Rudi On Thursday

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

One of the most oft repeated mistakes by investors and market commentators, I believe, is ignoring the fact there’s always a wider context why certain things are what they are, or why they have changed.

I am not pretending I have an answer for every question that comes in my direction, or that I never have to review my opinion about something, but a lot of confusion caused by conflicting statements and views in the market would be no more if more attention was paid to the broader context behind things; that I am 100% certain about.

Take oil, for example. Ever since the price of one barrel of crude surged past US$130, and the world instantaneously thought the next stop could only be US$150 and then US$200, I have been very vocal in my belief that such scenarios wouldn’t last very long as it would force the world economy, and thus equity and commodity markets, to their knees.

As oil was making its way to US$147 such a doom scenario was becoming a very real possibility and thus share markets did exactly what they should do: they tanked. Since then oil and equity markets have been trading in opposite directions of each other, which seems but logical given the real threat such a spike in the oil price represents to the world economy, and to corporate profits.

Next thing I know I am corresponding with readers who refer me to publications elsewhere, in essence proclaiming there is no direct relationship between oil prices and share markets. Their proof? Without any exception these opposing views are all based upon longer term correlation analyses, leading to the conclusion there’s no empirical proof that oil and equity markets should move into opposing directions.

Of course there isn’t.

The only reason why oil and equity markets are behaving as each other’s adversary at this point in time is because oil is trading above US$121, and it was more than US$25 higher only weeks ago – as such it represents a real and present danger. Oil at US$70 per barrel does not represent such danger. That’s why the current correlation between the two is something that wasn’t there in the past (no need to crawl through years of data analysis to prove the obvious as far as I am concerned).

If you think that’s an easy one, consider the fact that various experts in the market will still tell you investors shouldn’t try to distinguish between bank stocks in Australia. Ultimately they all move in unison, even if they can move faster or slower in the short term, is the experts’ credo.

This is what I would call a typical bull market legacy. Banks have enjoyed an unusually buoyant era since their near death experience in the early nineties. This not only brought them double digit earnings growth for successive years in combination with solid, reliable and steadily growing dividends, but it made them at the end of the last decade and in the early years of the current one also the undisputed leaders of the share market. With the exception of the technology-driven bear market between 2001-2003, these same banks all enjoyed strong economic growth and ever widening demand for their products.

Allow me to spell it out: during good times differences in management, in execution, or in whatever (as long as it doesn’t involve a disaster or a scandal), remain very minor – they’re all having a good time. Change the overall context, however, and what you’ll see is that differences between the various banks will be more pronounced. And that’s exactly what’s been happening since November last year.

Consider the following overview as published by The Australian Financial Review on Wednesday (30 July 2008):

Fall in bank shares from record highs nine months ago:

ANZ Bank ((ANZ)) minus 51%
Macquarie Group ((MQG)) minus 51%
National Australia Bank ((NAB)) minus 45%
Bendigo Bank ((BEN)) minus 44%
CommBank ((CBA)) minus 37%
Westpac ((WBC)) minus 35%
St George Bank ((SGB)) minus 33%
Bank of Queensland ((BOQ)) minus 29%

I have looked up Suncorp-Metway ((SUN)) myself: minus 41%

First conclusion I like to draw, and I am sure all of you will agree, is that for a group that is supposed to move largely in unison, the differences are actually quite large. Imagine you had owned Bank of Queensland shares instead of ANZ, or even Westpac-St George Bank instead?

Ah, but, I hear those experts say, this is not fair – we mean to say banks move as a group over the longer term.

Wrong message again.

Surely if you’re thinking about making a decision at a time when differences in share price movements have been large and substantial, you would want to take this into account with regards to your future potential returns?

In the end, and that is what investing in a bear market really is all about, you’re paying more for lesser risks. However, come the time when the skies turn blue again you’ll find the larger upside potential is likely with those who lost more during the downturn.

I have this theory, which is largely based upon the latest changes in earnings forecasts by stock broker analysts. According to these projections (and I am putting all individual banks together as one unit) this year’s earnings will look pretty disappointing given we were talking double digit growth (high single digits at least) only twelve months ago.

Now let’s assume current projections are correct and next year will even be worse, then our first recovery for the sector will only materialise throughout fiscal 2010. Single digit growth probably (depending on how bad those FY09 numbers will actually turn out). After that we might see those 10%+ growth figures again.

Is it a fair assumption to make that, on the basis of the scenario above, the market might start considering pushing PE ratios for banks from 8.5-11 towards 13-14 again from, let’s say, sometime late next year/first half of calendar 2010?

By then what is still left as competition from non-banks will have shrunk into oblivion. Once this whole credit curse and economic slow down has been dealt with the banks are going to have a real good time, and I mean a real good time. Flashback to the early nineties?

With these thoughts I leave you this week. Till next week!

And remember: there’s always a wider context to consider.

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Greg, Sarah, Grahame, Chris, Joyce, Pat, George, Todd and Paula)

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