Thursday, February 16, 2012

Without PE Re-rating There's Not Much Appreciation

The period from September 1974 to March 1992 was an incredible time to be a holder of the All Ordinaries.

This was the period after the first oil shock and during which stag/inflation was defeated.

The period was marked by the re-rating of PE ratios from 5.4 to 20.1. That PE re-rating drove huge increases in the value of the All Ordinaries.

When you compare that period to some others of equal length and to the period since June 2001 to now, you quickly see that when you strip out the period of the re-rating of PE's, capital appreciation from the All Ords is very poor compared to commonly quoted numbers like 7% pa.. The capital appreciation shown does not include dividends, which would add a few percent onto the return (and really should not be ignored, but are for the purposes of this comparison).

The table below shows the rates of return after indexing each period to 100 at the start date of that period.

Start Date Sep-1974 Sep-1994 Sep-1961 Jun-2001
End Date Mar-1992 Mar-2012 Jun-1979 Mar-2012
Start 100 100 100 100
End 815 210 197 124
N Per 70 70 70 43
Rate / period 3.04% 1.05% 0.95% 0.51%
Nom Rate PA 12.2% 4.2% 3.9% 2.0%

We can see the same thing graphically which brings the point home more sharply. The sustained dramatic capital appreciation occurred only during the period of re-rating of PE's as inflation was defeated.

We can also see the 2004 - 2007 boom quite clearly in the chart below ( at period 41 to 55 in red and 12 to 26 in yellow) and ask ourselves why we thought it would never end, particulalry when we look at consistency of 10 year government interest rates over the period and the lack of any real boom in GDP growth.

The only consolation we can take is that over the coming 27 periods we could see a higher rate of capital appreciation of 7.1% to the end of 2018 if we are to get to the 200 indexed value seen for the other two 70 quarter periods (not including the re-rating period) in the chart below.

The questions then are,
1. "What sort of appreciation ought we expect from buy and hold in the absence or a significant re-rating of PEs?"
2. "Are we likely to see a re-rating of PEs and if so which way?"

Long term bond yields are presently low compared to earnings yields on the All Ords. If interest rates go down and stay down then a re-rating is possible and even likely over a few years. If interest rates come back up, then there could be big losers in bonds and possibly in stocks.

Overarching all of this is "How long will the Balance Sheet Recession last?"

Tuesday, February 14, 2012

Mid Feb Coppock, Long MACD, Modified Turtle and Dashboard Update

My long term MACD indicators are saying BUY for the major markets I watch, The All Ords moving averages directions and crossovers other than 50 > 200 are saying BUY, but the traditional Coppock is saying "not yet" for the markets I follow (although the All Ords is neutral mid month). My big reservation for the All Ords is that it may still be range bound between 3900 and 4500 and my modified Turtle indicator has not signalled a buy, although it is set for few whipsaws. It requires a breakout above 4450 but having been whipsawn once I am looking at 4500.

Coppock Dashboard (including MACDs, using close US ETF as a proxy when looking at USD values).

Note that I have added a percentiles row in the Coppock Table. 4 of the 6 markets listed have Coppock scores in the lowest 30% in the history I have. Japan is unusual in that it has been in a Secular decline for over 20 years with progressively lower ending bear markets, so its Coppock score's relatively high percentile reflects that. one day Japan might move into a secular bull market, although its demographics are against it.

All Ords Dashboard including Coppock, Modified Turtle and Median Bottom Comparison (1 & 2 Yr growth).

Note that other than Coppock, modified Turtle and 3 year growth rate everything looks BUY. I think the 50 > 200 cross is too subject to whipsawing to be a first indicator of a BUY or SELL, so I tend to discount it.

I note that we are still around a medium term bottom in terms of 1 and 2 year growth, but as we approach the 3 year anniversary of the March 2009 bottom the 3 year growth and its percentiles become more worrisome.

At 4400 it would be 40% and 81st percentile.

At 4900 it would be 58% and 91st percentile.

As we pass the 3rd anniversary then it is possible that even if the All Ords stays relatively stable 3 year growth will moderate as the lows fall out of the period, but 4 year growth may increase as the 2008 highs fall out of the 4 year period. Remember, periodic growth figures are as much about what has fallen out of the start of the period as about the recent changes in the market. both ends of the period count.

Modified Turtle Says Not Yet

Because we are below the previous recent peaks around the 4400 mark there is a real risk of being whipsawn by a range trading market. The modified Turtle indicators are set to minimise risk of being whipsawn.

My Modified Turltle is not a guarantee against whipsawing, but it is set to minimise them, but at the cost of missing some rise before buying and enduring some fall before selling so any whipsaw will be costly. The BUY and SELL are 8.6% apart at present.

Fundamentals, GDP, Emerging Markets and Comparative Bond Yields not considered.

I have not considered fundamentals, fiscal settings or relationships with GDP and Bond Yield in any detail in this post. This post is primarily about market timing indicators.

 I remain concerned about recession risk in Australia. My indicator is YOY employment growth being flat and trending down, a strongly inverted yield curve 3M to 3Yr and 3M to 10Yr and AUD still very high and recently increasing hurting manufacturing and tourism.

All Ords growth compared to GDP growth is at a relatively low level, even if the extraordinary growth in the All Ords from '74 to '87 as PE ratios adjusted from 5.4 to 20.1 is discounted.

10 Year Bond yields are reflecting a strong preference for Government Bonds over Shares. This could lead to a PE re-rating over time, or could indicate danger for bond prices if there were no recession and emerging inflation leading to rises in rates across the yield curve or a liquidity squeeze because of our dependence on offshore savings to finance our debt. I regard inflation as unlikely given Australian fiscal policy of striving for surplus next year, but the squeeze on offshore funding is already evident from the recent bank rises in variable mortgage rates.

My article on the Cream Portfolio shows that a mix of 6 Emerging Markets have been very good over 10 years and seem very consistent and still trending well.

If the trend is your friend, then subject to the whipsawing and range trading caveat, its now, when Coppock turns up or at over 4500.

Maybe 1/3, 1/3, 1/3 is something to consider.

Not Financial Advice

As always, this is not financial advice, just my thoughts on investing which may be totally inappropriate for other people's circumstances and which change with changing markets. While history may rhyme, it may not be a good guide to the future.

Saturday, February 11, 2012

The Cream Portfolio

Give me the Cream
The Cream Portfolio comes in two flavours, Developed and Emerging. Each flavour has a special recipe.

Emerging Cream has a sweetness in excess of 3, while Developed Cream is much less sweet at only a bit over 1. (Average the top 6 scores in the far right column of each of the tables below to see what I mean.)

I sure wish I'd have seen the recipe for Emerging Cream 10 years ago!

What are the Recipes?

Developed Cream is made from:
1. New Zealand
2. USA
3 Ireland
4. Australia
5. Singapore
6. United Kingdom

Emerging Cream is made from:
1. Indonesia
2. Phillipines
3. Thailand
4. Colombia
5. Peru
6. South Africa

Can I improvise?
All good cooks improvise. You can have Emerging Cream with Developed Cream, or you can leave out or add ingredients. Or you could choose to mix up an entirely different batch, but it might not be cream, although it might become cream later. You could leave out the last 1 or two ingredients in each flavor, but that would reduce the diversification and increase the risk. You could add more ingredients and increase the diversification, and probably reduce the "risk"and probably dilute the return. You could make a Mixed Cream flavor with some ingredients from each recipe.

Show me the Money!

Here are two charts that show you the money about the Cream Portfolio.
Developed Cream

Emerging Cream

Look at the returns in the Emerging Cream. It has certainly been a lot sweeter than Developed Cream!


Making the Cream Portfolio is based on analysis of the best performing markets in USD terms over a number of different periods weighted towards following recent trends.

The data comes from MSCI Barra Performance tables for Countries.

I have weighted 3 Month To Date, 1 Year to Date and 3 Year To Date performance with multiples of 10, 7.5 and 5, then calculated a total. Then I have ranked each of the tables by the total score.

In each time period in each table I have coloured the better performances in Green and the worst ones in Red.

From the consistency of the Green and Red you can see that some countries know how to make the stock market go up or are blessed with the right resource mix and some don't.

Maybe the terrible performances of eg the EMU countries will revert. If they do it will be picked up through the heavier weightings of  3MTD and 1YTD compared to 3YTD.

You can get the data for free and make your own version and play wioth different weightings, but you can see from the consistency of the colours across time that it won't change the rankings dramatically.

Every 3 months (or more or less frequently if you like) you can redo the exercise and adapt the recipe.

A Few Caveats
This is stock market cream. Sometimes stock market cream can go sour virtually over night, like in 1987. Sometimes it goes sour slowly but still goes very sour, like in 2008. You might decide that too much stockmarket cream is not good for you and add some sort of Long Term Bond Cream to the mix. When you play with recipes sometimes you spoil them and wish you had stuck to the original. Nothing works all the time, but I was impressed by the historical consistency as well as the sweetness of both the Emerging Cream and Developed Cream. Finally recipes go out of favour and what was goo last year might not be good next year!