Rudi On Thursday

This story features ANZ GROUP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: ANZ

Life is full of strange paradoxes. As the Australian share market appears to be heading down towards its lows of August last year, the FNArena Sentiment Indicator has grown more bullish by the day.

For those who are yet to become familiar with this indicator: the FNArena Sentiment Indicator measures the relative number of Neutral recommendations against Buys and Sells by major stockbrokers in the country. As these stockbrokers traditionally don’t like to issue Sell ratings, it effectively shows the balance between Buys and Holds. The more Buy recommendations are being issued, the lower the indicator sinks.

Thus while Australian share prices are sinking lower and lower during the first weeks of the new calendar year, stockbrokers have on balance increased the number of stocks that are rated Buy/Outperform/Overweight/Accumulate (and all other equivalent ratings). As FNArena also measures the number of up- and downgrades in the market I can report that the past five days alone have generated almost four times as many recommendation upgrades as downgrades (44 against 12).

The indicator is currently in “Red Hot” territory, way below ”Bullish”, and equally heading for its August low.

How to explain this?

There are a few opposing forces at work at the moment. The first one is a clear negative one. As a group, securities analysts seldom run ahead of the market with their assumptions and previews. This means that while most of them constantly had to catch up with bullish developments over the past four years, many of them will now have to catch up with the major reversal in the outlook for global economies and financial markets. In other words: many assumptions and valuations will be proven too positive. And as the upcoming results season in February will bring an instant update for most companies in the market, analysts tend to leave their ratings and models unchanged until that update has been delivered by the company.

For investors in the share market the message for the upcoming results season is thus very clear: treat with caution and try to gauge the risks for negative surprises in your portfolio ahead of the results releases.

But there’s also a second reason why recommendation upgrades are currently significantly outnumbering downgrades: at times of indiscriminate selling the good ones are being sold together with the not so good ones and this creates the oft mentioned “value opportunities”.

A few examples:

On Wednesday afternoon, ANZ Bank ((ANZ)) shares are trading nearly 19% below their average price target in the market. At $25.70 the shares are near a FY09 price/earnings ratio of 10 (with projected FY08 and FY09 dividend yields of 5.8% and 6.3% respectively).

BHP Billiton ((BHP)) shares are trading 30% below their average price target of $48.74. Their PE ratio for FY09 is equally close to 10.

Qantas ((QAN)) shares have opened up a gap of 38% with their average price target. Qantas’ PE ratio for FY08 is 8.4, for FY09 it is 7.3.

Mind you, these stocks have been randomly selected from the FNArena database and this is not to say the price targets and earnings assumptions involved will not change during the year ahead (they almost certainly will) but when blue chip companies such as these three trade 19% and more below the average price target it becomes difficult to argue there is no value in the Australian share market.

Problem is, however, that in the current environment of fear and dismay about ongoing billions and billions in write downs by global financial institutions, amidst talk that Australian banks have been lending against too rosy property valuations, with assessments of the US economic health deteriorating on an almost daily basis and with Chinese authorities strengthening their grip on domestic liquidity, there’s simply no consideration for any value on offer.

I have stated many times in the past that value in itself is never a good enough reason for a share price to rise. There needs to be a catalyst. And right now, it may just as well be that even a 50 basis points interest rate cut by the Federal Reserve at the end of January simply won’t do it.

The problem is not, as many investors might assume, whether the US economy may or may not fall into a recession this year. The problem is that in the current negative environment financial markets are poised to price such a recession in beforehand. Under such a scenario it is difficult, if not plain impossible, to pick the low point in the market. As shown by Centro Properties ((CNP)) and by Citigroup this week, when things turn bad there’s always room for even more negative news.

Some experts have argued that the key for any market recovery lies with the financial sector. Unless the global banking system starts operating “normal” again, and institutions no longer need to announce major write-downs and subsequent fresh cash injections, the markets cannot genuinely recover from this malaise, they say. Well, the first factor is gradually happening with wholesale funding costs falling into the new year. Maybe the current results season in the US will mark the end of the massive write-downs?

Regardless, there will be a lot of negative news to digest in the weeks and months ahead. One of the technical chartists I read this week predicted the first six months will be characterised by the absence of a clear trend for financial markets. I instantly thought: if there’s no trend, will investors still have a friend?

Quantitative analysts at Citi responded to my question this morning with the prediction that 2008 will be a fantastic year for investors who have the ability to pick the right factor and the right stocks to focus on. Forget about value, says Citi, if you’re focusing on value and your horizon is limited (less than a year) you’re bound to end up disappointed. Instead, look for “growth” and for “momentum” to leverage off Australia’s unique exposure to growth in emerging economies.

The upcoming results season in February is likely to provide investors with such opportunities. Past analyses by various stockbrokerages have revealed that around 75% of companies that manage to surprise on the upside with their results release outperform the broader market over the subsequent three months. As far as “momentum” goes, it’s going to be hard to find a better one.

(Note that the time will come when investor focus will again shift to value, a fact acknowledged by Citi Quant, but that moment is still a while away).

One example of such “momentum” (arguably combined with a strong “growth” profile as well) was provided by Energy Resources of Australia ((ERA)) on Tuesday. Since reporting a much better production report than what analysts were expecting the shares have been rising strongly for two days in a row while the overall market was being characterised by sharply falling prices across all sectors.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team of Sophia, Paula, Grahame, George, Joyce, Chris, Pat and Greg)

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