The Experts

Michael McCarthy
+ About Michael McCarthy
Michael McCarthy is chief market strategist for CMC Markets in Australia. He has over 30 years of experience in financial markets – specialising in equity trading and trader education.

Two blue chip stocks with higher growth prospects

Thursday, August 16, 2018

The laws of the market are immutable. Risk and reward are directly related. Those seeking higher rewards must seek higher risks, and those seeking less risk must accept lower returns.* Therefore, investors seeking higher growth exposures must look outside the top blue chips. Right? Wrong.

Two top 20 stocks in Australia are offering estimated double digit long term growth. And both reported this week.

Woodside Petroleum (WPL) 

Woodside is the largest Australian-listed energy producer. It was built on the fabulous natural gas resources of the North West Shelf off WA, beginning in 1984. In 2012 it brought the Pluto fields on line, and it’s now well advanced in the planning of the Browse gas facilities. After a period of rationalisation it now has a number of longer term development projects and a cleaner balance sheet.

This week, the company reported a 6% lift in half year profit, and plans to invest $23 billion over the coming year. According to Bloomberg, the average of 16 analysts’ long term growth forecasts was 13.6%. And it will pay dividends of around $1.45 plus franking. Investors who agree that natural gas is the best compromise between the environment and the economy may find these numbers of particular interest.

CSL Limited (CSL)

CSL is a great Australian success story. It’s in the business of saving lives with its blood products. In the last seven years it rose from $26 to levels of over $200. A highly successful research and development culture is complemented by a globally diverse business. Simply put, CSL keeps delivering.

In its full year results this week, CSL not only delivered a 29% lift in net profit, it guided analysts to a 10% - 14% range for profit growth in the coming year. This is well above the profit forecasts for this season, with the top 200 stocks expected to show 5-7% growth. CSL management in the past have “under-promised and over-delivered,” and it’s unlikely many analyst will pull their long term growth forecasts that average 15.6%.

These levels of anticipated growth in blue chip stocks are eye-catching. The challenge for investors is that they can be hard to buy. Pull backs are relatively rare, and generally shallower. Some will baulk at paying $36 for Woodside, or $210 for CSL. Take it from a professional that thought CSL was “too expensive” at $30 and a “sell” at $66, they might be cheap.

*There are many further corollaries. When an investment delivers a much higher than expected return it’s a red flag. In an ideal world investors would revisit the investment to check that the risks were properly understood.  This practice is less popular than it should be.



Rio returns cash, gets trounced

Thursday, August 02, 2018

Rio Tinto Ltd reported its first half results after the market close on Wednesday Aug 1. Management must be wondering what they need to do. Despite a 12% lift in underlying profit, the highest ever interim dividend and another US $1 billion share buy back the shares were trounced in London trading immediately after the announcement.

One issue is that analysts forecast an even better profit on the back of higher aluminium and copper prices. The US $1.17 dividend reflects a 50% pay-out ratio, so by implication the 15% lift in dividend may also have disappointed. There were minor operational issues that affected some production, and some tricky negotiations with the Mongolian government over a power plant. The CFO also expressed concerns about the impact of a trade war on commodity prices. If these factors drove the market reaction in my view traders are missing the big picture.

Copper production is up 42%. Iron ore production rose 9%. The increased buy back and dividend reflect one of the biggest problems facing management – what to do with all the cash?

If Australian investors take the same approach as their British counterparts it may represent an opportunity. Price to earnings ratios are less commonly used in evaluating resource stocks due to their highly cyclical nature. Investors tend to “look through” the commodity cycle, pumping up the PE at the start of a cycle, and compressing it towards the end. Rio is trading on around 12x times next year’s earnings, and around 10.5x this year’s. At these levels, it suggests the commodity cycle is coming to an end.

However, the fact remains global growth is on an upswing, normally supportive of key industrial metals. Many commodity strategists maintain very conservative estimates of long run prices, in some cases well below current spot prices. These are the reasons any pull back in Rio’s share price could represent good value buying.

The weekly chart shows Rio could pull back to around $76 and remain in an uptrend. If it does, I’ll be waiting.


Does Rio have further to run?

Thursday, July 19, 2018

In January 2016, Rio Tinto shares (RIO) traded below $40. This month they traded above $80. This doubling in share price by a blue chip stock is a remarkable performance. Naturally shareholders who’ve enjoyed this rise are wondering whether it’s time to take profit. In my view, both the company’s production report and the long-term chart support the idea that RIO has further to run.

This week, RIO told investors it increased iron ore shipments from Australia by 9% in the first half of the year. Bauxite production is up 7%, and mined copper increased by 42%. Its Canadian iron ore operations have returned to normal, and guidance from RIO was pushed to the higher end of previously forecast ranges. On the less positive side aluminium production fell and the company warned of rising costs.

On balance, I read this as highly likely that some analyst will revise their share price targets upwards.

The long term chart is a stark reminder of how far the global mining group could rise in a buoyant environment.

Pre-GFC RIO shares touched $150. The post-GFC high is $89.04. If analysts revise their forecasts and the shares breach this ten-year high, traders could pile in on this share price signal. Note the (green) up trend line. Any positive response to this week’s production report would see it respect the line and continue the trend.

Naturally there are risks. China dominates the seaborn iron ore market. Investors (still) expecting a credit crisis or some other hard landing for the economy in China may have already sold RIO. However given these fears were well expressed when RIO was trading closer to $40 it seems unlikely that those still clinging to this idea don’t own RIO shares.

Another significant risk is that commodity analysts have underestimated iron ore prices. At the peak, iron ore contributed more than 70% of RIO’s revenue. Many estimates for longer run prices are in the $50 to $60 per tonne range. The average over the last year is closer to $70. If commodity prices are revised upward as RIO kicks production, higher the share price action could become explosive.



Banking on Queensland

Thursday, July 05, 2018

Bank of Queensland is a stock that polarises analysts, according to Bloomberg. Of 16 analysts, 5 say “buy”, 6 say “hold” and 5 rate BOQ a “sell”. The target prices reflect this honest disagreement. The average 12 month target price is $11.08. However the range of target prices is wide, starting at $9.50 and peaking at $13.03. What are investors to do when even the “experts” can’t agree?

One of the drivers of the fall in BOQ’s share price is the earnings downgrades that flowed from the half year results announcement in April. Cash earnings rose 4%, and net profit increased 8%. It’s arguable this was a good result in the current banking environment, but was lower than many forecasts. Commentators honed in on increased funding costs, despite a stable Net Interest Margin.

The effect on the share price was substantial:

This monthly chart of the BOQ share price shows trading this century. The recent, dramatic 30% + fall is at the extreme right of the chart. Perhaps of more importance to investors is the fact that it has now reached an important long-term inflection point at $10.00.

Last month BOQ fell through the level, but then rejected lower levels and bounced back over $10.00. From a technical point of view this is a positive development, and suggests there is a higher probability of further gains.

The rising borrowing costs given as a rationale for the fall are an industry concern, not stock specific. Despite this BOQ shares have dropped more than their peers. Another major challenge for financial institutions is the ongoing Royal Commission into the industry. In my view BOQ’s smaller size and stronger regional focus means it is likely to suffer less from any regulatory fall out.

Good investment choices are a function of investor circumstances as well as the market outlook. If an investor’s portfolio is already 75% banks, buying more bank stock may not add value. However, any investors underweight banks (given 2017/18 performance, well done) or looking to increase portfolio income, could be looking at BOQ right now.


How gut feel misleads investors

Friday, June 22, 2018

Rising interest rates. Trade wars. Credit bubbles. Housing market fears. Bank misbehaviour. Low wages growth. Low inflation. The list of market worries is extensive. Investors have a lot to fear. Among all this doom and gloom there’s a headline many investors may have missed:

Australian Share Market Hits New Ten Year High

In trading on Wednesday the Australia 200 index broke above the previous, post-GFC high tide mark. In the big picture view of the Australian market, this a highly significant event. The rise came despite weakness in oil and metals prices and a plunging Telstra share price, making it all the more remarkable.

The break to new highs occurred on turnover that was 20% + over average. This is what analysts call “volume confirmation”. From a technical point of view, while the index stays above the break-out point of 6,150, it is now more likely rise than fall. This long term chart shows why this market move is so important.

This is a monthly chart, meaning each of the blue and crimson ‘candles’ represents one month of movement for the index. The mountain on the left of the chart is the great bull run from 2003 to 2007, and the post-GFC fall. The horizontal lines are the previous ten year highs at 6,000, and the recent high at 6,150. The upward sloping line on the right is the up trend that began in early 2016.

The move above 6,150 highlights potential for the market to reach the previous all-time high at 6,852

Very few market watchers had the foresight or the courage to make this call (*ahem* Peter Switzer is one of them). This price action will very likely see many of the more bearish commentators lift their year-end targets for the Australian share market.

Yet for many investors, it doesn’t feel like a bull market. The media focus on negatives for the Australian economy and market could see many investors doubting the strength of the move, despite the unambiguously positive indication from the index.

Ironically this dynamic has potential to sustain the up moves. The emotional phases of a bull market are despair, scepticism, optimism and euphoria. Any scepticism around this market break out fuels later gains if the market rises. The doubters are forced to jump in late if the market continues to gain.

It’s not just investors who doubt the move. CMC markets has two separate platforms – our online Stockbroking pro platform, and the Next Generation trading platform. The trading platform offers a client sentiment indicator that reflects up the minute views of total client position in a market. Here’s the current sentiment for the Australia 200 index:

Two thirds of all traders with a position in the index are short. By value the negative sentiment is even more overwhelming, at 93%. Not only will fear of missing out force investors into the market, gains could be fuelled as traders scramble to buy back their losing short positions.



Wisetech: A stock for the active?

Thursday, June 07, 2018


Active investors reap rewards in markets that are trading sideways or mildly trending. Those who take advantage of market moves – locking in solid gains and buying good stocks under short term pressure – can outperform their “buy and hold” peers.

The Australian 200 share market index is higher than it was in December 2016 by 3% - 4%. In that time it has traded through an almost 10% range, between roughly 5,600 and 6,150. However in that period many stocks within the market have shown spectacular gains and heart stopping losses, far larger than the index moves. Some have done both.

A recent example is software logistics group Wisetech Global. It climbed from $9.00 per share in October 2017 to an all-time high at $16.27 in February 2018. That’s up 81% in 4 months. Investors who didn’t act may have watched in dismay as the share crumbled back to the $9.00 level in the following 2 months:

Wisetech Global Ltd – daily chart. (Top section is the price, middle is the MACD indicator, and the bottom section is the RSI indicator).

However once again WTC has climbed spectacularly. Any investors who bought around $9.50 in the first week of April (just two months ago!) are up more than 60%. Is it time to consider selling?

Bloomberg consensus estimates show that the price to earnings ratio for the next twelve months is around 107 times. This may be misleading in a high growth stock. However even after factoring in growth in earnings of better than 25% p.a. the PE ratio 3 years out is still higher than 50 times. That’s expensive in my book.

Further the chart is also flashing red. The MACD is crossing well above the zero line, usually considered as a sell signal. The RSI is in overbought territory and making lower highs – diverging from the share price’s higher highs. Another sell indication.


A matter of interest for high profile Australian stocks

Thursday, May 24, 2018


Many high profile Australian stocks are under pressure, despite the fact the share market is within a few percent of ten year highs. Major banks, Telstra, AGL and others are at or near multi-year lows. In many cases there are sector or stock specific reasons, but these may obscure a “big wave’ that is affecting markets globally, and investors cannot afford to ignore.

Telstra’s growth concerns are now well exposed. Beyond the roll-out of the NBN there is a large earnings hole. At this stage there is no easy way forward for management. Telstra is the largest Telco in Australia and its margins are wider. This means organic growth is not the answer. The longer term choices for Telstra are shrink, break up or make a significant acquisition.

The underlying problem for Telstra shareholders compounds this issue. Longer term interest rates are rising. The US ten year bond breached the 3% level, and many other countries’ bond curves are showing higher yields. While weaker growth in Japan and Europe may slow the climb of interest rates the long cycle appears to have turned.

Higher interest rates diminish the importance of dividend yields. Why would income seeking investors take the capital risks of share ownership if they can source income from more capital stable bonds?

This is a double hit to Telstra’s investment profile. The appeal of dividends yields is dropping, and so is Telstra’s dividend. The situation looks like a classic dividend trap. Shareholders tempted to “double down”, and buy more Telstra at the now much reduced share price, may suffer further.

This principal applies to other stocks and sectors. There’s little doubt the Royal Commission inquiry is weighing on the financial sector.  However this is potentially obscuring the impact of higher interest rates on the investment case for banks that are largely held for dividend yields. Utilities like AGL, with the focus on the future of the Liddell power station, are comparable. Shorter term factors are grabbing the headlines, and hiding the impact of the global shift.

The changing macro environment demands a shift in investment strategy. Income streams could become less important, and growth exposures more vital. The good news is that the interest rate sensitive property sector has rallied around 9% over the last three months. Investors looking to shift their portfolios could start there.


Locking in gains in resources

Friday, May 11, 2018

Just over two years ago Rio’s share price hit a low at $36.53. This week, it’s trading close to $82. BHP’s low in January 2016 was $14.06. Today, it’s closer to $32. Capital gains of better than 120% PLUS dividends. Who said blue chips are boring?

Traders say “Harry Hindsight is a great trader”, and it’s true. It’s easy to look back and say “coulda, shoulda, woulda”. But how do investors know at the time that a stock is offering an opportunity to either buy or sell? One approach is to throw off the blinkers and consider all the important factors that can drive a stock price.

Fundamental analysis of companies is a powerful tool in attempting to understand whether a stock is cheap or expensive. However all company valuations are estimates. They require analysts to make guesses about future earnings and costs, and external factors like interest rates and commodity prices. The often wide range of valuations of a single company tells that valuations are opinions, not fact.

Luckily investors can draw on additional sources of information in deciding entry and exit points. A simple one is a measure of sentiment. If there is almost universal consensus on a stock, it is often at a turning point. If everyone believes Wesfarmers is a buy, bearish analysts are capitulating and contrarian opinions are hard to find, it’s probably close to time to sell.

Further, if these extremes of sentiment coincide with important chart levels, the signal is reinforced. And if the most important stocks in a sector are displaying these characteristics simultaneously, investors should take note.

This brings us to BHP and Rio. Remember how oil prices hit a low below $30 a barrel and some were calling for $10? Iron ore touched $42 a tonne? All industrial commodities were under pressure, and the almost universal consensus was that they would fall further. That was the turning point.

Right now the commodity bears are capitulating. Analysts are reluctantly increasing commodity price forecasts. Share valuations are going up. And major mining stocks that ran hard against consensus are now the subject of buy recommendations from the same analysts that were bearish 50% ago.

This extreme in sentiment occur as the share prices of both BHP and Rio are hitting key resistance. For BHP that is the 3 year high at $32.16 in January this year. For Rio it is the high at $82.73 from February.  None of us know the future, but in my view there is a short term flush due in the global mining stocks. I’m looking for a 10% - 15% pull back in share prices.

This may not matter to long term holders. However active investment is a strategic response to a market with a modestly positive outlook and sideways tendencies. Decreasing the overall cost of my portfolio by locking in gains with a view to buying back at lower share prices can be an important tactical response to spectacular gains in blue chips.


Listen to the market - it's sending some strong signals

Thursday, May 03, 2018

The Australian 200 index is shouting a message. Investors who heed the market’s call will likely outperform those who don’t. But how do professional investors hear what a market is telling them? They study the charts.

The rationale for studying price action dates back to Aristotle. He is credited with the first acknowledgment of the “wisdom of crowds”. Statistician Francis Galton (Darwin’s cousin) performed a famous experiment in 1906, demonstrating that in a county fair competition the average of 800 guesses at the weight of a dressed steer was closer to the mark than the winning entry. James Surowiecki published on the topic in 2005, and scholars at MIT and Princeton (among many others) are currently working on refining crowd based analysis techniques.

Investors don’t need an economics lab to distil the wisdom of crowds. At any given time, a share price reflects the collective wisdom of all participants in that stock’s trading. Essentially, charts track the distilled wisdom of the crowd. Professional traders and investors benefit from studying the changes in market (crowd) thinking over time. And the local market is speaking right now.

This weekly chart shows the Australia 200 index is sending a clear technical signal. The slice straight through resistance at 6,000 is a sign of underlying strength. On balance this market action indicates a test of the post GFC highs around 6,150.

Adding confidence is the Moving Average Convergence Divergence (MACD) indicator at the bottom of the chart. When the MACD is near highs or lows it represent overbought or oversold conditions. Right now it’s close to zero, suggesting neither is present. The MACD also gives signals when the black line crosses the red. The black line is coming from below the red and is crossing upwards, generating a buy signal. The fact this is occurring on a longer term chart points to a longer term upswing.

Commodity strength, a lower Australian dollar and relatively cheaper valuations could all contribute to the positive momentum. Whatever the drivers, the higher levels of the Australia 200 index could in itself force more cautious investors back into the market as underperformance (due to defensive positioning) becomes a more prominent risk.

Traders and investors should respond in ways that reflect their own circumstances as well as the change in the market. No one can say with certainty whether the index will break through 6,150 to make new post-GFC highs. However a move through that level would in big picture terms introduce the possibility of a test of the all-time highs around 6,852.

Even at its much reduced level the financial sector plays an important part in the Australia 200’s performance. The sector comprises around 34% of the value of the index. That is substantially down on the peak composition of about 47%, reflecting the sell down in the sector from the 2015 peak. Mathematically, all the financial sector has to do for the index to make new post-GFC highs is sit still. Given a positive outlook for industrial commodities, any further recovery in financials (up 1.9% yesterday) may see those marks hit well before most investors currently expect.



The News on Isentia

Thursday, April 12, 2018

Value investors can be unbearably smug. Despite an overwhelming body of evidence that no one investment style is best in all markets, value investors delight in their own certainty. The stock is undervalued, the investor is right and eventually the market will agree and the stock price will rise.

Warren Buffet’s long term investment performance is often cited as an example of the power of the value style. There’s no disputing the strategy has many successes. However, there are at least two problems with this approach. The first is that the wait for a stock to “come good” can be interminable, tying up capital for years. This is an investment opportunity cost. The second issue is that value investors rarely use the discipline of a stop loss order. In other words if a value stock is falling, there is no share price at which many value investors will admit defeat.

This brings us to Isentia Group (ISD).

Isentia is a long term darling of the value investment community. Initially listed in mid-2014, the stock more than doubled in price from $2.40 to $4.95. Those buying ISD on a value argument were well rewarded. However, since the high in late 2015, the stock has slid dramatically and is now closer to $0.80 per share. The problem is the downward revisions of ISD’s market value have lagged the share price drop, trapping investors.

Many valuations are based on the present value of future earnings. This does not account for market failure. It’s hard to dispute that the failure of ISD’s content marketing business is the primary cause of the share price slide, and the trapping of value investors.

Now that ISD has shed content marketing and its CEO, my view is the stock has become interesting. The remaining media monitoring business is well established and profitable. I estimate the current PE ratio around ten times - cheap if there is future growth. The long term outlook for the media monitoring industry is not clear. Right now it is delivering. Some investors may wait for the share price to break the downtrend with a move up through $1.00.  But at eighty cents I’m happy to take a 12-month speculative view that this share price will recover significantly.



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Any value in Woodside?

Media under the Southern Cross

ANZ: forecasting disaster

Blowing housing bubbles

Australian shares back in the zone

Investment approaches in volatile markets

The not-so-big Australian

Signs of a market bottom

Slaying golden goose myths

Investment strategy and the reporting season

Good news for rational investors

Tightening tales

The upside of low energy prices

Australian shares: looking ahead

Energising your portfolio

The wisdom of copper

How will rising US rates impact your investments?

News versus noise

The investment toolbox

The three-stock portfolio

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How to keep your investment cool