Rudi On Thursday

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

(This story was originally published on Wednesday March 18, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).

Let’s start with some good news: at today’s close of 3442.40 the S&P/ASX200 index has clawed back nearly 9.5% since March 6 when the index closed at 3145.50. What’s more, and as flagged in my Weekly Analysis on March 3rd (“A Bottom In March And A Rally Next ?”), the Australian share market has thus far carved out a near perfect pattern to continue adding more gains in the weeks coming.

For those who missed my previous analysis (or who’ve forgotten about it by now), history shows the first two weeks of March often mark a reversal in trend for equities. Last year, for example, the selling during January and February ceased around the middle of March and the index in Australia reached a temporarily bottom on March 18. What followed was a strong rally that lasted for weeks.

Many an adviser and market watcher has drawn upon last year’s example to predict the share market would rally again in March this time around. They have been correct.

However, what I also pointed out fifteen days ago, was that history seemed to favour a certain pattern. This pattern sees the share market hitting a bottom in the first half of March, preferably in the first week. Once this bottom has been established the share market more often than not continues to book gains for weeks to come.

Analysis of trading patterns since 2002 suggests that if the share market peaks too early, the opposite happens. In 2002, for example, the S&P200 rose and rose and rose until it reached 3497.60 on March 7. After that it went downhill. By the end of April it was back at 3007.50, and by the end of June it was effectively still at that level (3026.90).

In 2004, again, the share market peaked too early. The close at 3424.90 on March 9 that year later proved a peak too soon too. By the end of the month the index was lower (3415.30), and by the end of April it was another notch lower (3400.80). One month later and all the index could show was a net advance of 35 points only (May 31 closing level 3460.20).

Compare these two examples with the more attractive alternatives:

In 2003 the S&P200 index bottomed on March 13 at 2700.40. By April 30 it had gained 11.4% to 3007.50.

In 2006 the index bottomed on March 8 at 4873.00. By March 20 it had bounced back to 5000.40. By the end of April the index stood at 5258.80 (up nearly 8% from the March 8 low).

In 2007 the index bottomed on March 5 at 5653.60. On the final day of April it closed at 6166.00 (up 9%). The next month it added another 150 points.

So what have we seen so far this month?

As things stand right now, March 6 is likely to mark the bottom for now with the index closing at 3145.50 on the day. The share market proved unable to hold on to its earlier gains today, but at a close of 3442.40 it is still nearly 9.5% higher than 13 days ago.

To be honest, the fact that the share market closed lower today has made me more positive about prospects for the weeks ahead than if the index had simply added another buoyant performance.

This seems rather contradictory, so allow me to explain.

One of the methods I use to gauge where the share market is, in terms of valuation, is the gap between banking shares and their average price targets. According to my personal experiences and observations throughout the past five years, whenever banking shares trade above their average price targets a share market pull back is about to follow.

This is because share prices have simply run up too high, too fast. Projecting bank earnings into the future used to be a relatively stable exercise. And these targets are usually set for twelve months into the future. Add one and one together, plus the fact that the banks used to be the largest group in the index, and what you get is an easy to explain gauge of where the overall share market stands in terms of valuation.

However, the Global Financial Crisis and the bear market for equities have created disparities between Australian banks. As such, these days I tend to look at the leaders and not at all Big Four as a group. So what does FNArena’s Stock Analysis tell me?

Commonwealth Bank of Australia ((CBA)) shares closed at $32.62 today, some 4.6% above the average price target of $31.19.

Westpac ((WBC)) shares closed at $17.73, which is only just below their average target of $17.94.

Even shares of National Australia Bank ((NAB)) at $19.15 are less than 2% away from the $19.49 average target. ANZ Bank ((ANZ)) shares still have a gap of 2.7% left to fill.

What this tells me is that the move up since March 7 is getting long in the tooth – for now. Gaining 10% in less than two weeks is a lot (especially considering US shares gained more than double over the period). What my banking shares versus price targets-method shows is that the first valuation barriers have started to appear.

Commbank and Westpac shares are now either at or close a forward looking multiple of 11. An optimist would say that’s well below the 15x these shares were trading at in the second half of 2007, but history shows banking shares usually trade at a multiple between 9-11 during times of economic duress. I don’t think we’re ready yet to make a successful transition into the next economic upswing.

Leading Indicators by Westpac and the Melbourne Institute, released today, indicate economic growth in Australia is likely to only get worse. And Meredith Whitney, who has gained a near God-like status among banking analysts and investors in the US since accurately calling the continuous downturn for banks, is still predicting the news will still get worse first.

What about the other important sector for Australia, the resources stocks?

Here the news appears a little better than for the banks, but only just and only because the sector was the biggest loser in the market on Wednesday. In what could have hardly been timed better, Rio Tinto received two downgrades to Sell today. BHP Billiton ((BHP)) shares closed 3.9% below their average price target, but as I pointed out last week, the trend remains down both for earnings forecasts and targets for the company.

I note that forecasts for the global steel market continue to be adjusted downwards. The World Bank today lowered its growth forecast for China to 6.5% this year. GSJB Were analysts have now lowered their anticipated new contract price for iron ore: instead of a price decline of 30% they now expect to see a fall of 40% from last year’s negotiated prices.

In addition, many publicly traded commodities, including copper and crude oil, are now trading at or near technical resistance.

Take a look at a price chart for the All Ordinaries index and/or for the S&P200 since the beginning of the calendar year. What you see is that technical resistance respectively at 3500 and 3550 has now been challenged three times.

Combine all of the above and I think the conclusion is there’s still room to move further upwards, especially for beaten down industrials, but the market leaders are getting close to valuation limits again (or have already moved too far). I wouldn’t be surprised if we’re in for a pause now, and this may well result into a pull back.

(My current thinking is that those beaten down industrials need the leaders to pull back so that both can move higher again.)

As those readers who have been following my analysis throughout the past years know by now, my banking shares versus average price targets-indicator has to date not disappointed one single time. Since I developed this indicator, the share market has retreated every time shortly after banking shares ran up too far – every time – without exception.

Why would this time be different?

With these thoughts I leave you all this week.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Andrew, Greg, Chris, Joyce, Pat, Grahame and George).

P.S. I found this chart in the Australian Financial Review this week. Puts the whole banks-financial crisis into perspective, doesn’t it?

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