invast's 2013 telco stocks update and global financial market correlations
DESCRIPTION
In this Invast Insights newsletter we shared the 2013 Telco stocks update and how our picks fared. There's a report on global financial market correlations, currency triangulation and using correlation to detect market anomaly. We also answered a client question on why we included Westfield in our portfolio as part of formulating an investment strategy.TRANSCRIPT
Invast Insights
Week Commencing October 14, 2013
www.invast.com.au | 1800 468 278
This week we look at the following topics:
1.0 Telco stocks update – how our picks have fared
2.0 US reporting season preview
2.1 Earnings beat rate
3.0 Market correlations
3.1 Currency Triangulation
3.2 Using correlation to detect market anomaly – Gold & A$ divorce
4.0 Client question and answer
www.invast.com.au | 1800 468 278
www.invast.com.au | 1800 468 278
1.0 Telco stocks update – how our picks have fared
One of the hottest sectors of the market in recent weeks has been the
telecommunications and software space. In our Invast Insights report
published on 9 September 2013, we mentioned three stocks in this sector as
potential growth opportunities as part of a wider discussion around growth
in software services and the “new economy”. If you didn’t read the report or
haven’t had time to go through the archive then unfortunately the following
section will cause you to sigh. The stocks we mentioned were Adslot (ADJ),
Mobile Embrace (MBE) and Moko Social Media (MKO). We’re pleased to say
that all three stocks have delivered positive results in a sideways trending and
often very difficult trading environment.
The best performing stock has been Mobile Embrace which has rallied 81%
since we wrote our report a month ago. The stock had run up strongly before
we decided to write about it and when we did we noted “We have been
skeptical of the run-up in share price but we thought we would
www.invast.com.au | 1800 468 278
lay down our prejudice against MBE and have a closer look” The lesson here is that when a sector is hot and a stock is earning the attention of savvy investors, it’s worthwhile putting aside your prejudices (sometimes ill-fated like ours) and focusing on what the market is interested about. It is also very important to be disciplined in a rising and euphoric market and so with that said, any subscribers to this report who acquired the stock on the back of our notes may consider banking profit.
Is there the prospect of Mobile Embrace rising further? It is possible but not enough for us to sacrifice a healthy profit already on the time in such a very short timeframe like one month. The company is still at a relatively small market capitlisation of $40m and some would criticise for taking profit on something that is in a upward trend. One of our staff members queried the research team in a recent morning meeting saying “shouldn’t you run your gains and cut your profit?” We agree that this is true when trading markets or even investing at times, but the extent of the gain should also be taken into consideration. It was also Warren Buffett who once said “be fearful when others are greedy and be greedy when others are fearful”. We don’t propose to be Buffett fans but we love taking profits and so that remains our primary motive here. Cash in the bank is king.
www.invast.com.au | 1800 468 278
Adslot has also had a solid month, adding around 19.7% during the period and at one stage the stock hit a high of 8.2 cents per share which would have presented a gain of around 34%. This is one we will be hanging onto, it sits in both our Wealth Creation portfolio which we update on a monthly basis and our list of 15 hidden gems which we published on 26 August 2013. The business announced an acquisition a few days after we published our report, acquiring Facilitate Digital, which will create an expanded global footprint. The acquisition owns the Symphony workflow and trading platform which is purpose built to meet the needs of large media buyers in the display advertising space. Adslot says over $800m of online media spend is processed via Symphony each year and growing. We aren’t sure at this stage just what that means in terms of earnings to the parent company.
Moko Social Media hasn’t performed as well as the other two stocks on the list but the share price is flat which is good enough. The stock has already doubled over the past year and so gains from here need to be result driven. The market capitlisation is in line with Adslot and Mobile Embrace. We’ll update these three stocks before the Christmas break to see how things pan out. The stock changed its name during the month from MOKO.mobi and just as well.
www.invast.com.au | 1800 468 278
* Table: Data as at 10 October 2013
2.0 US reporting season preview
US companies have commenced reporting their earnings for the quarter
ending September. While most of the market is focused on the debt ceiling
and government shutdown, there is the prospect that both are addressed but
the market falls because corporate earnings don’t meet estimates. The S&P500
is currently trading on a 2013 price to earnings ratio of around 15x and is still a
few percent away from its all time high. This isn’t exactly a high price to
earnings ratio, the average between 2004-2007 was somewhere between 16-
18x earnings, depending on which earnings base is used for calculation.
www.invast.com.au | 1800 468 278
The real story for the S&P500 though is the recovery in earnings and
expectations of future growth.
Corporate earnings are what drive stock prices. The trend in earnings is what
traders are really looking at. Average earnings for the S&P500 have grown
from around US$61.60 in 2009 to an expectation of US$111.30 currently. The
market is expecting earnings of around US$123 next year, which is around
double the amount of earnings in 2009. There would be a 5 year gap between
the two numbers and given the collapse in markets during the 2009 earnings
season, there is scope for the improvement. But if September quarterly
earnings break the positive earnings momentum, traders will take this as an
opportunity to sell off stocks on expectations that brokers will cut earnings
estimates.
So which stocks will be a bellwether? For the S&P500 we think the following
list will dictate market direction.
www.invast.com.au | 1800 468 278
* Table: Data as at 10 October 2013
www.invast.com.au | 1800 468 278
These top ten stocks represent around 17.7% of the S&P500 and will set the
tone for market direction. The first of these stocks to report will be Johnson &
Johnson – two days before the debt ceiling deadline. The market is currently
expecting Johnson & Johnson to book third quarter earnings of US$1.32 per
share which is a mild decline on the prior quarter. The stock is trading on a
price to earnings ratio of around 15.5x future earnings, a slight premium to
the market. Anything short of US$1.30 per share will disappoint the market.
Microsoft and Apple will report after the debt ceiling deadline – both trailing
at a price to earnings ratio discount to the market at 12.5x and 11.8x
respectively. The discount reflects the fact that the market is slightly cautious
on the current earnings base and so both these companies will not only have
to show growth but show that the earnings base is sustainable.
www.invast.com.au | 1800 468 278
2.1 Earnings beat rate
One thing which many analysts look for during quarterly reporting season in
the United States is the “beat rate” – a calculation that looks at the final print
of earnings and compares them with consensus market expectations. It tends
to give an overall indication of corporate health relative to expectations and
we all know that the market prices stocks on future expectations of earnings.
The earnings beat rate isn’t a perfect number because expectations are
measured on an average basis. So say for example, the expectations for a
particular stock’s earnings are set at US$1 per share – this may have been
compiled by questioning ten analysts in the market or by asking just four of
which one might have not updated their number recently, hence skewing the
average towards an out of date figure.
www.invast.com.au | 1800 468 278
For the second quarter this year, around 66% of the S&P500 companies that
reported their earnings the final number was above measured expectations.
This is higher than the long term average of 63%. Around 54% of companies
booked revenue above expectations which was lower than the 61% long term
average according to Thomson Reuters. In terms of individual sectors, some
76% of financial stocks beat expectations while for technology stocks the
figure was at 73%. The surprise factor in financials was 11% which is very
significant. The performance of financial stocks this time around will matter.
Going into the third quarter, there were 94 S&P500 companies who provided
negative pre-announcements compared to 18 positive preannouncements.
This suggests to us that around 20% of the market felt like analysts were
getting too ahead of themselves and their third quarter results would not
match preset expectations. So as we started the discussion in this section of
our report, we reiterate that the upcoming reporting season will be very
important in terms of recent momentum in stock markets – perhaps more
important than the whole debt ceiling or government shutdown
conversation.
www.invast.com.au | 1800 468 278
3.0 Market correlations
Global financial markets are inter-related to one another, whether you are
looking at bonds, equities, currencies, option locally or internationally;
everything is connected and affected by any changes in the financial market.
Traders, economists and analysts look at this correlation between markets to
get an indication of where the market is going to move. The currency market
contrary to popular belief, is the largest market in the world and is the link to
almost all of the global financial market. Consider the interaction involved
when purchasing a share in a company, currencies are used for the exchange
and as such buying a share involves selling a currency.
For the reason above, understanding currency correlation is an important
factor when trading on the currency market, this is especially true when it
involves the benchmark currency, US dollar. Most major, market moving
economic data comes from the United States and not only in terms of the
www.invast.com.au | 1800 468 278
currency market taking its cue on the US dollar movement, share markets globally look to Wall Street’s performance as a guidance and benchmark of market sentiment.
Correlations between markets can be classified under two classes:
Positive correlations: two markets moving in the same direction 90% of the time.
Negative correlations: two markets inversely related and moving in the opposite direction 90% of the time.
From these correlations, a trader can gauge the sentiments in the market (is there appetite for risk in the market or is the market more risk averse) which is a crucial factor in trading. A risk averse market typically saw the high yielding currencies like the AUD/USD and GBP/USD for example track lower as traders run towards a safer currency like the US dollar, Swiss Franc or the
www.invast.com.au | 1800 468 278
Japanese Yen. Conversely a risk on market would likely see an increase in
global indices and high yielding currencies.
Let’s take a look at some of the global instruments traders look at for
correlations, they are not limited to currencies alone.
Negatively Correlated
EUR/USD and USD/CHF correlation is a text book example of a negatively
correlated instrument. More than 90% of the time these two pairs are a direct
opposite each other. A gain in EUR/USD typically see s a drop in USD/CHF.
www.invast.com.au | 1800 468 278
Figure 1 USD/CHF VS EUR/USD source: Invast MT4
www.invast.com.au | 1800 468 278
Another inversely correlated example is the relationship between the US
dollar and the stock markets, in particular the Dow Jones Industrial average
Index. A gain in the index represents risk appetite in the market, this normally
happens when data released from t he United States are good or indicative of
improving economic condition. An interest rate cut is also associated with an
increase of risk appetite in the market, as borrowing costs become cheaper,
and a nation’s currency becomes less attractive to investors.
www.invast.com.au | 1800 468 278
Figure 2 US Dollar VS DJIA source: Bloomberg
www.invast.com.au | 1800 468 278
Positively correlated
Positive correlation describes two financial instruments that move in the same
direction, as such one of the main purpose in monitoring positively correlated
instruments is to use one instrument as a leading indicator of the other. A
great example is the correlation between EUR/USD and GBP/USD. Very often
we find one currency leading the other in a positive correlation and in the
case of EUR/USD and GBP/USD, the interaction between the two is a little
more unique, which I will explain in the next section.
www.invast.com.au | 1800 468 278
Figure 3 EUR/USD VS GBP/USD source: Bloomberg
www.invast.com.au | 1800 468 278
The graph below illustrates some of the most watched correlations in the global
financial market.
www.invast.com.au | 1800 468 278
3.1 Triangulation
Most currencies in the FX market seem to move in the same direction most of
the time, but in reality one typically moves more than the others.
Hypothetically speaking let's create trader A. Trader A understood the notion
that EUR/USD and GBP/USD are positively correlated, in other words both are
often found to move in the same direction most of the time. Trader A decides
to pick either EUR/USD or GBP/USD to minimise his exposure in the market.
Take a look below on EUR/USD and GBP/USD price movements:
www.invast.com.au | 1800 468 278
Figure 4 EUR/USD VS. GBP/USD source: Invast MT4
www.invast.com.au | 1800 468 278
Notice that while both are moving in the same direction, they rally at different
intervals, and while one rallied significantly the other remained flat. In the
above example GBP/USD rallied on the 14th of August and EUR/USD had to
wait a week for its turn.
Should trader “A” had picked GBP/USD he would have enjoy one move up but
he would probably missed out on the major move on the EUR/USD. How then
as a trader could we maximise and anticipate these moves? Which one will
actually move faster than the other?
To answer this, we need to be rid of a certain currency that exists in both
pairs; US Dollar. Doing so would leave us with EUR/GBP in which we can look
for potential changes in the strength between these two currencies.
www.invast.com.au | 1800 468 278
Figure 5 EUR/USD vs. EUR/GBP source: Invast MT4
www.invast.com.au | 1800 468 278
Figure 6 GBP/USD vs. EUR/GBP source: Invast MT4
www.invast.com.au | 1800 468 278
Notice that during the rally in GBP/USD on the 14th of August, EUR/GBP fell
significantly, which in turn keeps the pressure on EUR/USD from rallying,
conversely on the 20th of August, both EUR/USD and EUR/GBP rallied,
keeping the pressure on GBP/USD.
By analysing the movements of EUR/GBP (even if trader “A” does not trade it),
he could have identified which currency pair is likely to move more than the
others. Currency Triangulation is the term used to look at the market in such a
way. While the original term of currency triangulation attempts to profit from
market imperfection between 3 currencies, this modern take can be used to
identify which currency pair is worth a trader's time; especially when day
trading and minimising market exposure is a goal.
The above example uses EUR/USD, GBP/USD and EUR/GBP, but there are other
triangulations out there such as AUD and NZD or even the JPY crosses.
www.invast.com.au | 1800 468 278
3.2 Using correlation to detect market anomaly – Gold & A$ divorce
While correlations work most of the time, they are not 100% there are short
periods where instruments are not perfectly correlated and some trader s
await such moment to exploit these mismatches in t he market.
Recent development in the global financial market is also a concern, as we
saw Gold and AUD/USD breaking away from their positive correlation on the
back of concern over US Debt Ceiling and US Budget leading to the
prolonged US government shutdown.
It is ironic to see the market flog to t he US dollar because of their safe haven
status and at the same time Gold takes a hammering because of the risk
aversion in the market. Australian economy on the other hand remains strong
and stable, causing a de-coupling of correlation between Gold and AUD/USD.
www.invast.com.au | 1800 468 278
Below is the correlation between the two last year and as can be seen, the
two are positively correlated working perfectly as a leading indicator.
Figure 7 AUD/USD vs. Gold in 2012 source: Bloomberg
www.invast.com.au | 1800 468 278
And below is the de-coupling between the two since August 2013, where Gold
and AUD/U SD becomes negatively correlated.
Figure 8 AUD/USD vs. Gold in 2013 source: Invast MT4
www.invast.com.au | 1800 468 278
What we can tell from the change in AUD/USD and Gold correlation is the
potential anomaly in the current market, where market is likely to be more
volatile, indecisions amongst traders and general uncertainty in the market.
Normally these anomaly do not last for long and a return to normal
correlation could signal a potential end towards the current economic threat
brought upon the market by political bickering in the Unites States.
Not all correlations are experiencing this anomaly and triangulation strategies
between currency pairs still work wonders and could assist traders in making
trading decisions.
4.0 Client question and answer
“I noticed last week that you have WESTFIELD in your portfolio. My question to
you is….why do you hold this company when the retail situation is so bad in
Australia??” – Ali, Melbourne
www.invast.com.au | 1800 468 278
Ali, thanks for the question. There is so much happening in the markets at the
moment. The unemployment rate in Australia has fallen but the numbers
don’t tell the full story, the United States continues to struggle with its debt
situation and Europe is still fragile. Many investors are asking themselves
questions like – are dividends the way to go? Is it time to get into mining
stocks? Is it better to trade short term or take long term positions? Often
there is a lot of confusion and at Invast our portfolios are there to help
navigate you through the turmoil.
The trick is really around formulating an investment strategy, which we have
done across the three portfolios. It all sounds very formal, having a strategy
around your investments, but it really is one of the most important starting
point to every investment process.
Many investors think they have a strategy, but if you ask them to define it in
one sentence, they will struggle. If you're reading this, ask this question of
yourself. The most common answer is
www.invast.com.au | 1800 468 278
something along the lines of: "I want a little bit of income and capital growth.
I also want to find a small-cap stock with huge returns and not lose any
money during the process.“
Basically, that's an "I want it all" approach, which we all know is not possible.
It's not just individual investors. Many companies also fail to define their
investment strategy. We met a company at an investment briefing a few
months ago, which was looking at putting together an IPO (initial public
offering) in the real-estate space. After an hour-long presentation and various
questions from the analyst team, we realised the presentation slides did not
contain a section or even sentence on strategy. It's something that is often
overlooked.
The very intelligent and experienced managing director managed to answer
the question when asked, but not having it in the presentation slides shows
how even the most intelligent investor in the market can often overlook the
most simplistic issues. So, what's the right investment strategy? That is
www.invast.com.au | 1800 468 278
something that you will need to answer for yourself but something we try to
help via the portfolio strategies. Otherwise, it largely depends on
circumstances, motivations, risk tolerance, goals, and the pace at which you
want to achieve them.
What we plan to do here is show you an example of how strategy setting in
portfolios plays an important part in success. You can look at fund managers,
or even better, find companies that have strategised successfully over the
years. One of the best-performing stocks on the Australian market over a long
period of time has been Westfield Group (WDC). The company has changed
forms over the years, more so in recent history, but the focus on strategy is
something that is always front of management's mind when driving the
portfolio.
It's a simple business - build and develop shopping centres, rent them out and
manage the operation. But without a firm strategy, the business could have
easily lost its way over the years. Many property groups blew up during the
www.invast.com.au | 1800 468 278
crisis, particularly larger ones in the US of comparable size. Yet Westfield managed to ride out the downturn in good shape. The strategy is simple and summed up in one sentence, which you will always find within the first few pages of a Westfield presentation to the market: "To develop and own superior retail destinations in major cities by integrating food, fashion, leisure and entertainment using technology to better connect retailers with consumers.“
The strategy changes over time. Food, for example, is now a main priority in the development and management of centres. People have to eat - and Westfield wants to feed them. Will Westfield develop in remote areas? Probably not, since the strategy says the focus will be on major cities. Are they afraid of online shopping? Probably not, since the strategy embraces technology that connects retailers and consumers.
So, does having a well-thought-out strategy make Westfield a good investment? Assets are geographically diversified: Australia 41 per cent, US 40 per cent, the UK 15 per cent and other locations the remaining amount
www.invast.com.au | 1800 468 278
Please note that the Westfield Retail Trust (WRT) is a different vehicle. Total
assets under management for Westfield Group are $64.4 billion. Group
occupancy is at 97.8 per cent, with comparable growth in net operating
income of 3.3 per cent.
The brand has become iconic globally, perhaps similar to a Mercedes, Prada or
Louis Vuitton. We often complain that the Australian market lacks such global
consumer brands, but I would argue that we have the brand to house them all
in one location - shopping malls. We might not comprehend this in Australia
because we have become so used to walking through a Westfield mall, but
many developing economies around the world who seek to embrace Western
brands would acknowledge a Westfield mall as a sign of progress in their
economy.
Having Westfield flagship malls on Pitt Street in Sydney, at the World Trade
Centre site in New York and the Olympic site in London is no coincidence. It's
all part of the strategy. Does the gloss stack up financially?
www.invast.com.au | 1800 468 278
Return on contributed equity is at 11.4 per cent - the return Westfield is
earning on its investments. It's not a great amount of money, but to me it
means there is scope for earnings growth. Remember, Westfield is not just an
owner of malls, it also develops and manages them. The development
pipeline has been slow in recent years, but that is a sign of prudence and
patience. Westfield targets 12-15 per cent un-geared returns on its
developments.
With property and banking stocks, chasing a dividend yield can pay off, but
the quality of dividends and growth is more important over the medium term.
Many will dismiss Westfield as expensive with a dividend yield of around 4.6
per cent unfranked. Telstra, in comparison, is around 6.1 per cent fully franked.
But it's not fair to compare the two. Westfield has huge scope for
development growth. It will continue to generate a passive income on its
current mall portfolio and brings a track record of developing solid growth
over the past few decades.
www.invast.com.au | 1800 468 278
Almost half the rental income Westfield derives is from its US assets. Keep in
mind that the US is still underperforming and occupancy is at 94.4 per cent,
so growth in passive income has further scope. Telstra will give you a higher
rate of initial income, but it doesn't have the growth profile, geographical
diversity or track record of returns like Westfield.
If Westfield's dividend grows at 5 per cent annually over the next decade, this
year's 51-cent distribution will become 84 cents a share. It's by no means
guaranteed, but it's also worth noting that Telstra paid a 27-cent dividend in
2003 and paid 28 cents a share this year, so the growth has been much less.
The banks have seen a much larger rate of growth in their dividends over the
period, but for investors looking at diversifying outside of the banks, Westfield
on merit deserves to be within a well diversified portfolio. It sits in our Wealth
Preservation portfolio together with Woodside Petroleum, Woolworths, the
top 200 stocks in Australia and the top 300 stocks in Japan.
www.invast.com.au | 1800 468 278
So Ali, we hope that answers your question. Westfield is a quality exposure
which over the medium to long term will do well within the portfolio. In the
short term there might be some volatility but if you are a believer in the
United States economy improving, there are few names best placed to benefit
in the Australian market when compared to Westfield.
Get more information about this topic on our resources page.
www.invast.com.au | 1800 468 278
5.0 Disclaimer
Please note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.
General Disclaimer: This newsletter contains confidential information and is intended only for the person who downloaded it. You should not disseminate, distribute or copy this newsletter. Invast does not accept liability for any errors or omissions in the contents of this newsletter which arise as a result of downloading this newsletter. This newsletter is provided for informational purposes and should not be construed as a solicitation or offer to buy or sell any financial product. Invast Financial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).
www.invast.com.au | 1800 468 278
Risk Warning: It's important for you to read and consider the relevant Product
Disclosure Statement, and any other relevant Invast Financial Services Pty Ltd
documents before you decide whether or not to acquire any financial
products listed in this email. Our Financial Services Guide contains details of
our fees and charges. All these documents are available here on our website,
or you can call us on +612 8036 7555. CFDs and Foreign Exchange are
leveraged products and carry a high level of risk and you can lose more than
your initial deposit so you should ensure CFD and Foreign Exchange trading
meets your personal circumstances.
General Advice Warning: Being general advice, this newsletter does not take
account of your objectives, financial situation or needs. Before acting on this
general advice you should therefore consider the appropriateness of the
advice having regard to your situation. We recommend you obtain financial,
legal and taxation advice before making any financial investment decision.
*Distributed with the permission of Invast.com.au