Risk Off

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By Rudi Filapek-Vandyck, Editor FNArena

Kerry Duce, Senior Strategist at ANZ Bank, on Friday joined a rapidly expanding list of market experts calling for a pause in the rally for global risk assets.

What makes Duce's call different is that it is not based upon some technical chart observation, or the good old gut feel instinct, but on the bank's in-house econometric tools. Global economic momentum is peaking, says ANZ Bank, and history suggests risk appetite is usually not far behind.

That was before authorities in Beijing issued another scare on Friday evening by announcing yet another (mild) clampdown on domestic property speculators.

Mind you, Duce is not calling for a repeat of the experiences in each year since 2009 when early year optimism has been followed up each time by a good old fashioned sell-off. He's talking about "consolidation rather than capitulation" and about "buy risk on corrections" because momentum is projected to reinstate itself later in the year.

For now, however, economic weakness and risk off have become the new outlook.

Duce's outlook for a mild corrective phase ahead is supported by quant analysts at Macquarie who, on Monday, released their latest findings on the basis of historical data research. On Macquarie Quant's assessment, the rally for equities is now 77 days old with history revealing this is quite rare, though not as exceptional as commonly assumed.

Of more importance is that history shows this does not automatically lead to the inevitable pull-back or "correction". In the absence of genuinely bad news, report the quant analysts, it is well possible that equities merely move into a sideways pattern and grind their way higher as the year matures.

This is good news because a political impasse in Italy and a mild clampdown from Beijing on rising property prices are both negative developments, but hardly Class-A or Category 1 shocks to the global investor mindset. Not with central bankers in Europe, the UK and the US ready to jump into action if and when necessary, while colleagues in Japan are preparing for the biggest all-in liquidity stimulus plan the country has ever witnessed.

If there's one important lesson from the past five years it is that central bank liquidity policies trump everything else in the short term and this year will prove no different, says Duce. It is one important reason as to why he forecasts the re-emergence of economic momentum and global investor risk appetite later in the year.

The pause that refreshes should thus be treated as a buying opportunity.

Certainly, that also seems to be the underlying message from equity market strategists at Macquarie who also updated their latest findings on Monday. On Macquarie's new assessment, the ASX200 is destined to break through 5300 by February next year, which translates into a total return of some 8.6% of which 4.6% (majority) will be coming from dividends.

What makes Macquarie's latest projections unusual is that a carbon copy return is forecast for resources stocks (8.6%) which carry lower dividend yields. Of course, these projections are not static and Monday's price action (first trading day after the Chinese announcement) suggests that by the time momentum turns there will likely be more rally potential for resources stocks than suggested by these numbers, if only because share prices by then are likely to be lower than when Macquarie updated its calculations.

Here's another way to put it: don't expect the emphasis on sustainable dividends in the Australian share market to reverse anytime soon.

I note the February reporting season has been sufficient to retain a positive bias towards future earnings momentum for corporate Australia, but the overall impact on estimates for fiscal 2013 has been minimal. A fact also observed by experts at Goldman Sachs, Macquarie and elsewhere. The impact on FY14 estimates has been more noticeable and positive, but this merely shifts the focus to the next reporting season in August – in particular with the RBA on hold and the Aussie dollar still above parity.

An important pillar underneath a recovery in earnings per share growth next financial year in Australia is the expectation that growth will return to the resources sector which was a stand-out negative during the four weeks in February. Apart from cost control and production expansions, this upside has to come from rising commodity prices and this, alas, is not happening (iron ore has become the sole exception, with skepticism abound about the sustainability of it all).

Quite the opposite has been happening, really, with many a market observer pointing at the gap between equities and commodities thus far in 2013.

No matter where we put the exact starting point for the rally in equities (we don't all have to agree with the 77 days chosen by Macquarie Quant), fact remains the rally in Australia has been carried by financials and by industrials and resources stocks, in particular the second and third tier, have been noticeably absent from the majority of investor funds flows.

I wouldn't be the only one to remark that buying undervalued industrials and solid dividend payers in the Australian share market is quickly becoming an overcrowded strategy. Which is why analysts at Goldman Sachs have come up with the concept of "value at reasonable growth". The idea is to find stocks (not necessarily industrials only) that still seem to offer value while earnings growth should be strong in the years ahead.

Stocks selected by Goldman Sachs include Asciano ((AIO)), Orica ((ORI)), Arrium ((ARI)), Beach Energy ((BPT)), Leighton Holdings ((LEI)), Sims Metal Management ((SGM)) and WorleyParsons ((WOR)). This week's research update has added Bank of Queensland ((BOQ)), Macquarie Group ((MQG)) and Qantas ((QAN)) to the list.

Equally noticeable are the stocks that were previously on the list but have now fallen off: Regis Resources ((RRL)), Suncorp ((SUN)), Seek ((SEK)), Insurance Australia Group ((IAG)), Incitec Pivot ((IPL)) and Rio Tinto ((RIO)).

Market strategists at BA-Merrill Lynch issued another stern warning to investors this week: the Australian share market is now trading at higher PE multiples than stocks in the US. This is only the fifth time in 25 years, note the strategists, and each time in the past this observation was followed by a relative de-rating of Australian equities vis-a-vis the US.

Will this time be different?

At the stock level, BA-ML strategists find valuations have become stretched for defensive yield stocks such as Telstra ((TLS)), Tatts ((TTS)) and CommBank ((CBA)), while some growth stocks seem expensively priced, including CSL ((CSL)), James Hardie ((JHX)) and Insurance Australia Group, while investors are now paying high multiples for cyclical recoveries in retail and financial markets, with companies in these sectors still subject to structural headwinds while any earnings recovery is yet to emerge.

Concludes BA-ML: Better value exists in resources.

The latter may well be true, but a close connection with risk on/risk off suggests investors may have to be patient for this gap in relative valuation to turn into a profitable opportunity.

In what is possibly the ultimate proof that investors weren't necessarily looking for a good earnings report in February, quant analysis of positive and negative surprises in February by JP Morgan puts the worst performance on Sonic Healthcare ((SHL)) with the company's financial report generating the highest negative score among large caps in Australia.

The irony: Sonic Healthcare shares have since reporting outperformed the market by 6%!

Final note: part of the sell-off in resources stocks on Monday has been linked to a damaging broadcast on Chinese ghost cities by CBS News in the US. The broadcast certainly is commanding a lot of attention on social media and can be accessed via the followig link:

http://www.cbsnews.com/video/watch/?id=50142079n

(This story was written on Monday, 4th March 2013 in Perth where I will give two presentations to local investors on Tuesday (see below). It was published on that day in the form of an email to paying subscribers).

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(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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Rudi On Tour in 2013

– I am in Perth this week for two presentations both on Tuesday March 5: Australian Shareholders' Association first at noon (State Library of WA inside the Perth Cultural Centre) and Australian Investors' Association later in the evening (7pm) at the Wembley Downs Tennis Club.

– I will also present and contribute during the 2013 National Conference of the Australian Technical Analysts Association (ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23

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