Interesting Stocks in Sideways Market

Invast Insights

Week Commencing March 24,2014

www.invast.com.au | 1800 468 278

This week we look at the following topics:

1.0 FOMC outcome & impact on your portfolio

2.0 Technical outlook on global indices

3.0 Interesting stocks in sideways market

4.0 Got milk? Clover Corporation one to watch

5.0 Book review: Stock Market Wizards



1.0 FOMC outcome & impact on your portfolio

Last week’s US Federal Reserve (Fed) meeting was a turning point in markets.

Make no mistake about this. When the world’s largest central bank signals an

end to cheap money, global fund managers start to readjust their capital

allocation. Incoming Fed Chairwomen Janet Yellen made clear that there is

still a lot of room for improvement

in the US economy but the central

bank knows very well the

consequences of leaving monetary

policy too loose for too long. It’s not

that this comes as a complete

surprise, bond yields in the US were

already pointing higher over the

tightening, but the difference now is that the Fed has made its interest rate

goals official – it sees the official cash rate rising to around 2.25% sometime

towards the end of 2016 compared to 0.25% at the time being.


They key takeouts from the US Fed meeting last week are summarised below:

1) Initial read of FOMC was more hawkish than consensus expectations – US

dollar and bond yields rallied significantly 2) Fed continues to reduce its

monthly bond purchases by another $10B, rates unchanged for the time

being 3) Interesting to see the Fed dropping the 6.5% unemployment rate

threshold which it had previously set in stone. Says economy nowhere near

full employment 4) Qualitative guidance takes form of "Wide Range of

Information" including employment, inflation and financial market

developments. Unemployment now not the sole issue 5) Lowers 2014

Unemployment Rate forecast to 6.1%-6.3% range from 6.3%-6.6% range 6)

Not all happy though, Kocherlakota dissents on switching to qualitative

guidance – perhaps a risk here that less transparency in the market hence

more possible volatility 7) Fed downgrades 2014 GDP forecast but upgrades

2015, 2016 GDP forecasts 8) Fed raises core inflation forecasts. Perhaps this is a

sign that inflation is coming to the global economy after record low rates and

money printing 9) Some 13 out of 16 Fed officials see first rate rise in 2015 and

then two in 2016.


All of the above nine points are equally important, there is no individual point

that we think stands out above another. They all set the stage for a recovering

US dollar as the single global reserve currency. It’s not very often that you see

a central bank downgrading growth forecasts but increasing inflation targets

and this is what many currency and bond traders will be watching very

closely. Core CPI printed at a measly 0.1% in the US last week and while there

doesn’t seem to be any inflation alarm bells at the moment, the Fed’s hawkish

outlook will start to play into the minds of large investors who need to find

investments that have inflation hedges built into them. This is now our

primary aim for Invast clients over the next six months. We want to position

you on the same level playing fields as the smartest investors in the world.

Inflation is coming, the Fed has said so and the smart investor will be he who

acknowledges this very early on.

The impact of raising interest rates from 0.25% to 2.25% might not seem

significant on face value but this is very significant when it comes to the

valuation of global assets. We’ll spend time over the next few months

articulating this to our clients. Let’s take a simple example for the time being


Suppose for arguments sake that a company is generating $5m in annual

earnings. The most conventional way an analyst would value this business is

by forecasting its earnings into perpetuity and then discounting those

cashflows back to today’s time value of money. We’ll use an even simpler way.

Suppose that an investor is willing to accept a 5% return on his funds. That

means in theory, he or she should be willing to pay $5m/0.05 for the above

business or $100m. This is how stocks are valued on the market, often with a

lot more detail but this is the basic principal of fair value investing.

The rate at which the investor is willing to accept is based on his or her ability

to borrow and to deposit funds. If global interest rates are low and the

investor is able to borrow at 3% then a 5% return on his investment will net

him a healthy spread. When interest rates start rising, so too does the required

rate of return for the investor. When interest rates start rising in the world’s

largest economy, the rest of the world takes note. If the cost of borrowing for

this investor has risen to 4%, he now might require a rate of return of say 6%

which means the price he is willing to pay for that same company now falls to


$5m/0.06 or $83. This example shows that just a 1% change in the investor’s

required rate of return has a $17m impact on the company’s valuation or 17%.

Keep that in mind, 1% change in expectations on interest rate returns in this

example has a 17% impact on a company’s valuation.

The example doesn’t stop there. If interest rates are rising, so too should

inflation. This means the business should be able to pass through higher

prices for its goods and services. A good CEO will make sure his revenue rises

by more than his expenses which means earnings are inflation proof. Let’s say

for example that the same company used in the above example is able to

achieve this benefit to rising inflation and support that it manages to grow its

earnings by 5%. So under the new circumstances, earnings have increased by

$5m*10% = $0.5m to $5.5m and even when using the new required rate of

return of 6%, the price the investor is willing to pay for the company is now

adjusted to $5.50/0.06 which becomes $92m. The business that is able to

adapt to a rising interest rate environment is able to achieve a $9m difference

in value than the business that doesn’t have inflation abilities.


There are of course some businesses which have the opposite impact, they

actually are able to grow their value in a rising inflation environment. We’ll

start presenting these to you in the coming few weeks. For now, we hope that

you have accepted the impact of rising interest rates on your investments and

acknowledged that the US Fed has spoken. Get ready, inflation is coming.

2.0 Technical outlook on global indices

Below we updated our technical levels for key stock market indices as part of

our monthly review process. We review and Nikkei 225, Dax 30 and ASX200.

The title of these indices below is renamed to correlate with the way they are

quoted on our MT4 trading platform so that you can find them easily and

execute your trades.

JP225 - In our 2014 Forecast Guide published in January, we predicted a

pullback towards 14250 and 13800 to occur in Q1 2014. The Nikkei 225 did fell

as low as 13900 in the first quarter of 2014, but is that the limit? Longer term


technical still suggest for a deeper correction at play, and we think we could

see this happen very soon. One thing that we took note as a bearish sign in

the near term is the break below support trend line on the daily chart. Which

immediately took the index lower towards 14250 again. The immediate levels

to be of concern are resistance at 14500 and support at 14250, this is where

price was traded at time of writing. There are a series of resistances beyond

14500, but one that stood out is 15125. This is the limit of Ichimoku cloud

resistance on the daily chart as well as previous 23.6% Fibonacci retracement

levels. As long as JP225 continues to be traded below this level we will

consider to sell on any pullbacks. In terms of losses to the downside we see

the potential for JP225 to track towards 13500, a level confirmed on both

weekly and daily chart to be of significant Fibonacci ratio. The 13500 level

represents the 61.8% Fibonacci retracement while on the daily chart it

represents 127.2% Fibonacci extension.


Image: JP225 daily chart via Invast MT4 platform


GER30 - GER30 continued to push higher at the start of 2014, but as with the

rest of the global indices we have not seen a sustainable momentum behind

the push. That said, we still anticipate a return to at least 8500 before any

further upside is possible. In the near term we expect some resistance

between 9325 and 9400. This is the 50% and 61.8% Fibonacci retracement of

the fall in February. Daily Ichimoku cloud is currently located between the two

prices as well. We remain bearish and look to sell further on any rallies

towards these key resistance levels.


Image: GER30 daily chart via Invast MT4 platform


There are two key support trend lines on the monthly chart, one located in

the vicinity of 9100 and the other closer to 8500 support we discussed in the

2014 forecast guide. While this support trend line might seem that any trend

reversals are unlikely, we need to point out how overbought the German Dax

is. Ever since November 2012, stochastic have been trading above the 80 level.

Stochastic above 80 indicates a strong bullish momentum, but one at risk of

being overbought should it dip below the 80 mark. In layman terms, the

German Dax is trading on a minefield, one that could explode at any given

moment.

This is why we are hesitant to make bullish calls on the German Dax, as we

think we could be in for a much larger correction than what we initially

envisioned. Our downside targets have been adjusted to accommodate the

January rally, and we are now looking for a push lower towards 8650 (23.6%

Monthly Fibonacci Retracement) followed by 7950 (38.2% Monthly Fibonacci

Retracement).


AUS200 - We were cautious on any gains in the AUS200, this was outlined in

both the Forecast guide as well as the Follow up webinar to the guide last

month. Similar to what is happening in Europe and Japan, the AUS200 is

showing signs of weakness. From a technical point, the weekly chart has

developed a “Class A” bearish divergence. This is indicated by price posting a

higher high, while oscillators (in this case the stochastic) posted a lower low.

In fact the bearish divergence did not happen overnight but was first

indicated in November 2013. Our downside targets for AUS200 have not

changed they are located at 5250 and 5000, with the potential to go lower

around 4800. Key resistance are located at 5450 and 5500. In our follow up

webinar last month, we called for a short at 5450 with a stop loss above 5500.


Image: AUS200 weekly chart via Invast MT4 platform


3.0 Interesting stocks in sideways market

We recently screened for ASX listed companies which are either making

higher highs or lower lows over the past twenty days of trading activity. This

is just one type of indicator which some traders look at to see where

momentum is trading in certain stocks, particularly in a sideways trending

market. We think the outcome of our scans suggests stocks that are bullish or

bearish at the moment. This doesn’t necessarily mean that they are a buy or

sell but that traders should keep these in mind when looking for trading ideas

in the market. Technical scans are not perfect so we have tried to remove any

distortions and have limited our sample for ASX200 constituents, removing

smaller companies which can be subject to volatility distortions. Data taken as

of 21 March 2014 via Invast Share trading platform.




4.0 Got milk? Clover Corporation one to watch

One of the most significant financial changes is currently occurring across the

Asia Pacific region. Millions and potentially billions of citizens are

experiencing a drastic improvement to their standard of life, increased wages

and with that the associated impact on traditional diets. The diary industry

has recently come under the spotlight in Australia via the takeover battle for a

Victorian producer called Warrnambool Cheese and Butter. The takeover

attracted several key international conglomerates who no doubt will be

eyeing diary assets right around the world. New Zealand based Fonterra is

already a global heavy weight, contributing to a large proportion of New

Zealand’s exports which we discussed in last week’s report.

With all this in mind, Clover Corporate is a business which has caught our eye.

Clover develops technically advanced and cost-efficient delivery systems for

long chain polyunsaturated fatty acids for their application in infant and

children’s nutrition, nutritional supplements and functional foods. Infant


formula is a huge growth market. Clover doesn’t itself manufacture the infant

formula products but it provides the raw materials to global producers. This

author of this report has been keeping a close eye on the market over the

past few years, having welcomed three young children into his family who

have all derived their primary nutrition and diet from infant formula in the

first few months of their lives.

There have also been many anecdotal cases of Chinese buyers looking to raise

Australian super markets of their infant formula products with little trust in

those manufactured in China. The situation occurred when Fonterra

announced that certain whey protein products they produced may have been

contaminated. This was later revised as a false alarm according to Clover’s

presentation made at its annual general meeting last year. The contamination

scare led to the panic seen by Chinese buyers but it has also had an impact on

consumer confidence in the whole infant formula market. Clover says that

many consumers have been scared to trust formula and this will lease to

lower volumes in its business this financial year. It is only expected to be a

short term issue though as the whole situation was a false alarm – or so we


are being told.

Because of lower volumes, Clover’s share price has been languishing at

around 50-55 cents per share for the past few months. Investors are unwilling

to bet on a quick recovery in earnings and volumes until they see results. This

might present a great buying opportunity for the long term, strategic focused

investor. As the global population grows and the emergence of a larger

middle class across the Asia Pacific region impacts diary and other

agricultural prices, the demand for infant formula and other nutritional

products will only rise. Clover is perfectly placed to benefit from this growth.

It competes in a competitive global market but each region has its own rules

and regulations on what raw materials can go into consumable products.

Clover has the ability to adapt and target emerging markets which are

differently regulated to Europe and the United States for example.

Key shareholders include Washington H Soul Pattinson which owns around

29% of the stock. Clover’s head office is also registered to the same address as


Washington H Soul Pattinson, so there is no surprise as to the relationship

between these two groups. Washington H Soul Pattinson is a savvy

investment vehicle and management’s track record is formidable, we want to

make that very clear. Their presence is a positive. Clover’s compound annual

total shareholder returns over the past three years have been 27.5% and an

even better annual return of 30.2% over the past five years.

The stock is down around 8% or so over the past year, no doubt impacted by

the short term earnings fallout from the Fonterra contamination scare. Interim

results are expected to be released this week on Wednesday 26 march 2014.

Below is some more commentary from Clover on the opportunities in the

Chinese infant formula market and how the business is positioning itself to

benefit from the changes.


Image: Clover Corporation 2013 AGM presentation made on 29 November 2013


5.0 Book review: Stock Market Wizards

One of the keynote speakers at the expo was renowned investor and author

Jack Schwager. Jack has written numerous books throughout his investment

career and most of these are essential reading for any trader and investor.

Perhaps one of the best known is Stock Market Wizards which has come out

in numerous updates since first hitting stands a couple of decades ago.

Jack’s book Stock Market Wizards is a collection of interviews with America’s

top stock traders. In an often candid and very direct way, Jack talks with these

traders and asks them a whole range of question on their personality, their

background and their market philosophy in detail. Some of the conversations

are absolutely amazing. This is a must read book. Some of those interviewed

include Stuart Walton who runs a hedge fund in San Francisco, with very

humble operations. To put this into perspective, Walton has only own

employee – his part time secretary. Others interviewed include Steve Cohen

who runs SAC Capital Advisors. Cohen recently featured prominently in the


media for what some consider being “borderline” trading practices – insider

trading allegations which we cannot substantiate nor do we have a view on. A

simple Google search will reveal a range of opinions.

We found a whole range of opinions on the book via Amazon.com. We don’t

see much point in quoting the positive reviews. Of those who rated the book

poorly the main criticism centred around the quality of the interviews in the

latest version which is on sale compared to the first two versions of the book.

One of the most striking criticisms we found on Amazon read “Many of the

interviews are with individuals who practice arcane strategies involving

financing packages or interest-rate hedges with corporations designed to

essentially eliminate any market risk. These strategies are of absolutely no

value to the individual trader/investor. In one interview, the person not only

refused to discuss any of his trading strategies or techniques, but also refused

to even discuss what markets he traded. This of course immediately begs the

question of why this interview was included in the book.”


We don’t necessarily disagree with this, but we don’t think that what the book

tries to achieve is to provide a perspective into the minds of traders. The book

doesn’t try to impose those views as correct; it just tries to bring these views

to the attention of the general public. With that in mind, we don’t think it is

necessarily a waste of time reading about an unethical or unpractical trading

strategy. This isn’t a book about strategies to implement; it’s a book about

how various traders have implemented their own strategies – some good,

some bad. It does open up your mind into the market landscape and the

savvy trader can judge for themselves what to make from each interview. As

another critic made clear on Amazon “This book is about anything and

everything EXCEPT trading.”

The market is a collection of human beings, each with their own lives, their

own problems and their own circumstances. We can learn a lot about markets

by understand all these types of things. Trading doesn’t need to be taught, it’s

something that is experienced. With all that in mind, we think the book is

definitely worth reading even in its current updated form. Not a bad read at

at all for around US$13 via Amazon, you can click here to decide for yourself.

http://www.amazon.com/Stock-Market-Wizards-Interviews-Americas/dp/0066620597/ref=sr_1_1?ie=UTF8&qid=1395186839&sr=8-1&keywords=stock+market+wizards












7.0 Disclaimer

Please note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.

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Interesting Stocks in Sideways Market