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The Experts

Michael McCarthy
Expert
+ 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.

Bursting Bitcoin’s bubble

Tuesday, December 12, 2017

These days it seems any market that goes up for two sessions in a row is a bubble. This is of course nonsense. While the chaotic nature of bubbles makes definition difficult, there are characteristics of bubbles on which many traders agree.

Those new to cryptocurrencies may know there are other examples besides Bitcoin. They may have heard of Ripple, Etherium and Bitcoin Cash. In fact in June this year the number of cryptocurrencies exceeded 900, and it now stands at more than 1,300. The universe of digital money is exploding as well as the prices.

What makes traders think Bitcoin is in a bubble right now? There are three requirements to tick off. The first is that the gains in the market are increasingly higher and faster. The price action becomes exponential. This is the first marker of a bubble, and is already occurring in Bitcoin.

The second characteristic of a bubble is a version of the argument “it’s different this time”. This saying alone is enough to make experienced traders groan. However by their nature cryptocurrencies ARE different. They are created (mined) digitally. You’ll never hold a Bitcoin in your hand. They are unregulated. Governments and central banks have no say in the supply, the relevant interest rates, the exchange and the records of transactions. 

The “it’s different” argument is important because it permissions market behaviour that is unusual. Despite eye-watering gains and dramatic volatility, new and potential participants are not deterred. Extravagant and enthusiastic optimism rules.

The third characteristic of a bubble is the giveaway that the end is coming. A term commonly used is a “blow-off top”. This price action can vary enormously, and there are many chart based patterns that fit the description. Most of them involve an even larger gain than previous moves quickly followed by a sharp reversal that takes the price below its starting point. Examples include “island reversals”, “evening stars” and “a hanging man”.

The Bitcoin market is yet to make a blow off top.

The newer aspects of digital currencies do not exempt them from their organic nature. Market prices are an organic function of human behaviour, not a product of a mathematical process. Bitcoin prices are subject to the same conditions and drivers as any other market, although many will dispute this during the “it’s different” phase.

The anonymous and unregulated use of cryptocurrencies was the initial driver of their success. They are used to circumvent government currency controls and make illicit purchases. There is a contradiction in them becoming mainstream financial instruments, potentially alienating the original users. Here may lie the seeds of crypto destruction.

Now that Bitcoin is moving into the mainstream with the listing of futures contracts, family, friends and clients ask; “Is it too late? Should I buy Bitcoin?” The problem is that despite what we know, no one can say with certainty when or at what price a bubble will burst. Bitcoin may collapse tonight, or it may reach $100,000 US dollars first.

Perhaps the answer lies with one of the best salesman I’ve ever come across. He was a ruthless blackheart who could seduce minds with his soft patter – so his motives may not have been pure. It was 2000, about a year before the tech bubble burst. He overheard a group of traders ridiculing the height and valuation metrics of the Nasdaq index (it gained a further 65% before imploding). He interjected:

“Sure, the fools are dancing. But the even bigger fools are sitting on the sidelines.”

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Buying the farm

Tuesday, December 05, 2017

Shareholders in the Australian Agricultural Company (AAC) have had their patience tested. A shock loss in the first half of the year has the share price plumbing two year lows. However, the implementation of a major strategy shift is well underway and AAC could turn sharply as investors see the benefit of a shift to quality over quantity.

Despite recent discussions there is ample evidence of thematic investing paying handsome dividends – think commodity super cycle, dividend yields, housing recovery etc. The key is identifying the trend and investing before share prices take off.

The pure foods produced in Australia and New Zealand are highly sought by a rising consumer class across Asia. Stocks such as A2 Milk and Bellamy’s are buoyed by this investing theme, but their share prices reflect well established support. Investors looking at “buying the worst house in the best street” could have AAC on their list.

The cattle farmer is transforming its brand, investing in an integrated supply chain and (finally!) adopting suitable technology to drive productivity. In the last year it has launched in Singapore and Taiwan, bought more of its product internally and invested in data analytics. In my view these investments will restore AAC to a more profitable footing. Investors with the same view may wish to move before the market does.

 

 

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Flexible thinking

Tuesday, November 28, 2017

By Michael McCarthy

Flexigroup (FXL) is in the “new” consumer finance space. It offers technology enhanced payment systems and solutions across a diverse range of industries. Earnings over the past few years faltered as the company dared to innovate. Taking risks means sometimes getting it wrong. The 66% plus slide in the share price since 2013 indicates many investors thought Flexigroup got it wrong.

The share price slide brings Flexigroup to lows not seen since 2011. Earnings fell from a peak 29 cents per share in 2015 to last year’s 24 cents.  Forecasts show a consensus 23 cents for 2018, before a return to growth in 2019.

However at its AGM on Monday, the company highlighted its success with payment cards. Key commercial relationships with traditional consumer credit channels and newer industries such as travel could have analysts re-cutting their estimates.

Admittedly a number of Flexigroup ’s woes stem from self-inflicted injuries. It’s arguable that in the past Flexigroup ’s product suite was too diverse and unfocused. There are also questions over the company’s ability to deliver, and prove up what look like sound business ideas into reliable earnings.

In my view, the share price is encouraging investors toward a higher risk / higher potential reward scenario. The volume growth in card business suggests to me Flexigroup  may have found a winner. Despite the lower estimates of earnings for 2018 the PE ratio is around seven times. The dividend yield at current constrained earnings is over 5% with franking.


The technical picture is also supportive. A double bottom formation is in place. The share price has moved above the $1.55 support level, and is testing the $1.63 resistance. A break above this level would signal a new uptrend. The MACD indicator at the bottom of the chart adds to the positive picture. The leading black line has crossed the lagging red line, and both moved up through the zero line, indicating a postive otlook with momentum.

For investors Flexigroup may represent a long term hedge. A portfolio full of banks is common in Australia. They are all potemntially vulnerable to disruption in the payment space. Owning a disruptor like Flexigroup  may offset some of the risk. And a lower share price for Flexigroup is the right time to examine the risks.

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Washington H Soul Pattinson - an expert investment

Tuesday, November 21, 2017

By Michael McCarthy

Washington H Soul Pattinson’s (SOL) name is possibly misleading. Many investors associate the name with the chain of chemist shops. This represents its origins, but it is now much more. Essentially SOL is an investment vehicle with an impressive track record.

The Washington H Soul Pattinson portfolio is broad. It contains cash, term deposits, property, shares, energy and related assets, copper and gold holdings. Washington H Soul Pattinson also provides corporate advisory services. One of its share holdings is a controlling interest in Brickworks, and Brickworks holds a similar stake in Washington H Soul Pattinson. This structure has been criticised. However, one effect is that it is very difficult for a hostile bidder to remove the existing management team.

In 1998 Washington H Soul Pattinson shares hit a low at (the equivalent of) $2.22 (there was a share split in 2002). While there are fluctuations over the years, the quarterly chart shows a rise over the intervening years to the all-time high of $19.00 in June this year.

So this is a structurally stable investment group with a strong track record – at least judging by the long term share price rise. The daily chart (pictured) shows a significant pullback from the highs. Some of this share price pressure is due to activist shareholders agitating for a change in the cross-shareholding, and the stock is now ex the November dividend. It’s now trading nearer an important support level at $15.75.

A challenge for many investors is the narrowness of their portfolios. While this often reflects a cautious approach, selecting only higher quality investments one at a time, it ironically means there is higher risk due to the larger exposures to single stocks. Investors looking to draw on long established investment expertise, and wish to diversify to reduce portfolio risk, could have Washington H Soul Pattinson on their radars.

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Orica’s implosion

Tuesday, November 07, 2017

By Michael McCarthy

Buy the rumour, sell the fact. Orica reported on Monday. You can see from the chart the strong rise into the announcement, and that investors certainly “sold the fact”. However this could offer an opportunity for investors not yet on board.

The recovery in metals prices is driving mining stocks higher. By extension, a pick-up in mining activity should see the associated mining services powering ahead. Naturally this includes explosives maker Orica (ORI). The issue here is that miners have not fully responded to the commodity price signals – yet – and therefore Orica’s bottom line didn’t improve. In fact, revenue and profit fell by around 1%.

Investors who see a global upswing in industrial sentiment indicated by strong industrial commodity markets are the likely drivers of the recent Orica rally. Mining services operations offer a diversified exposure to a surge in mining operations.

In some respect stocks like Orica offer an exposure to the theme without the mine specific nature of many choices in the resource sector. This pull back eases valuation concerns. Additionally, the price action is supportive. In Monday’s sell down the stock fell through a support zone between $19.00 and $19.20. However this was enough to spur buyers back into the stock.

By the end of the day the share price rejected the lower levels and respected the support. This is a positive for technical analysts. While Orica holds above $18.80 the risks for the stock are on the upside.

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Time to go shopping

Tuesday, October 31, 2017

By Michael McCarthy

Many investors are attracted to a value based approach to investing. Buy good quality businesses on the cheap, and let the market prove you right. Fortunes are made this way. The catch is that there’s (almost) always a reason a stock is cheap. Deciding whether the current rationale for a low share price is temporary or permanent is a core skill for value investors.

Amazon is coming! The Chicken Littles of the share market are panicking. Many do not seem to know that Amazon commands a princely 3% of US retail sales. Their entry to Australia lifts competition, but it doesn’t lay waste to the retailing landscape. And in my view the associated sell down has brought some quality choices to lower share prices.

This argument is not new. However, the price action in JB Hi-Fi (JBH) suggests a lower risk entry.

Note how the price found consistent support around $22.50. This price behaviour is an indication of “back foot” buying. A buyer or buyers are happy to soak up stock at that level, but are not chasing the stock higher. This is particularly important where a stock is short sold, as this sopping up of sellers reduces the ability of short sellers to buy back. And JB Hi-Fi is the fourth most shorted stock in Australia, with 15% of stock short sold.

Adding to the technical support is a lower PE, around 11x, and a dividend yield with franking of around 5.2%. This coincidence of technical and fundamental support increases the chances of a melt up in JB Hi-Fi's shares.

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Copper and oil ring BHP’s bell

Tuesday, October 24, 2017

By Michael McCarthy

Copper and oil are bellwethers for global industrial sentiment. Copper is used in everything from computers to construction. Other than nuclear fuels, the world’s energy markets are closely linked to the price of crude oil. Global investors take note of the signals coming from these key industrial commodities, and right now there is a bell ringing.

Here’s a longer term copper chart:


Note the price recovery back to levels last seen in 2014. Admittedly, the picture in crude oil is less impressive. However the price has stabilised, and is now trading near the top of the two-year trading range. Importantly both iron ore and coal prices are also trading above many analysts’ long term forecasts. Now take a look at the BHP chart:

More aggressive investors snapped up BHP shares at prices below $20. However purchasing at those lower prices meant a higher risk profile, and was not suitable for all portfolios. Now, the profile is shifting again. I know there’s nothing more mundane than a “buy BHP” call.

But.

In my view all four of BHP’s main commodity markets are pointing higher, and BHP’s share price is lagging this broadly co-ordinated move. If BHP lifts above $28 there could be a scramble, and investors could miss out not on a bargain, but on a key driver of any significant moves higher for the Australian share market.

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Taking a chance on telecommunications

Tuesday, October 17, 2017

By Michael McCarthy

On Monday the S&P/ASX 200 index broke out of its four-month trading range. In good news for investors, it traded up through the ceiling, meaning from a technical point of view, further gains are more likely. However, the challenge for investors is “what to buy?”.

Simplicity is a virtue in investing. The clearer a principle or proposition, the easier it is to determine its worth. This applies to many investing endeavours, from valuation to portfolio construction and beyond. One of the most straightforward approaches to buying stocks is to start by looking at sectors that are lower.

There are eleven official sectors of the Australian share market. Looking at the last four years, only two are nearer lows than highs, Telecommunication and Energy (Consumer Staples stock are around the midpoint).

The telco sector is suffering from NBNitis. This is characterised by delayed roll outs, margin pressure and under delivery. Naturally these are real investor concerns, but not everyone will lose from this nationally important infrastructure build.

The sector incumbent, Telstra (TLS), is also the most widely held stock in Australia. Its apparent lack of a growth strategy beyond the NBN roll out makes it, in my view, the most likely to lose market share, and therefore no bargain at the currently depressed share price. Others in the sector spark more interest.

TPG’s (TPM) ambitious mobile plans have analysts worried about the required capital commitment and its potential impact on cash flows. The construction of the NBN will also hurt its cable network revenues. On the other hand it has scale in its business but is still more agile than the sector gorilla. This combination of characteristics could make it a winner from the changing telco environment.

Importantly the market has trounced TPM’s share price. Taking a chance on the future was hard to justify at $12 a share. Below $5 per share it’s a much more interesting proposition.

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Healthscope under the microscope

Tuesday, October 10, 2017

By Michael McCarthy

When you hear “healthcare sector” what do you think of? Hospitals and aged care? The Australian healthcare sector is all that and a lot more. They were lumped together when investors sought “defensive” earnings. An aging population and government payment of many bills dominated individual company features. As this desire for defensive earnings recedes, the sector may be viewed in a more nuanced way.

It’s easy to underestimate diversity in the sector. There are hearing and anti-snoring device manufacturers, blood product makers, medical suppliers, pathologists and drug companies, as well as the traditional medical services groups. The recent half year earnings reports saw responses at the company level, and share price performance varied enormously.

One to catch the eye is Healthscope (HSO).

HSO traded to all-time lows into its August half-year result announcement. Then a miss on earnings, and forecasts some analysts thought were too optimistic, saw share price targets slashed. The stock fell a further 15%.

Note most analysts’ earnings estimates are below HSO management’s guidance. Even at these lower levels the price to consensus earnings ratio is around 17.5x – close to the broad market and well below the healthcare sector average.

This healthcare provider is not an income play. A key question revolves around the current hospital build – when will the site start earning, and how high will those earnings be? Given the conservative consensus view and the lower share price it’s time investors take a good look at this hospital care provider in development.

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A free hand in a free market

Tuesday, September 26, 2017

By Michael McCarthy

Profound industry change can happen in slow motion. The changes to Australian retail are playing out over decades. There is no end in sight to the evolution in the way we buy goods and services, and we first started talking disruption and disintermediation in 1998. The change in the media space is just as glacial.

Twenty years after the Naked News first went to air, and twelve years after the Huffington Post “published” its first edition, changes in media delivery and content roll on. The Australian government recently abolished the media “two out of three” and “reach” rules, anachronisms from the pre-Internet era. The general view is that “old media” companies now enjoy greater freedom to compete with their newer rivals.

This freeing up of the landscape should accelerate the process of identifying winners and losers among the established media groups.

In my opinion, Fairfax’s (FXJ) demonstrated propensity to sell off any areas of new media they develop (SEEK, Carsales.com etc) continues as they ready real estate business Domain for IPO. It’s as if FXJ management think this whole interweb thing is one giant fad that will end at any time, and they want to sell out while they still can. I put a big “L” on FXJ’s management’s collective forehead.

While the rules of media have changed with the internet world, principles of good business remain. Give an entrepreneur a free hand in a free market and results can be astonishing.

The development of Seven West Media (SWM) is a case in point. It has a foot in both camps. Its old media assets include Channel Seven, Pacific Magazines and WA News. However it has long held a position in new media via its Yahoo! portal. With the ownership gloves off, its proven track record in acquiring and building businesses could be a competitive advantage.


The clear downdraft in Seven West Media’s earnings and subsequent write downs over the last four years are a major driver of the share price decline to all-time lows. At current prices SWM is trading on a PE ratio around 8x – half the market’s 16x. Despite the earnings downturn, Seven West Media has reduced debt since 2014 from over $1.2 billion to below $800 million.

The media landscape is about to change – perhaps radically. Seven West Media is an experienced player with a cleaner balance sheet, and potentially a winner from the shifting media sands.

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MORE ARTICLES

Ausnet flying without a safety net

Time to take a bite of Retail Food Group?

Don't fall into the dividend trap

Domino's looking tasty

Bluescope under the microscope

Stock in the spotlight: oOh!Media on display

Key company reports: What to look out for

Stock in the Spotlight: Brickworks

Investor alert: Heightened downside risk

Profiting from a holding pattern

Fairfax (FXJ) and the damage done

Diversification across sectors is key

Milk bubbles?

JB Low-Fi?

Is the market set for a pullback?

Wild Western Areas

Retail tales: The Amazon effect and JB Hi-Fi

Stock in the spotlight: Adding growth exposures

Stock in the spotlight: Going for Platinum

Climbing the wall of worry: 3 events that could derail the market

A beef with P/E ratios

Going for growth

Stock Spotlight - Healthscope (HSO)

The triple top: Is the market set to slide?

Are shares at risk of a pullback?

Gold for Australia: stocks to watch

Reporting season: the good, the bad and the ugly

Factors affecting portfolio performance

Common behaviours that could hurt your investments

Can the 'Goldilocks' economy keep the bears away?

How to invest in 2017

Who’s afraid of the big bad Fed?

Market volatility demands action

3 market hurdles in the silly season

ASX 200 could reach 5900 by year's end

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Healthcare stocks catch a cold. Time to sell?

This week's jobs numbers could make or break the market

Will there be a Santa Claus rally?

Should you buy the banks?

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Is the market in the sell zone?

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Flight Centre has its wings clipped

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Media under the Southern Cross

ANZ: forecasting disaster

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The not-so-big Australian

Signs of a market bottom

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Tightening tales

The upside of low energy prices

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News versus noise

The investment toolbox

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“Dow 30,000 Now” and CSL

Canberra puts a Buy on shares

Market volatility and dividend floors

Dusting off the portfolio

Market routs, corrections and sell offs

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