Monthly Archives: September 2018

Taking the market’s temperature

Bonds yieldsShelby Davis, one of the greatest value investors you’ve probably never heard of, who in 47 years turned $50,000 into a $900 million fortune, said: “You make your money during bear markets – you just don’t know it at the time”.
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In my experience the inverse is also true. We make our biggest mistakes in bull markets but we don’t know it until the market turns ugly.

So with the All Ordinaries Accumulation Index up 111 per cent since the lows in March 2009, let’s use Howard Marks’ Poor Man’s Guide to Market Assessment discussed in his book The Most Important Thing, to see what action we should be taking.

Poor Man’s Guide To Market Assessment

(1) Economy: vibrant/sluggish. Australia’s economic growth is tipped to be slightly below average over the next few years but we’ve ticked “vibrant” as the economy is performing relatively well, even though it may not feel like it.

China is still growing strongly thanks to renewed stimulus, official unemployment isn’t far off record lows and low interest rates are reducing debt repayments.

(2) Outlook: positive/negative. Bill Smead of US funds manager Smead Capital Management says: “In the latest week (October 21-25), individual investors, as measured by the American Association of Individual Investors and investment newsletter writers, as measured by investors’ intelligence, were bullish by nearly a 3:1 ratio to bearish”.

(3) Lenders: eager/reticent. In March last year interest rate comparison website RateCity warned that nearly 70 per cent of lenders were accepting mortgage deposits as low as 5 per cent. The competition has only heated up since then.

(4) Capital: loose/tight – see (3).

(5) Terms: easy/restrictive – see (3).

(6) Interest rates: low/high. Rates are at record lows, which is usually not a good sign for shareholder returns.

(7) Spreads: narrow/wide. Junk bond yields have fallen to record lows below just 5 per cent (see chart).

While defaults are very low, there’s no margin of safety if bankruptcies or interest rates increase.

(8) Investors: optimistic/pessimistic; sanguine/distressed; eager to buy/ not interested in buying – see (2).

(9) Asset Owners: happy to hold/rushing for the exits. Not only are passive owners happy to hold, but the initial public offering market has sprung to life as private equity groups and entrepreneurs take advantage of investors prepared to back companies with short histories, leveraged balance sheets and few competitive advantages.

(10) Sellers: few/many – see (9).

(11) Markets: crowded/starved for attention. Many individual investors have shunned the market since the global financial crisis, with 38 per cent of Australians owning shares. Of those, 34 per cent are direct investors, down from a peak of 44 per cent in 2004.

Things could be changing though. Perpetual recently recorded its first inflows for a while, and investors fed up with low interest rates may be jumping back in to the sharemarket to avoid missing out on further gains.

Institutional investors are also increasing their weighting to stocks and we’ve heard that local small-cap managers are winning mandates, which is a sure sign of bullishness.

(12) Funds: hard to gain entry/open to anyone. I chose “hard to gain entry” as hedge fund managers Seth Klarman and Dan Loeb are returning funds to their clients due to a lack of attractive investing opportunities. I’d weight their actions over just about anyone else’s, given their remarkable records with large sums.

(13) Recent performance: strong/weak. The All Ordinaries Accumulation Index is up 36.4 per cent over the past two years.

(14) Asset Prices: high/low. From art to stocks, asset prices across the board are being inflated by low interest rates.

(15) Prospective returns: low/high. In an article republished in the US with the headlines “Market valuations are obscene” and “The stockmarket will probably crash”, US fund manager John Hussman recently calculated that “virtually every reliable measure of market valuation we observe is now within the highest 1 per cent of historical observations prior to the late 1990s bubble.”

In Australia, Perpetual reportedly calculated that the price-to-book ratios of the big four banks have breached levels from the tech boom and before the global financial crisis.

(16) Risk: high/low. Marks recounted earlier in the year that in his career the list of risks had never been so long.

(17) Popular qualities: aggressiveness/caution and discipline. I picked aggressiveness as margin loans have been increasing despite remaining well below pre-financial crisis levels. With the amount of money flowing into property, many individual investors scarred by the financial crisis may end up swapping one bubble for another.

More importantly, though, institutions have been taking larger and larger risks as interest rates have fallen, particularly in the fixed-income markets. This could be another bubble waiting to pop.

What to do

Marks advises that for “for your performance to diverge from the norm, your expectations – and thus your portfolio – have to diverge from the norm, and you have to be more right than the consensus.”

First, that means you need to avoid highly valued, popular stocks. The best margin of safety is a cheap valuation and, right now, just about every high-quality, high dividend-paying stock is achieving record highs with regard to price and valuation.

Second, don’t lose your discipline and invest in poor quality stocks you wouldn’t normally consider. However, keep an eye open for average stocks priced cheaply because of short-term quality concerns.

Caltex is a good example of an ugly duckling that should look more like a swan in a few years, as its retail fuel business grows. Profits and cash flow should also become more predictable once the Kurnell refinery closes.

Third, control your portfolio limits. Don’t risk your wealth by getting overexposed to particular stocks or sectors.

Fourth, don’t get sucked in to chasing stocks as they climb, and let valuation and a decent margin of safety temper any greedy thoughts.

The time to be aggressive was in 2009 and 2011. Now’s the time to ensure you hang on to your profits.

Fifth, don’t be afraid to build your cash holdings. Billionaire investor David Tepper recently told a class of graduates that even in a world of derivatives and complex securities, cash was the best hedge against uncertainty.

His fund is 40 per cent in cash, which has never been the case before, and plenty of other respected value investors have 30-40 per cent cash holdings and are returning capital to clients.

Sixth, consider taking advantage of the high Australian dollar to invest overseas. As well as opening up more opportunities, this will reduce your dependence on the local economy and, by extension, Chinese growth.

Finally, maintain your focus on value. There are still opportunities but they may not be in the areas you normally expect to find them. Despite the extreme conditions, we’re still finding stocks that combine defensive characteristics and attractive valuations.

This article contains general investment advice only (under AFSL 282288).

Nathan Bell is research director of Intelligent Investor Share Advisor.  You can unlock all of Share Advisor’s stock research and buy recommendations by taking out a 15-day free membership.

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Ten shareholders to vote on billionaire-backed loan

Rescue plan: Lachlan Murdoch and James Packer join billionaire Bruce Gordon in a plan to guarantee a “covenant lite” loan for the Ten Network. Photo: Rob HomerTen risks breaching its debt covenants if shareholders do not approve a deal that could hand security over all of the media group’s assets to three of its billionaire shareholders, James Packer, Lachlan Murdoch and Bruce Gordon, in return for the three guaranteeing its new $200 million loan.
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A covenant breach could lead to another highly dilutive capital raising if the “covenant lite” loan is not approved at its December 18 shareholders meeting.

“Given current operating conditions and recent performance, there is no guarantee that Ten will be able to meet covenants,” the company said in its notice of meeting, which was released on Monday.

In the company’s annual review, which was also published on Monday, Ten chairman Lachlan Murdoch said: “The outlook for the media sector remains challenging”. Advertising bookings remained short and the outlook for advertising was “uncertain”.

The media group’s independent expert, Deloitte, said the transaction – which could cost the company up to $43.8 million in interest costs to its lender, Commonwealth Bank, and fees to the guarantors – was fair and reasonable to shareholders not involved in the transaction.

Most of the money would go to the billionaire guarantors, who will receive a minimum 3.5 per cent fee for the life of the four-year loan.

The fee may rise if the company’s debt breaches certain ratios but could cease earlier if earnings improve to the point that the company can arrange a less onerous loan.

The fee is also convertible into shares in Ten – at the option of the guarantors when the loan ends – with a strike price based on the average share price in the 10 days leading up to the company shareholders meeting next month.

Ten has said Australia’s richest person, Gina Rinehart, has indicated she will vote her 9.9 per cent stake in approval of the transaction, which she declined to be involved with.

The guarantor shareholders will not be able to vote their combined 32.8 per cent stake on the proposed transaction.

The transaction will free Ten of loan covenants that are preventing it from investing in programming at a time when its ratings are at record lows.

“Without these covenants, Ten will have greater capacity to pursue its programming and turnaround strategies during this period of depressed and potentially volatile earnings,” said David Gordon, who heads the independent board committee that dealt with the directors providing the guarantees.

Commonwealth Bank will take security over Ten’s assets and earnings in return for its “covenant lite” loan, but if Ten is in breach of its loans and the guarantors are forced to act, the security over Ten’s assets passes to these guarantor shareholders.

“This may lead to the shareholder guarantors having the right to enforce that security and appoint a receiver which may conduct a sale of Ten group assets in which the shareholder guarantors may participate,” the company said in the explanatory notes to the meeting.

This week News Corp denied reports that its chairman, Rupert Murdoch, spoke with government “about the possibility of acquiring the Ten Network”.

At the meeting next month, shareholders are also being asked to approve the issue of up to 50 million shares to chief executive Hamish McLennan under its executive incentive share plan.

Ten’s shareholders will be asked to approve an incentive plan for Mr McLennan.

The long term incentive component, worth up to $1.48 million a year, will be awarded to him each year in the form of loan-funded shares in Ten with the value of these options based on the share price on issue and “potential volatility of the company’s shares over the life of the loan”.

Any dividend will be paid to Ten as interest on the loan, which is effectively non-recourse to Mr McLennan. Ten is responsible for the debt if the incentive shares are below the market price.

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Game of Thrones author George R.R. Martin rules out sharing Westeros

Game of Thrones’ author George R.R. Martin speaking in Brisbane, with actor Jerome Flynn, who plays Bronn. Photo: Renee MelidesGeorge R.R. Martin, the author of the epic bestselling novel series A Song of Ice and Fire, which has been adapted for television as Game of Thrones, has vowed that he will never let anyone else write a story set in the universe he created.
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“Not while I’m alive,” Martin says. “But eventually I will not be alive because Valar Morghulis – all men must men die.”

Martin has followed up comments in Brisbane at the weekend, where he described fan fiction as lazy, by ruling out the possibility of allowing other authors to write licensed works set in the lands described in the Song of Ice and Fire series.

Yet he seems resigned to the notion that Westeros will not die with him.

“I don’t think my wife, if she survives me, will allow that either. But one thing that history has shown us is eventually these literary rights pass to grandchildren or collateral descendents, or people who didn’t actually know the writer and don’t care about his wishes. It’s just a cash cow to them.

“And then we get abominations to my mind like Scarlett, the Gone with the Wind sequel.”

Martin himself has written three novellas, the Dunk and Egg series, which are set in the same world, 100 years before the events of A Song of Ice and Fire. However, he will not license other authors in the manner that the estates of Ian Fleming (James Bond) or Robert Ludlum (Jason Bourne) have done, or that George Lucas did with the Star Wars franchise.

“I’d hate to see that actually,” said Martin. “I’ve always admired [J.R.R.] Tolkien and his immense influence on fantasy. [And] although I’ve never met the man, I admire Christopher Tolkien, his son, who has been the guardian of Tolkien’s estate who has never allowed that.

“I’m sure there are publishers waiting in the wings with giant bags of money just waiting for someone to say ‘yes, go ahead, let’s write Sauron Strikes Back’.

“I hope I never see Sauron Strikes Back written by some third rate writer who leaps at the opportunity.”

George R.R. Martin will appear at the Dymocks luncheon in Sydney on Tuesday, hosted by Giles Hardie. In Melbourne, Martin will appear at the Wheel Centre on Wednesday night and at the Dymocks luncheon on Thursday. Martin will attend the Supanova convention in Adelaide at the weekend.

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Podsiadly ready for new start with Crows

James Podsiadly has a bit of a head start on his peers when it comes to any butterflies which might be associated with joining a new club at a more senior age than most recruits.
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Firstly, he’s done the football rounds over the years. Including his junior career, Adelaide becomes the seventh different club of any description for whom he’s played. And then there’s the matter of his deceptive birth certificate.

The former Geelong key forward might be 32, but in football years, has a profile a fair bit younger. Podsiadly didn’t even start playing the game seriously until the age of 17.

And as far as the wear and tear of AFL-standard football goes, there’s just four season’s worth. Compare that, say, with the similarly-aged but recently-retired St Kilda veteran Jason Blake, for whom 2013 was his 14th.

“I’ve got to go against the trend,” he conceded on Monday after a first training run with Adelaide’s younger list players. “I know physically and mentally I’m right, but just learning the game is where I think I can improve and take my game forward.

“I don’t know what a 32-year-old footballer is supposed to feel like, but from what I’ve been told I don’t feel like that. I’m not here to fill spots or fill numbers, I’m hopefully here to make an impact.”

And early indications are that Podsiadly will have every chance to do that. One of the key factors in the demise of Adelaide in 2013 was its inability to score enough, the Crows falling from a ranking of second for points scored in their top-four finish in 2012 to only ninth last season.

The hole left by the departure of Kurt Tippett was never adequately filled, the subsequent loss of Taylor Walker early in the season to a serious knee injury proving a fatal blow. And with Walker’s return date still uncertain and another key forward in Josh Jenkins recovering from ankle surgery, Podsiadly may end up playing much more than the 20-25 games coach Brenton Sanderson said he would over the duration of his two-year contract.

“The club could have a whole heap of injuries and if you’re not prepared to play 25 games after a pre-season you’re almost letting the team down,” Podsiadly said. “If it’s five, if it’s 10, if it’s 25 it doesn’t really affect me.

“I definitely wouldn’t have put my hand up and asked a club to give me a contract if I didn’t think I could play a full season. When the start of the season comes we play the NAB Challenge games, we’ll see where the side’s at and where my body’s at.”

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Online poll pans giant hat pergola

Crass, tacky, and an unnecessary waste of ratepayers’ money.
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A proposal to build a hat-shaped pergola to honour Orange’s poet Banjo Paterson has been almost universally slammed by Central Western Daily readers.

As of Monday afternoon, 87.8 per cent of 303 respondents in an online poll said Orange City Council should abandon the hat pergola.

Just 12.2 per cent wanted the council to build the $30,000, five-metre-high monument.

Many of the reader comments objected to ratepayer funds being directed to the Paterson tribute, with several saying the money would be better spent on road repairs or efforts to improve employment prospects in Orange since Electrolux announced its closure.

But the man behind the pergola idea, councillor Chris Gryllis, is unswayed by the criticism and believes it could even be a selling point for the would-be tourist attraction.

“Quite often controversial things bring attention,” he said.

“If it becomes controversial, the more publicity we get out of it. We might have it on the national news.”

Cr Gryllis said people were free to express their opinions opposing the pergola, but he had received an encouraging response from ratepayers supporting the project.

“Beauty is in the eye of the beholder,” he said.

“It will serve a purpose and create an undercover area for people to enjoy a meal and it won’t be out of place. It won’t make anyone broke.”

The few favourable reader comments said the giant hat would put Orange on the map and could bring thousands of tourists to town.

Cr Gryllis believes there is still time for the pergola to be up in time for the Paterson festival in February.

Members of the public have 28 days to have their say about the pergola before councillors make a final decision.

Footing the bill for Banjo’s birthday

If Orange City Council decides to honour Banjo Paterson with a $30,000 hat-shaped pergola, it will bring the total spend for the poet’s 150th birthday celebrations to $187,000.

And the money is well worth it to celebrate the one-off event, according to councillor Chris Gryllis.

So far the council has budgeted $20,000 to improve Banjo Paterson Park and $10,000 to design a life-sized bronze sculpture of the poet.

Taste Orange was given $5000 to manage February’s 10-day Banjo Paterson Festival and last week the council agreed to give $5000 to the Rotary Club of Orange towards the official opening of the restored Emmaville Cottage.

The estimated $90,000 for the bronze sculpture and $30,000 for the pergola has not been budgeted.

The council is also yet to allocate funds for $7000 extra needed for the cottage restoration and about $20,000 for its landscaping. Cr Gryllis said Paterson deserved more than one monument.

“These bits and pieces bring people to that area. I don’t think it’s a waste of money … it’s not extravagant and it’s not overkill,” he said.

FEDORA UP: Councillor Chris Gryllis and mayor John Davis want to construct a giant Akubra to commemorate Banjo Paterson

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