspects of the themes listed below. In terms of the interest rate cycle headwinds, the March blog noted the “lower for longer” message from Japan with negative yields on interbank debt and the US Fed declining to raise short term rates during that month. The Platinum presentation takes a more pessimistic view on interest rates. This makes it difficult for retirees and others dependent on an interest income. Your diarist commented in the March blog that “it seems likely it will be 2017 before there is any expectation of material rises in long term rates”. The Platinum commentary may well take any rise in long rates off the agenda in the foreseeable future. Short term rates may fall further.
Moving away from the above presentation, the S&P ASX 200 index rose by 400 points from 4909 on the 15th of December 2015 to 5319 on the 31st of December 2015. It then proceeded to give up all of this rise in the first few weeks of January 2016 as China corrected and fell to a low of 4765 on the 12th of February 2016. The dividend yield driver together with the reporting season gave investors confidence that a number of stocks in the Australian market were good value, particularly those with sustainable dividend yields and on the 21st of April 2016 the market achieved 5272, close to its 31 December level. The message in all of this is that while markets are difficult, Burrells recommendation is for investors to stay the course and to apply the usual investment principles supported by independent research and Burrell advice in managing portfolios. Be wary of the usual traps such as trying to predict the un-predictable. In the March blog we noted Glenn Stevens, Governor of the Reserve Bank of Australia gave a paper noting that virtually no one had predicted the move by Saudi Arabia in November 2014 to flood the market to increase the production of oil and that those who might now purport to predict such things probably really did not do so. Rather the challenge within these difficult markets is to look forward and in resources, to continue to ask the questions as to what might be the likely prices of the various commodities going forward and whether the current stock prices do reflect those commodity prices.
In terms of possible X factors, $20 oil seems unlikely and China has acted responsibly in terms of its economy. Factor A: US Stock market valuations and possible corrections remain the most likely cause of disruption, although in the context of a recovering US economy the issue is more around earnings per share growth and a lower GDP growth for the USA overall. A possible trigger for this would be something arising from the presidential election, although the most likely outcome remains a Clinton win rather than a Trump win and so the US markets have not particularly reacted at this time to the inundation of press concerning the USA presidential primaries.
Thomas Ross Burrell OBE, my father always commented “an election is an excuse for people to do nothing”. Casual discussions with SME businesses indicated this is indeed occurring. Investors may well be wise to take a tip from the above presentation and be a touch contrarian looking for stocks with good valuations, growth at reasonable prices and those with dividend yields to offset lower forecast interest rates. The best buying is likely to be prior to the July election, rather than after the uncertainty is resolved.
Themes for 2016
↗ Dividend yield driver
↗ Interest rate cycle headwind
o Central banks in different parts of the cycle
↗ Segment stocks in Burrell Universe into four segments
o Other high yield, but steady/lower growth
o High growth & sound business model, management, Balance Sheet, ROE > 10%
↗ Adopt a realistic view on China, not a sentiment view
o Markets wholly reactive to China as a proxy to demand growth for energy & mineral resources. There is relatively well developed themes so looking for inflection points in calendar 2016.
↗ US economy and the USD
↗ Digital disruption and competition
↗ Australia innovation stocks: medical appliances; global champions
↗ Weaker resources sector = lower A$ = Mergers & Acquisitions (M&A)
↗ Deloitte Fantastic Five: agribusiness, gas, tourism, international education and wealth management
↗ Property: more positive moves driven by low interest rates, demand and low valuations
↗ Possible X factors
A. US stock market valuations and possible correction
B. $20 oil
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