I finished the end of 2017 with a distinct bearish view on Australian banks and retailers warning of their extreme vulnerability to tightening lending conditions, rising living costs and a massive oversupply in the housing market. At the same time, many of the opportunities that presented themselves were all concentrated in the mid-cap space, specifically in the lithium, rare earths and other stock specific opportunities.
Let’s run through some of these positions I held on the proprietary trading desk to see how they have unfolded and where my views sit right now. Firstly let’s start with my bearish views on retail and banks and it has been a dismal start to 2018 for these two sectors. So far in 2018 the banks have dropped between 8% and 15% across the board while the likes of Super Retail have fallen 18% and Harvey Norman 19%. From their highs 12 months ago when I was warning on Share Café of these risks, the declines have actually been significantly larger.
I am still negative the banks and retailers in general. I see absolutely no reason to be buying into this space considering much of the real world dangers I see unfolding have actually begun to play out. So far housing price declines have started in Sydney and Melbourne, housing starts have slowed, auction clearing rates etc are only confirming my analysis a year ago. More importantly – and this is the key – the banks have been using extremely low provisions for bad and doubtful debts as a way to short-term prop up profits. The last results from the banks saw a huge emphasis on how low bad debts were. Once bad debts begin to rise and banks will need to make provisions, profit declines will be even larger.
When I look technically at the banks, the decline isn’t over. Sure a short-term technical bounce will always occur. Remember the biggest 1-3 day gains in history are short covering rallies and it is important to not be short sighted in such circumstances. As we head into reporting season for the banks and dividend payouts there will no doubt be a rally, especially since they have fallen so far. But the real ‘meat’ of the drop will come afterwards when many of the current headwinds accelerate. Add to this offshore risks stemming from an overpriced US equity market and real dangers really.
Look at the chart of CBA below going back 10 years. There is a clear multi-year top formation in the process of being completed. This topping process has been in formation for the past 4 years. As time passes and this major support across $70/69 is tested once more, given everything we know, the probability increases substantially for a downside break leading to an acceleration and extension of the current downtrend. And don’t think this is just a circumstance that plagues just CBA. All the major banks have similar formations with the regionals fairing worse.
I continue to use rallies as selling opportunities.
The retailers are also persistently underperforming and for me has been a simple play on consumers tightening the wallets. It has never been an Amazon impact story for me. I have been very vocal in being short Harvey Norman and Super Retail. Both are suffering from the aforementioned trends and with JD Sports entering the market from the UK, Rebel Sports (owned by Super Retail) is under intense new competition. None of these ingredients are positive for stock prices.
It can be seen below that the top on Harvey Norman is well and truly complete and no matter how many shares Gerry buys or appears on CNBC to tells us to “sell our house and cars to buy HVN shares”, it won’t stem the slide. Seriously though, who shops at Harvey Norman anymore?
While my views on my shorts have not changed (aside from some short-term upside possibility) the views I have on small and mid-caps have. I was uber bullish this sector through the second half of 2017 due to this chart below that compares the Small Ordinaries Index to the ASX 200 on a relative basis.
Back in July there was a significant breakout of the performance of Small Ordinaries to the ASX 200, inferring that small and mid-caps would outperform their large-cap counterparts. Basis this the focus turned to smaller companies and I highlighted the “green movement” stocks such as lithium, cobalt, rare earths and organic milk stocks that would be the drivers behind this as the world focused on the personal health, the environment (electric cars and renewable energy).
Now it is only rare earths producer Lynas Corp (LYC) that I still consider to be a key stock to own. I see ongoing risks to the lithium story as production around the world ramps up and investors must remember the take up of electric cars is still too low, costs too high, range is an issue, recharging an even larger one and with the gains seen in the sector over the past nine months I no longer own anything in this space – aside from LYC.
LYC result was spectacular with a notable reduction in debt, jump in cash flow and solid production levels. Rare earth prices will continue to rise (it doesn’t suffer from the same rapid supply side response that lithium does) and LYC share price has continued to be one of the few making new highs as below. It was one of my favoured picks in 2017 as well as 2018 and there is no change to that. Stay long.
Returning back to the outperformance of the Small Ordinaries to the ASX 200. As the original chart shows, we have reached an extreme point relatively and the clear cut opportunity that was present almost 12 months ago has now passed which in itself, warns us to take profits, be cautious and that the widespread number of opportunities has passed. Focus is now not on sector or industry thematics but rather single stock stories of which there are few.
In December, I wrote that Helios Energy (HE8) was another key favourite for 2018 and despite the first well having an infrastructure issue with its first well (but oil flowed to surface) the second well is currently being tested – I have purchased more to increase my exposure to what is expected to be a new oil basin in Texas. This was a play backing management and despite share price volatility I remain with that strategy.
Finally I also wrote a piece back on the 8th September last year stating that I was turning more optimistic on gold producers and the gold price. While I wasn’t turning super bullish I believed gold producers would be likely to enjoy ongoing support and most local gold producers have had some substantial re-ratings with many hitting fresh multi-year highs. I still like gold producers and believe that the sector will enjoy further gains. Stocks like Northern Star (NST) that I noted as being good buys are up 37% and Saracen (SAR) 28%. I think there is more to come especially if gold can surpass the US$1400 level – the level I use for the start of the next gold bull market.
So in essence I remain broadly bearish and see significant downside risks persisting throughout 2018. It is important to remain cautious and not determine that value is purely a case of a share price falling too far. Bear and choppy markets can be very frustrating and the last thing anyone should do is buy too much or too early.