The market has had a move higher of approximately 4% during April. But interestingly there has been an unusual difference in this rally from the last ones we have had. This time it has involved the materials sector where in the past it has relied solely on the financial sector. The catalyst for this was a move higher in the price of Oil and an increase in stocking numbers from Chinese steel markets, which has pushed the price of Iron Ore higher. Chart 1 illustrates this point visually as we overlay the Materials, Financials and the XJO 200 index for the month of April. Material were well below both of these sectors at the start of the month but has closed higher at the end of the month.
CHART: Index vs Financials vs Materials
Chart Source: eSignal
The question is why was the rally so strong? Short Covering. Short covering can be a strange experience in equity markets. It is the process of investors closing out of their “SHORT” positions and effectively buying the market higher. The question that was on everyone’s lips in the middle of the month was “are we just experiencing short covering or is this the beginning of the much needed rally?”.
To illustrate the point we will take a closer look at one of the most shorted stocks in the market – Fortescue Metals. From the low in January to the high in April the stock rallied over 150%. Once the chart broke out of it’s range investors who are short become nervous about the position they hold and will eventually close out of their position. This can become a frantic experience and will typically correlate with a number of other stocks in the market. In this case we saw BHP and RIO move higher in similar trading patterns. Is the rally in iron ore a seasonal upswing which must soon be followed by a downswing?
CHART: Fortescue Metals
Chart Source: eSignal
Only 2 months ago were discussing the value that some of these Oil stocks represented and we continue to favour these as a core portfolio strategy for 2016.
The Growth Portfolio
During the month we closed out of one of our most favoured stocks in the portfolio – A2 Milk. Over the last 6 months we have seen a number of regulation changes emerging from China. A lot of these have focussed in the imported dairy industry and we believe that A2M has been fortunate to avoid any direct exposure to these.
We have continued to hold Metcash which is moderately up from our initial investment. They are due to release their annual report shortly and we will look to hold heading into this. TNE and GEM are both trending higher and we continue to hold. Technically they are both at critical levels and we would like to see them push above the current resistance levels to solidify the gains we have made.
Scentre group was sold during the month locking a profit of over 15% including dividends.
CKF is the only stock which we are currently seeing a loss on but believe that it still represent excellent value at these levels.
The return for the month was below the market at -0.43% but overall we continue to outperform by 10.62% per annum and 32% since inception.
Growth Portfolio returns
The Income Protected Portfolio
The month of April saw the resource space and broader index preform exceptionally well and within that, our IPS portfolio stocks also followed suit.
CSR continues to be a star performer with the position rallying strongly above our call strike price meaning we are still in maximum profit from a capital gain perspective. We are now just waiting for the dividend in June so we can ideally unwind the strategy and crystalise a healthy profit. The building materials and general property sector continues to do well so we are happy to maintain some exposure within this space.
Telstra (ASX:TLS) is back above our purchase price after collecting the dividend and is also performing well. The heavy hitting telco recovered well after the ex-div date and continues to be a solid yield play.
Commonwealth Bank (ASX:CBA) continues to be one of the stronger of the banks and still represents good value at current levels trading at a discount to its historical average PE. Out of the financials, CBA continues to be our preferred banking stock to own and should continue to be well supported by the market with interest rates at record lows and its yield still above 5.67% plus franking credits.
We did add one new position to our portfolio which was in Transurban Group (ASX:TCL). TCL operates and maintains toll roads across Australia and the U.S and recently reported solid growth for the march quarter in relation to the corresponding year on year period. We purchased the stock at around $11.45 and also purchased July dated $11.00 put options to protect the downside. We selected the July options as the stock pays a dividend in late June so holding it throughout this period will ensure we receive the dividend which is a pivotal part of this strategy. We elected not sell call options as we’re anticipating a price rise and would ideally like to sell calls at a higher level, but in the event the stock underperforms we will look to sell calls to generate some income.
All in all, a solid month for our Income Protected Portfolio.
Income Protected returns
The Option Portfolio
April has been a more challenging month for our options trading after some good wins in March.
Early in the month we saw the market fall back to 4900 and this allowed us to take small profits on our short XJO positions.
We entered short positions on CBA looking for it to break below $70, however it found support at these levels and bounced back into the mid $70’s. We did structure this trade so that risks were minimal and only incurred small losses ($500-$1000 for most clients).
We have recently entered option spreads in QAN & WOW this week with positions that will do well if those stocks rally over the next couple of months.
We have also established short positions on the XJO which will payoff very nicely if the market pulls back into May & June. We are coming into a high risk period with the “Sell in May & go away” mantra weighing on the minds of investors. Currently we are trending higher, however the XJO has stalled this week just above 5200. It remains to be seen whether we can push higher up towards the 5400 level. If we are to get to 5400 we would expect to see the banks have another push higher as we see 3 of the big four banks reporting and paying dividends in the next month. We are watching for opportunities in the financial sector prior to their dividends being paid, however in the past we have seen that these plays are nowhere near a “sure thing” so we need to be selective. We are also alert to the possibility of the market quickly reversing.
From the chart below we can see that volatility has fallen about 50% from the high levels we saw in February. This high volatility allowed us to structure several trades that performed well with the falling volatility despite not necessarily getting the direction right. Lower volatility requires different strategies and more directional strategies which we will be focused on in the coming weeks.
CHART: Volatility Index
Chart Source: eSignal
Feature: Budget Insights
Tuesday May 3rd. A day that will live on in infamy. The lead up to Budget Tuesday is now overshadowed by the lead up to the RBA rate decision at 2.30pm on that same day. Recent inflation data means a May rate cut moves into ‘coin flip’ territory. The idea of making a significant interest rate decision on the same day most of the Nation’s financial and political journalists are in Budget lockdown to us seems more than a little odd, as such I sit in the ‘no rate cut’ camp.
Focus should be on the first budget for Scott Morrison with extra attention on it being the foundation on which the election campaign will be based.
Trying to predict the contents of a Budget is a game for braver players than us, however we’ve already seen the PM flagging an alternative method to making housing more affordable without removing negative gearing: transport and infrastructure.
Look for money allocated to the Nation’s cities and the follow through into stocks exposed to that corner of the economy. Names like CSR, Boral, Lend Lease and anything in the real estate development subgroup will be on our radars here.
There is of course the possibility that this will be a ‘tame’ Budget, the Government running out of revenue in the form of profit taxes (case in point- BHP) and spending running away from them. This year’s deficit is expected at $41.7bn up from $37.9 last year. Campaigning with a deficit blowout is not how you build economic credibility so there’s every likelihood this will be an austere Budget. Looks like the RBA decision isn’t the only coin flip on Tuesday.
As always, I will be watching the speech with much anticipation.
If you want to find out more about how the budget will affect the economy, your investments, your SMSF and your taxes. CLICK HERE to register for our panel discussion webinar on Wednesday May 4th.
