“I don’t know.”

Many readers may be familiar with the wonderful Ray Walston based on his portrayal of My Favorite Martian. Others may know him as Judge Henry Bone from Picket Fences.

On the big screen he earned fame as Mr. Applegate in Damn Yankees. And in the 1980s he once again flashed in the rowdy coming-of-age classic Fast Times at Ridgemont High.

His Mr. Hand, history teacher/foil, immortalized Sean Penn’s Jeff Spicoli in chalk, etching the ne’er do well surfer/stoner’s response to questions about his consistent tardiness on the board for all his students to enjoy, giving Mr. Spicoli “full credit, of course.”

“I don’t know.”

Mr. Hand was being ironic. (“Mr. Hand, will I pass this class? Gee, Mr. Spicoli, I don’t know.”)

I’m being earnest–honest–when I say I don’t know when the current market slide will end.

I don’t know when the deterioration in the value of the Australian dollar versus the US dollar will end.

I don’t know where the bottom is. And I don’t know where the next top will be, so I don’t know when, exactly, it’s a good time to sell in order to avoid the next, inevitable correction.

I do know it’s been a long time since the last correction and that in historical terms we were well past due for one.

I do know that my mission is not to trade in and out of stocks, generating return-eroding fees.

I do know that owning high-quality companies–with easily understood business plans, clearly identifiable cash flows, strong balance sheets, competent management teams–and collecting dividends from them is a tried and true blueprint for building wealth over the long term.

Focusing on underlying health of individual companies–approaching them as if we’re small business owners, with the long-term commitment that implies–is how I choose to approach the market.

Of course there are macro factors that will impact the well-being of our AE Portfolio Holdings, and so I do spend a good bit of time following economic indicators from key markets, commentary from central banks and research from a number of sources.

But at the end of the day I don’t know which way the market will move today, next week or in 2015. I don’t know whether we’re on the verge of another recession. And I don’t know when interest rates will rise.

I have a lot more to say about the Australian dollar, policy posture at the Reserve Bank of Australia and the US Federal Reserve and the current global context in this month’s In Focus feature. But it’s a framework only. Don’t look for definitive answers. We get those on a quarterly or a semiannual basis for our dividend-paying Australian holdings.

I can report, and there’s more detail in this month’s Portfolio Update, that the AE Portfolio outperformed the main Australian benchmark as well as two Australia-focused exchange-traded funds listed on the New York Stock Exchange in the third quarter.

Also in this month’s Portfolio Update, as part of a larger discussion about Rio Tinto Ltd (ASX: RIO, NYSE: RIO), BHP Billiton Ltd (ASX: BHP, NYSE: BHP) and dynamics of the iron ore market, I’ve downgraded Mineral Resources Ltd (ASX: MIN, OTC: MALRF, ADR: MALRY) to “hold.”

Mineral Resources is a solid outfit, with a great reputation in the mining services space. Its recent expansion into iron ore production has gone well.

But its core business is suffering because of the broader sector slowdown. And it’s going to get as the Rios and BHPs of the iron ore world boost output, drive down commodity prices and grab market share.

The facts supporting our case for Mineral Resources have changed. So we’ve changed our mind on the stock.

I don’t think Mineral Resources qualifies as a “mistake” the way Iluka Resources Ltd (ASX: ILU, OTC: ILKAF, ADR: ILKAY), Grange Resources Ltd (ASX: GRR, OTC: GRRLF) and perhaps SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF) do.

The first two were poorly timed, the third we stuck with it well past the point where a turnaround in Australian corporate investment was likely to stem financial and operating deterioration.

I try to admit mistakes as soon as possible and move on. That’s as important in this endeavor as knowing what I don’t know.

The most important thing for any investor is self-understanding, the limits of risk tolerance, the ability to ride out volatility, the financial capacity to endure losses.

The AE Portfolio is a model. It is long-term in nature. We have neither the capacity nor the sanction to tailor advice to any individual. That may seem like a cop-out. But it’s reality.

Ultimately, my goal is to follow the evidence, at a company level and at the macro level.

This approach, based on Portfolio performance for the third quarter at least, appears to be working.

Portfolio Update

The third quarter was a rough one for Australian equities.

It was particularly difficult for US-based investors long dividend-paying stocks from Down Under, as a 7.3 percent decline in the Australian dollar versus the US dollar exacerbated what was actually modest underperformance versus major global equity benchmarks.

The S&P/ASX 200 Index was down 7.8 percent in US dollar terms, 0.6 percent in local terms during the three months ended Sept. 30, 2014. The S&P 500 Index gained 1.13 percent, while the MSCI World Index lost 2 percent.

The AE Portfolio generated an average total return in US dollar terms of negative 5.9 percent.

The Aggressive Holdings posted an average US dollar total return of negative 9.5 percent.

Every Aggressive Holding posted a negative total return in US dollar terms. The top performer was October Sector Spotlight Amalgamated Holdings Ltd (ASX: AHD) at negative 2.4 percent.

The Conservative Holdings, meanwhile, were down 2.9 percent in US terms but gained 4.2 percent in Australian terms.

Private hospital operator Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF), another October Sector Spotlight, posted a third-quarter total return of 3.1 percent.

Portfolio Update has more on third-quarter performance as well as an update on iron ore horses Rio Tinto Ltd (ASX: RIO, NYSE: RIO) and BHP Billiton Ltd (ASX: BHP, NYSE: BHP).

We also take a look at APA Group’s (ASX: APA, OTC: APAJF) options in the aftermath of its failed bid for Envestra Ltd and Transurban Group’s (ASX: TCL, OTC: TRAUF) fiscal 2015 third-quarter traffic and revenue numbers.

In Focus

A combination of factors–including investors seeking the comfort of the US dollar safety, forecasts for weak global economic growth, softening commodity prices, speculation about the timing and pace of an anticipated rise in US interest rates and Reserve Bank of Australia (RBA) attempts to talk it down–sent the Australian dollar sliding in September and into October.

Shocks such as a hard landing for China or a collapse of the domestic property market could drive the aussie sharply lower from here.

More likely outcomes include finding support around the 10-year average in the USD0.88 neighborhood, thanks to further monetary easing in Europe and Japan and a surge in liquefied natural gas (LNG) exports from Australia as new facilities come on stream.

Australia’s advance to the lead among global LNG exporters will materially improve the Land Down Under’s current account balance.

The aussie is under pressure, having shed 7.3 percent of its value versus the US dollar during the third quarter.

But strong underlying economic fundamentals–supported by its abundance of in-demand natural resources, complemented by one of the lowest debt-to-gross domestic product ratios in the developed world–and persistent demand from foreign currency reserve managers provide long-term support.

In Focus takes a look at the Australian dollar, including the story on the short-term causes of its recent slide, the medium-term catalysts and the long-term case for sticking with it.

Sector Spotlight

Strong demographics support operations at home: A doubling in the proportion of Australians older than 65 is set to underpin earnings for health care companies in the longer term, as beyond that age people become large consumers of health-care services.

Evolving policy in key developed markets promises short-term headwinds as companies adjust to efforts to reduce public spending.

But over the longer term policies that increase the number of insured patients should result in rising volumes.

And growing incomes and awareness in key emerging markets that neighbor Australia provide significant opportunities for growth, particularly in the private health sector, which is growing rapidly in emerging-market countries.

Across the developing world, population growth, increasing life expectancy, growing disease burdens and patients’ demand for treatment are driving reliance on private health care companies.

AE Portfolio Conservative Holding Ramsay Health Care Ltd (ASX: RHC, OTC: RMSYF) is a legitimately global operator with a geographically diverse portfolio of hospitals across five countries.

Ramsay, which operates private hospitals in Australia, Indonesia, England and France, is well positioned to grow earnings and dividends based on these trends.

Ramsay Health Care is a buy for long-term earnings and dividend growth under USD52.

We have more on Ramsay Health Care in this month’s first Sector Spotlight.

AE Portfolio Aggressive Holding Amalgamated Holdings Ltd (ASX: AHD) is the No. 1 movie exhibitor in Australia and New Zealand and it’s also the dominant cinema operator in Germany.

It’s true that movie-going represents a cheaper entertainment alternative during times of economic distress, but the most significant factor in box office numbers remains the quality of the product exhibited.

Hollywood has gotten better at turning out dependable hits in recent years by relying on sequels, prequels, spinoffs and reboots featuring popular characters and story lines.

Amalgamated has a solid track record of boosting its payout, with six total increases over the past five years. The five-year dividend growth rate is 6.8 percent.

Making movies work as an investment is a matter of smoothing out box office revenue that can be as volatile as any Hollywood diva or director.

Amalgamated generates solid revenue from on-screen advertising and merchandise sales in its theaters. And it’s one of the most technically advanced theater operators in the world, having upgraded exhibition technology to accommodate 3D, digital and IMAX projection that supports premium ticket prices.

Amalgamated Holdings is a buy under USD9.

This month’s second Sector Spotlight focuses on Amalgamated Holdings.

News & Notes

How Frothy Is Australia’s Housing Market?: The country’s regulators hope to dampen housing investors’ exuberance without undermining the sector or the broad economy, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced reduced dividends during the recently concluded earnings reporting season Down Under.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

How They Rate

How They Rate includes 111 individual companies and four funds organized according to the following sectors/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business. We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

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David Dittman
Editor, Australian Edge