Rudi On Thursday

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

(This story was originally published on Wednesday, February 10, 2010. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

Straight up: I do not think that the Australian share market, after a correction of close to 10% from its peak at 4955 on January 11, is now full of buying opportunities.

For starters, the push upwards on low volume between Christmas and the second week of January had made the share market overvalued on short term metrics. Above all, I think this correction has further to go still and many shares will become cheaper than what they are priced at today.

Of course, "buying opportunity" is a relative term. If anyone thinks BHP Billiton ((BHP)) shares back below $40 a piece is "cheap" enough to jump on board, by all means, go ahead, but I would not be surprised if the same shares can be bought for $36-something later this year.

This view is based upon the following observations:

– Risk assets across the spectrum have all (ALL!) broken through upward trend lines originating in Q1 2009

– Equity indices, both in the US as in Australia (and elsewhere), have in the past few sessions fallen below technical support lines with such ease that it was as if these support lines weren't there in the first place. Admittedly, major indices in Australia have both managed to stay above 4500 on a daily closing basis, but it's the ease with which 4500 was put aside intra-day that seemed quite discomforting.

– Quant and technical analysts across the globe continue pointing at deteriorating internal market dynamics such as low volumes versus high volumes on respectively rising and falling days, a shrinking market breadth on up-days, plus deteriorating medium term technical signals versus rather neutral short term indicators.

– Above all, however, I think the market (both investors and media) is once again displaying its strictly one-dimensional approach to day-to-day events and right now the all-dominating subject is called "Will Europe bail out Greece?" (in various shapes, extensions and varieties).

It should be no surprise thus that currency markets, always the quickest to absorb this type of information and risk, have been leading equity and commodity markets throughout this correction, the EUR/USD cross in particular. I'd like to add the fact that too many players in the global markets had leveraged their portfolio towards further USD-weakness, and many have been (and will be) forced to make sudden re-adjustments. These processes can be very painful at first, and usually take longer than anyone thinks they will.

So while everyone on TV, in the markets, in the newspapers and online is all but focused on "Greece-sovereign debt-the euro-GFC Part Two", I think there's another story developing that is currently not receiving the attention it should. A story that could be equally damaging for financial assets as the present Euro-crisis (it probably already is).

Could it be that global economies are heading towards a slow down in the first quarter(s) of the new year?

If the answer is yes, this could have serious ramifications for the immediate outlook for commodities and equities, especially within the shaky framework as painted above.

For good measure: I am not saying recovering economies in the US, the UK and Europe are about to fall off a cliff again, as some doom and gloom forecasters keep assuring us they will, but history shows a mere suggestion of slowing economic growth at this stage of the global recovery story can have a disproportionate effect on investor sentiment.

No matter how positive a spin economists, stockbrokers and (most) market commentators put on each of the recent data that were released in Australia, the least one can say is that, combined, these data seem to suggest that the overall buoyancy and economic momentum from late 2009 seems to be tapering off somewhat into the new calendar year.

In fact, today I spotted the first local economist on financial television who actually admitted that, thrown together, recent data seem to indicate the Australian economy is slowing down in the first quarter. No need to panic though, but this is Australia, where market valuations for the likes of CommBank ((CBA)) and BHP Billiton never became more than fully valued, at the most, during the late 2009 rally.

Australian investors know local earnings growth is still going to be very modest this reporting season, and hopes remain for average earnings per share (EPS) growth in excess of 20% for fiscal 2011, but over in the US expectations are higher, and share price valuations reflect this. Probably the worst imaginable scenario would be if the US economy starts sneezing and sputtering.

Yet, this is exactly what economists at IHS Global Insights are forecasting will happen. I assume that to most of you IHS Global Insights is not your daily household name, but IHS economists have built up a solid reputation over the years, and for those who watch Peter Switzer's daily program on Sky Business in Australia, he often quotes from IHS economists.

IHS has developed an Economic Outlook Index for the US, which is published in conjunction with newspaper USA Today. The latest update of this index anticipates a gradual tapering off in GDP growth figures. If current forward looking indicators prove correct, US GDP growth will have slumped to 2.3% by June – surely, if correct, this is not going to make too many people happy.

Remember the 5.7% GDP growth reported for the fourth quarter? IHS's indicator suggests this figure will be revised down to 3.7%. The good news is that January's GDP should come in at around 4%, but it should be all downhill from then onwards.

One thing to keep in mind is that economic predictions remain more art than science, and certainly views and opinions about where economies, and share markets, are heading are at present very wide and diverse. But IHS Global's scenario is very much likely, it does not anticipate a return to Lehman Brothers times, but it is bound to keep a lid on too high market valuations.

Certainly, recent data releases in the US, including last week's non-farm payrolls, seem more in line with IHS Global's index than with more rosy predictions elsewhere. And that's not even mentioning others such as Nouriel Roubini, whose team of economists believes the second half will be worse than the first in terms of US economic growth.

On Wednesday, Chinese import data revealed iron ore imports in January were down by 25%, while copper imports were down by some 21% compared with January. There's always an explanation ready for why these figures do not necessarily imply darker scenarios. China experienced a cold snap in January, for instance, and last year's import data were so strong.

It is very unlikely though, that softer economic data will support a new spike in investor optimism.

Here's a fact nobody can deny: it is impossible to know what exactly will happen in the weeks and months ahead. As such we will all have to find out how long exactly the present correction will last, and how deep it will be – both will be determined by events that have not yet taken place, and by their impact on investor sentiment.

I wouldn't necessarily expect the worst at this stage, but given the high degrees of uncertainty I would rather wait and try to assess how exactly this correction, and further global developments, are playing out. It's easy to jump on board of "buying opportunities", telling yourself you're in this game for the longer term, but think -for a few moments- about the wisdom shared by one experienced fund manager:

"unless you get the short term right, there is no longer term".

With these thoughts I leave you all this week.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team at FNArena)

P.S. I – Support levels 4300 and 4200 are so often mentioned as the next likely targets for Australia's S&P/ASX200 index that, for this reason alone, one would have to assume the index is going to put these levels to the test in the weeks ahead.

It has to be noted that, if we take the S&P500 index in the US as benchmark, the Australian market is once again underperforming the US in this correction. Were the US index to experience a pull back of 10% from its peak, this would take the S&P500 back to 1,035.2. Those looking for more like a 20% pull back are projecting the index back at 920.18. This would be considered a "bear market" by many commentators and take the index back to mid-July last year.

Also note that the Dow Jones Industrial Average first rose above 10,000 in 1997. The comment in the chart above is from Dennis Gartman who, similar to what I have been doing since January, continues to highlight that so many trend lines have been broken in this correction. As reported earlier, Gartman is now talking about a new bear market having started. I will only join him in this if and when major economies slide back into a quagmire, and we're still far from such a scenario (though it is not impossible).

P.S. II – All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.

Click to view our Glossary of Financial Terms