rob zdravevski's blog

Everything is OK. A 23 year low in the VIX.

A low reading in the VIX suggests little or less equity market volatility. It could mean that the world is OK and perhaps there is ‘smooth sailing’ ahead.

To the contrarian, a low VIX could be a signal of an expected reversal, whereby the VIX rises and investor fear increases. Often, such fear translates into declining asset prices.

23 years ago (December 1993) the VIX was trading at the same level which it is today.

Over the next 6 years, the VIX quadrupled. This tells us that volatility has increased but back then I don’t recall an overwhelming sentiment of fear.

How we read the VIX Index is not always the same.

How did the equity market react to a rising VIX?

Commencing in 1993 (with subdued trading volumes) up until 1999, the S&P 500 Index (see chart below) trebled in value.

In 1993, the markets were 6 years into recovery following the 1987 stock market crash and Bill Clinton was a year into his presidency. Incidentally, in December ’93, the S&P 500 was trading 43% higher than its 1987 pre-crash peak.

And it wasn’t until another 3 years (Dec ’96) until Alan Greenspan made his “irrational exuberance” speech.

Unlike, the 2008 -2009 spike in the VIX which resulted in a sizeable decline in equity prices, the 1993-1999 period was prosperous for equity investors, even though volatility was rising or at least it was according to the VIX Index.

On the interest rate front, even though the yield in the U.S. Treasury 10 year bond (see chart below) shows a spike in interest rates from 5.3% up to 8% between late ’93 and late ’94, interest rates resumed their downtrend trend down reaching 4.3% in 1998. While we saw fluctuations (volatility) in interest rates, it was interesting to note that the average yield over this period was 6.2%.

Even more so, the average interest rate over this 37 year chart is also 6.2%, as displayed in the data box in the top right hand corner of the image.

So, between 1993 – 1999, the VIX (volatility) increased, equity prices also rose and interest rates stayed low.

Today, the VIX is at historically low levels, we have subdued trading volumes (arguably with low investor participation), the S&P 500 is 8 years into a recovery following the 2008-2009 “crash” and its trading at levels 54% higher than the pre “crash” high.

It is plausible that interest rates continue to stay low, that the VIX rises from its 23 year low and equity prices climb.

After all, no one has made an ‘irrational exuberance’ speech.

Waiting for complete certainty means it’s too late

“. . . information generally follows the well-known 80/20 rule: the first 80 percent of the available information is gathered in the first 20 percent of the time spent. The value of in-depth fundamental analysis is subject to diminishing marginal returns.”

“Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.”

Source: Margin of Safety, Seth Klarman, 2007

4 year stock charts of major Aussie banks

Going wrong with Aussie banks

For investors in Australian banks, the stock charts (below) of the four major Australian banks (ANZ, Commonwealth, NAB and Westpac) show that over the past 4 years it has been possible to have either lost money or currently show a capital loss.

It all depends when you bought them.

It is concerning that retail investors often elbow their mates in the ribs and re-affirm that “you can’t go wrong owning bank shares”.

Well, yes you can.

As an extension of my recent post about the misnomer of “blue chips” being the major qualifier of asset quality and safety, these charts shows without any reference for fundamental valuation analysis that investors can do themselves a disservice by not being intellectually honest.

“So, you just stick with blue chips”

When I meet people and get talking about my business of being an investment advisor, it is a natural progression in the conversation that they ask about my investing and analysis style.

I start by telling them that I am a value investor. “Oh, like Warren Buffet!”, they respond. Well, “no” I say, because I’m not Warren Buffet for all the obvious reasons. I have a style and philosophy based on analysing a company, its business, their management, its products or services, the balance sheet, income statement, cash flows etc etc.

This helps me to build a basis for whether I investigate and analyse the company any further, let alone try to determine whether it’s current stock price is attractive enough to become a shareholder.

The listener, then usually responds with, “So, you just stick with buying the blue chips, don’t you”.

Here lies the shortcomings of many amateur investors. They think that buying “blue chips” circumvents the need to perform analysis. Many amateur investors just don’t do enough “work” prior to making investment decisions. This type of investor thinks that if you “just buy blue chips”, then you are safe and OK.

I can tell you that this is simply not the case.

In short, if you don’t buy your assets cheap enough leaving you with a margin of safety or error, then your capital is always vulnerable to a loss.

Being an investor who looks for bargains, means that you look for assets of any kind which present value. The asset or security doesn’t come with a pre-determined label of “blue-chip” or any other descriptor.

You can buy a house in a “dress circle” part of town, but if you pay too much, you can lose money.

Buying “Blue Chip” is not the saving grace when investing, if you pay the wrong price.

Separate interest rates for Western Australia?

I read a newspaper article which cited that borrowers in Western Australia may be disadvantaged by the interest rate policy being set by the Reserve Bank of Australia.

It was written that the RBA may be concerned about the rising property prices in Sydney & Melbourne and (in order to temper housing affordability issues) may influence an increase in interest rates.

The article then quoted a Western Australian property “expert” who expressed concern that any rate rise will hurt an already lagging and subdued Perth property market.

I think the author should have either asked the question or argued the point, “should Australia have more than one official Central Bank lending rate”?

Perhaps an even lower borrowing interest rate for those living west of the 130th meridian?

The (my) answer is no!

I do hope that the Reserve Bank of Australia isn’t placing too high of a weighting on eastern seaboard property prices when formulating interest rate policy.

After all, banking lending practices remain quite tight and I think alternative Australian lenders aren’t engaging in the worrisome practices of 10 years ago.

Credit may be historically cheap but lending isn’t loose yet. The RBA would be looking at status of the lending and banking markets rather than whether people are engaged in the greater fool theory in Sydney or Melbourne real estate.

(Un)commercial banking

So the cost of money has never been cheaper in Australia, yet commercial banks are not being commercial. My anecdotal reports tell me that they are reluctant to lend unless they have an abnormally high amount of security (collateral).

At this point, a bank should increase its lending rate when they are taking greater risk, but I am hearing that they don’t have the commercial ability to do so. Australian banks remain firm in their rules and as a result are not facilitating the credit requirements of smaller to mid sized Australian companies.

I could pick on another and greater offensive fact. The Reserve Bank of Australia’s official cash rate is 1.5% and Australian banks are lending money at 5% for home loans. This is 350 basis points above the Reserve Bank’s cash rate. Quite a juicy spread especially when its secured against bricks and mortar and your salary from your job probably counts on it too.

I would dare suggest that banks in no other developed world charge that high of a spread above the cash rate, than which the Australian banks do.

and the interest rates are much higher for business loans.

Oh… but here is NAB coming to rescue offering unsecured $50,000 business loans where “Your track record and the strength of your business is all you need to apply”.

for a friendly 13.85% p.a. interest rate.

It’s either time for Australian businesses to start courting cheaper foreign capital or Australian private funders, whether it’s other smaller companies or individuals who are willing to be the “bank” that the “uncommercial” banks aren’t prepared to be.

There are little new jobs

When a cafe opens up and claims they are creating 7 new jobs, this is actually not the fact. It is generally from the same labour pool that already exists in the immediate community.

This fact doesn’t vary too much should you see a new manufacturing plant being established, yet employers and embarrassingly so, politicians, claim the creation of new jobs. We need to remember that it is mostly existent labour transferring to a new workplace.

Does that mean new employment numbers when reported by the government are not true?

Probably so…

Market Views – December 2015

It’s been a while since I’ve written a note, mainly because markets have been so boring that there hasn’t been much of anything to say. Since this August, my time has been occupied with reading and thinking rather than making any notable changes to client portfolios, for there are times when doing “nothing” is the correct thing to do.

If you’re wondering what a boring, directionless equities market looks like, observe any of the major indices over the past year and you’ll get a quick idea. Such trendless markets do play a role in each cycle where markets literally pass time before its next trending move. 

Sideways markets can also frustrate investors who don’t accept the concept of allowing your investment to “work and mature”, not to mention adding the element of time.

To highlight such uninspiring activity, the total return of following indices (in their local currency) over the past 12 months have been;

ASX 200 1.1%

Hang Seng (4.1%)

Dow Jones 1.8%

FTSE 100 (3.7%)

It seems as if the equity markets urge to rise has been nullified by various global concerns.

It’s not 2007 and I’m bullish: 

Many signals, whether they are qualitative (such as geo-political tensions or central bank policy) or quantitative (negative sovereign interest rates and foreign exchange volatility) may suggest danger for global equities. Keep in mind that these observations are looking at the past and present and they disregard what will occur in the next economic cycle or more importantly, the next movement of capital.

Logically, the action and look of todays global equities market does remind me a little of how I observed them in 2007 however, markets and asset prices tend to move where they can do the most damage and presently that calls for higher prices.

I am still bullish on equities. 

Although this stance remains measured for it is accompanied by a heightened awareness of when to adjust and shift our asset allocation and the amount of money being exposed.

In other words, I think equities will provide an adequate return on one’s money when compared to the risk being taken when compared to other assets, whilst it’s not the time for the old “set & forget” attitude.

And we are not suggesting that we are going to “trade” the markets as this is not our investing style.

Today I see;

Multi-Year lows in various commodities such as Gold, Oil, Wheat, Coffee, Copper, Shipping Rates & Natural Gas,

Out-of-favour Emerging Markets,

Increased volatility in the FX market,

Negative 2 year debt amongst some European governments, 

Rising defaults in U.S. corporate debt and,

Investors who are acutely focused on the short-term.

I think;

Commodity prices will stay low for a further 18 months, albeit they are nearing the end of their longer term trend,

The USD continues to strengthen,

Over the long term, the AUD falls further to test the 0.65 region, 

In the interim, probability is rising for the AUD to move higher to 0.7850 but needs to break 0.7630 first,

The long term upward trend in the U.S. equity market is still intact,

Look for U.S. bond yields to rise and,

Gold continues to fall, pick a number….$900, then $750…..

But the “macro” only matters when you are actually trading the macro.

In our case, we focus on specific stock selection but unfortunately the macro tends to dominate and it weighs on many investing conversation and future strategy.

Watching Credit:

I have said many times, that if you watch and learn the credit markets, it will help you with your equities investing. 

Today, my analysis of the bond markets tell me that equities will go higher.

I believe that the U.S. bond market is at the beginning of a divergent shift as I look for yields to rise and with that comes the selling of bonds and that extra cash results in major capital flows into the stock market.

There is no reason to own government bonds. 

Capital Flow:

It’s quite amazing that the advance in global equity indices since 2010 has been on low and waning volume. In general, investors have been underweight equities and haven’t generally liked them and which has resulted in little capital has flowed into equities when compared to other asset classes.

Part of my thesis for calling higher equity prices is that I expect a greater flow of capital into equities over the coming year with European markets being a beneficiary, although this doesn’t necessarily mean that the Euro will rise.

Furthermore, bullish sentiment surveys remain at low levels, corporations have bought back huge amounts of stock thus reducing the amount of shares on issue and Mutual Funds cash balances are high.

Other things:

The US Dollar remains the king of the currencies and should continue to trend higher.

I think there is little reason for global capital to flow into Australian assets and or its dollar.

In fact, the ASX 200 is one a few major indices to be in an intermediate bear trend and on the verge of it becoming stronger.

A bit about us;

In the past year, we have been correct to lighten or exit positions in Australian banks and giant mining conglomerates whilst we initiated holdings in various industrial and cyclical stocks.

The “oil trade” has hurt our client portfolios, however our view is that the decline in the oil price is closer to finding a floor rather than commencing a new, longer, larger downtrend.

Finally, we are quite pleased with the performance our International Portfolios, simply cause those markets have offered better opportunities. 

Oh and here is the disclaimer, in case somebody acts on these words, becomes upset and tries to sue me,

Disclaimer

All information, terms and pricing set out in this document is indicative, based on, among other things, market conditions at the time of this writing and is subject to change without notice. This document is for informational purposes only and is neither an offer to sell securities, or other financial products nor a solicitation of an offer to buy securities, or other financial products. Mayfield Green Pty Ltd (trading as Karri Asset Advisors) “Karri”, its related entities and each of their respective directors, officers and agents (together the Disclosers) have prepared the information contained in these materials in good faith.  However, no warranty (express or implied) is made as to the accuracy, completeness or reliability of any statements, estimates or opinions or other information contained in these materials (any of which may change without notice) and to the maximum extent permitted by law, the Disclosers disclaim all liability and responsibility (including, without limitation, any liability arising from fault or negligence on the part of any or all of the Disclosers) for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from these materials. Any reader is strongly advised to make their own enquiries and seek independent professional advice regarding information contained in these materials. In no way shall Karri and its related entities be deemed to be holding itself out as a fiduciary of the recipient hereof. The recipient must independently evaluate any investment include the tax, legal, accounting and credit aspects of any transaction. Financial products and trading strategies of the type described herein may involve a high degree of risk, and the value of such financial products may be highly volatile and may be adversely affected by the absence of a market to provide liquidity. To the extent that this document includes any financial product advice, the advice is of a general nature only and does not take into account any individual’s objectives, financial situation or particular needs. Before making an investment decision an individual should assess whether it meets their own needs and consult a financial advisor, the product disclosure statement, prospectus and/or available research in respect of the financial product. Karri does not make markets in the financial securities referred to in this document. Karri and its directors and employees may hold such financial securities and may, as principal or agent, buy or sell such financial securities. © Copyright 2015 Mayfield Green Pty Ltd. All rights reserved. This material is proprietary to Karri and may not be disclosed to third parties. Any unauthorised use, duplication or disclosure of this document is prohibited. The content has been approved for distribution by Mayfield Green Pty Ltd AFSL 406083.