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Here we go again.  No investor expects share markets to remain in an uninterrupted upward trend forever.  In the first month of 2014 global share markets are moving downward – and the question uppermost in the minds of all share market participants is how low will we go?  Is this a blip on the radar; the beginning of a full-blown 10% market correction; or are we on the precipice of a more severe downturn, perhaps even another GFC?  

In less than one month investors world-wide have seen cautious optimism for 2014 descend into yet another litany of interwoven doom and gloom possibilities.  As has been the case several times since the GFC, the current panic began with China.

The preliminary HSBC Purchasing Managers Index fell to 49.6, below 50 for the first time in months, although that has happened in the past as well.  The portent of a slowdown in China was only one factor in the toxic brew that soured investor sentiment.  In no particular order, here are the four issues troubling share markets:

1.    US Federal Reserve/Bank of Japan/Bank of England Tapering

2.    Emerging Market Currencies

3.    China Slowdown

4.    China Shadow Banking System

For years analysts and experts have sounded the alarm: easy money policy of Central Banks is propping up fundamentally weak economies, especially the United States.  The US Fed is putting on the brakes, with the latest announcement calling for another $10 billion monthly reduction in its bond buying program.  The other two global Central Banks with robust stimulus programs – the Bank of England and the Bank of Japan – may follow suit, although neither has provided a time frame.  The US Fed policy weakened the dollar against emerging market currencies and the low interest rates led to increasing private sector leverage throughout the emerging markets.  Money poured in leading to what some analysts are now calling asset bubbles.  The potential of the cumulative effect of a stronger US dollar and higher interest rates in the emerging markets as a result of Fed tapering led to a massive sell-off in emerging markets in mid-2013.  The following chart of the IShares Emerging Market ETF (EEM) tells the tale:

At that time Fed “tapering” of its bond buying program was only a possibility; now it is reality, commencing in December 2013.  Fed tapering and the currency weakness in the Emerging Market countries makes the latest Chinese PMI number a real concern – as a slowdown in China could lead to a global slowdown, especially in emerging market countries that rely on China to buy commodities.  The preliminary HSBC PMI reading was 49.6 and the actual number was 49.5. 

The Chinese banking system is another concern.  Traditional Chinese banks have rigid lending criteria, resulting in a preference toward lending to the country’s State-Owned Enterprises (SOE).  Small to medium sized businesses have been forced to turn to other sources for credit, leading to the unregulated “shadow banking” system.  Pools of money from a variety of sources provide the loans, including what are called Wealth Management Products (WMPs).  Investors have limited options for where to park their money in China and these unregulated instruments promise a handsome rate of return.  Analyst estimates for the total size of the shadow banking sector in China range from 40% to 70% of Chinese GDP. 

Some cynics claim that economic forecasting is a fool’s game, but common sense suggests only a fool would be buying on these dips right now without sober reflection.  However, one thing appears to be a near certainty.  The odds are highly in favor of a return to volatility in share markets. 

The devaluing of the Argentinian Peso followed by the drop in the Turkish lira sent markets reeling the moment the Chinese preliminary PMI was released.  Then the Turkish Central Bank surprised with a dramatic increase in interest rates.  Share market participants tend to “shoot first and ask questions later” so the initial response to the news of the hike was the snapping of a multi-day losing streak with global share markets moving upward. 

Less than 24 hours later, gains of the previous day quickly evaporated.  The US Fed announcement of another $10 billion taper for the month of January coupled with the final release of the Chinese PMI numbers kept the downturn intact.  The following day GDP growth for the US in Q4 came in at 3.2% and consumer spending showed a 3.3% increase.  A smattering of positive US earnings reports along with the solid economic indicators was enough to send stock prices upward once again.

Bulls acknowledge that Emerging Markets may be the new Europe, but take comfort in the fact the dire outcomes predicted for Greece, Spain, Italy, Portugal, and others have not yet materialised.  The China story seems to repeat itself like a broken record and here Bulls can find solace in the knowledge China is an autocratic country with a controlled banking system that is largely free of entanglements with the global banking system.  In short, the Chinese government can step in to reverse a downturn in their economy and they have the cash to do it.

Some would argue now is the time to consider defensive stocks; picking the “best of breed” in a defensive sector.  Others caution in a wildly bearish market, no stock is spared.  Healthcare is a defensive sector benefiting from the long term trend of baby boomer retirement.  Yet even Healthcare dropped 6% during the GFC.  The question investors need to ask is how much time they are willing to allot to their share market holdings.  

To illustrate we have a table of six defensive stocks from retail and healthcare.  We will look at the share price, adjusted for splits and dividends, as of the close of trading on 30 January, 2014 against the adjusted closing price five years ago – 30 January 2009.  Here is the table, along with dividend yields and average annual rates of total shareholder return:

Company

(CODE)

Adjusted Closing Share Price 30 January 2009

Adjusted

Closing Share Price 30 January 2014

Dividend Yield

Forward P/E

(FY 2015)

3 Yr Total Shareholder Return

5 Yr Total Shareholder Return

10 Yr Total Shareholder Return

Woolworths

(WOW)

$22.17

$33.95

4%

16.24

13.2%

8.6%

15.3%

Wesfarmers

(WES)

$12.63

$42

4.5%

17.36

12.9%

28.1%

10.6%

CSL Ltd

(CSL)

$37.50

$70.78

1.6%

22.61*

(FY 2014)

26.5%

16%

30.8%

Ramsey Healthcare

(RHC)

$10.10

$43.87

1.7%

24.1

40.3%

38%

28.7%

ResMed Inc.

(RMD)

$1.52

$5.0

1.9%

17.8

16.9%

10.5%

14.2%

Sonic Healthcare

(SHL)

%11.45

$16.59

3.9%

15.2

16.8%

8.4%

12.7%

 

The Forward P/E’s of these stocks do not exactly qualify them as “screaming buys,” but if you look at the historical total shareholder return figures you can see they do conform to the #1 Rule of Investing proposed by Warren Buffet – Don’t lose money. With the exception of Woolworths and CSL these companies have double digit 2 year earnings growth forecasts.  Here are the numbers:

•    WOW        4.8%

•    WES        10.2%

•    CSL        6%    

•    RHC        15.7%

•    RMD        14.5%

•    SHL        12.9%

Woolworths Ltd (WOW) and Wesfarmers Ltd (WES) sell things consumers need.  And while tough times can lead to reduced spending, people have to eat.  They will continue to spend although they may spend less.  For the first month of 2014 the share prices of both have dipped a bit.  Here is a one month chart:

The remaining stocks are all from the Healthcare Sector.  Some financial gurus tell us share markets throughout history have advanced over time due to long term trends originating in some form of disruptive change.  Examples include major demographic changes, technological breakthroughs, and advancements in the discovery, extraction, and use of natural resources. 

Trend watchers wise enough to realise early the huge impact baby boomers would have on the Healthcare Sector have been handsomely rewarded.  The trend is intact and coupled with another trend – longer life expectancy – suggests the best Healthcare stocks have room to run.

CSL Limited (CSL) is a biopharmaceutical company operating globally with blood plasma treatments.  The company is actively pursuing recombinant DNA therapies and the share price has been on a largely uninterrupted run for the past decade.  Here is a ten year chart, comparing CSL to another ASX Healthcare Stock that has been “on fire” for the last ten years, Ramsey Healthcare (RHC):

Ramsey Health Care operates private hospitals and same-day surgery centers in Australia as well as in Indonesia, France and the United Kingdom.  Ramsey acquired a French psychiatric hospital at the close of 2013 and is actively pursuing additional acquisitions in France.  Ramsey and CSL have forward P/E’s that place them in growth stock territory.  Thus far neither has suffered from the January sell-off, but the Relative Strength Index (RSI) is a technical indicator that can identify future buying opportunities.

The RSI uses a complex mathematical formula to identify overbought and oversold conditions.  RSI values range from 1 to 100, with 20 and 80 being the lower and upper limits indicating when a stock has been oversold and is due for a bounce and when it is overbought and due for a dip.  Some analysts use the less stringent values of 30 and 70.  The following chart for 5 years of price performance for CSL includes the RSI at the bottom.  Study the chart and you can see the RSI seems to be fairly reliable as an indicator of price trends.  

Sonic Healthcare Limited (SHL) is principally a medical diagnostics company, offering pathology and radiology services to medical practitioners in eight countries around the world.  ResMed Inc. (RMD) is in the business of developing and distributing medical devices to treat respiratory disorders, principally those impacting sleep.  ResMed sells its products in about 100 countries around the world through its own offices and a network of distributors.  Year over year ResMed’s stock price is up more than 25% while Sonic Healthcare’s stock is up over 20%.  However, for January to date, SHL is flat while RMD has dipped 6%.  Here is the one month chart:

Australia is blessed with a strong medical device and biopharmaceutical sectors with several stocks worthy of consideration for buying on the dips.  

NOTE:

The first edition of last week’s article entitled Searching for Value in the Worst Stocks of 2013 failed to define the use of MRQ, or Most Recent Quarter, when highlighting total debt figures for Silver Lake Resources Ltd (SLR).  MRQ refers to Financial Reporting Periods – Half-Year or Full Year – and does not reflect financial information that may or may not be included in Quarterly Production Reports the ASX requires of resource companies.  The figure cited reflected total debt as of the most recent financial reporting period – 30 June 2013.  Silver Lake’s Quarterly Production Report for the December Quarter showed total debt of $8 million, reportedly down from the $62.8 million in the 30 June audited financial statements. 

Click on the links below to read other articles from this week’s newsletter

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