Rudi's View | Aug 17 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, editor FNArena
About ten days ago something extraordinary happened. The FNArena Bear/Bull Indicator, which measures the underlying market sentiment by balancing Buy recommendations by ten major experts in the local market against their Neutral and Sell ratings, fell through the bottom of its measuring frame.
The Indicator works counter-intuitively, so the higher the amount of Buy recommendations, the lower its reading. Some of our readers were quick in notifying us: Hey FNArena, the needle of your Indicator needs fixing! We added another compartment.
Within days the Indicator fell further to reach again the bottom of its extended measuring frame, where it still is today, so it remains possible we have to add another compartment at the bottom of the framework soon.
In the five years we have observed and analysed the recommendations of the major local experts in the share market this had never happened before. So it is that I can now announce there have never been as many Buy recommendations in the Australian share market as today, at least not during the past five years.
To put this in perspective: the ten equity experts we monitor daily combine a total of 2126 recommendations on individual ASX-listed stocks. Close to 42% or 891 of these recommendations are currently Buy, Outperform, Accumulate or Overweight.
When we had a closer look at these recommendations this week we discovered that out of the total of 479 individual stocks covered by these experts combined no less than 347 stocks are rated as Buy by at least one of them. This is more than 72%.
Allow me to rephrase that last paragraph for you: 2.25 out of every three stocks covered is currently rated Buy at least once. We have no historical data to prove it, but we believe this must be another record.
Last week we calculated the average gap between share prices and price targets for the Top 40 of highest recommended stocks was about 22%, an average 4% in dividend yield not included. We’re pretty certain this is another record too.
Taking these figures into account, it is easy to see why some commentators and experts believe the current subdued environment for global equities is providing investors with excellent buying opportunities for the longer term. Hey, who wouldn’t want a 26% return with 2.25 stocks out of every three to choose from?
But are investors in the Australian share market looking at a return of some 26% in the year ahead?
Not according to the strategists employed by these same ten local equity experts. Most would put the S&P/ASX200 index at around 7000 by mid-2008. This only implies 17% upside (plus dividends).
But even at 17% (plus dividends) with only 0.75 stocks out of every three to fail, why aren’t investors piling up on Australian shares? Surely any diversified portfolio will diminish the impact of a few dog stocks that are included in the selection?
The problem is that all these recommendations and targets and the calculations that support them are, in effect, yesterday’s figures projected into tomorrow. Securities analysts have been slow in catching up during the past four years when things were constantly improving. The result was that shares of the likes of BHP Billiton (BHP) and Rio Tinto (RIO) have been pushing ahead of price targets set by the experts, forcing them to continuously catch up with the reality of the Commodities Super Cycle.
Now that developments in the global financial system have taken a turn for the worse, who is willing to guarantee things will be different? Are yesterday’s assessments still viable tomorrow while the world is changing today?
A recent study by JP Morgan suggests investors have already drawn their conclusions, and they started doing so before the world awoke to central bank emergency operations (which arguably took most experts by surprise but also showed most had been underestimating the severity of the crisis).
JP Morgan found that between January and last month investors had started to sell high growth/high PE stocks in favour of more defensive low PE stocks as the gap between both groups of stocks has contracted over the past months.
Could the market be telling us something different to what is currently reflected in analyst forecasts? Will securities analysts have to play catch up again in the months ahead, only this time by cutting back instead of increasing their numbers?
Arguably, this process is already taking place. Earnings forecasts have been in decline for at least two months as a stronger Australian dollar has been put into valuation models and forecasts. Some analysts have started to delete so-called takeover premiums in their models. Others have started to account for higher borrowing costs for companies with debt.
What else could change yesterday’s figures? The amount of experts who believe the Chinese economy is poised for slower growth in the months ahead is still increasing. What will be the effect on commodity prices? Traditionally the third quarter of the calendar year is the weakest for metals. The recent shake-out from the global credit crunch already had an impact on prices of LME listed metals. Technical chartists are now suggesting the sector seems on the verge of emitting a bearish signal.
The most severe adjustments would have to come from a slow-down in US consumer spending. So far, almost every expert is sticking to a positive script. However, some highly regarded market strategists, such as those at BCA Research, have already issued a firm warning to their clientele: avoid everything with exposure to US consumer debt and spending.
Higher prices for food. Higher costs for petrol. Falling house prices. Increased foreclosures on mortgages. Higher prices for imported products (as the US dollar is widely expected to weaken further). And the fact that mortgage payments with a combined worth of over a trillion US dollars will climb from low monthly costs to current market yields between next month and March next year. One can only conclude this cocktail makes for a very compelling scenario that sees US consumers hitting the brakes at some time. (This is not to say the US economy is inevitably steering towards a recession).
Macquarie Bank (MBL) shares have been sold off to $70. The average price target for the stock is currently $109.59 (Citi still has a target of $122.88).The shares never traded any higher than $98.64 at the peak, and actually only exceeded $95 very briefly.
Hands up everyone who thinks Macquarie Bank shares will rise 56.50% over the next twelve months.
Thought so.