Rudi On Thursday

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

Next week, probably on Tuesday or Wednesday, the S&P/ASX200 index will once again close above the 6700 level. This will mark the sixth time since mid-October.

Has anything changed since the previous five times?

BHP Billiton ((BHP)) has publicly admitted it is after Rio Tinto’s ((RIO)) assets. And since Xstrata is after Jubilee’s (JBM)), investors have drawn the conclusion that resources companies might well be valued at too low multiples.

Note that Iluka ((ILU)) shares jumped more than 11% today following an announcement to the stock exchange that US based commodities hedge fund Ospraie Management LLC held 12.02% of the company’s outstanding capital and 10.77% of the voting rights.

This is not the only thing that has changed over the past week or so. Ever since the results season commenced in early August earnings estimates have been trending down and the amount of recommendation downgrades significantly outnumbered the upgrades.

But last week, as the market pulled back following another round of bad news announcements by US financial institutions, the balance between recommendation downgrades and upgrades abruptly reversed – and the gap has only widened further in favour of recommendation upgrades.

Last week, I hinted at the fact that this market would rather unlikely be able to move confidently beyond the 6700 level as investors seemed to be buying a select group of stocks only. As everyone will understand, even the best of the best stocks ultimately reach their valuation limits. (See last week’s analysis “Lack Of Value? Or Too Many Investors Chasing The Same Ideas?”)

 This week, however, I have to conclude that a minor shift has taken place in the Australian share market – minor, but large enough to be noticeable. Assuming the next few trading sessions don’t see another mini-crisis in either Europe or the US, it may well be that for the first time in a month the foundations seem in place that might allow the S&P/ASX200 index to confidently surge beyond the 6700 level.

Let me illustrate this shift through the example of the major banking stocks in Australia. Banks were among the key performers on Wednesday, recording large share price advances. Unfortunately, this has again resulted in the fact that CommBank ((CBA)) shares, as well as shares of National Australia Bank ((NAB)) and St George Bank ((SGB)) have now -again- moved near or beyond their average twelve month price targets.

There are currently only two major stock brokers that have set a twelve month price target above CommBank’s closing share price on Wednesday – one suggests another 0.5% should be achievable, the other one by super-bull JP Morgan still leaves a gap of more than 3%. All other targets, however, are multiple percentages below today’s closing share price.

The picture looks similar for St George, but not for National. Most price targets for National are between 3.7 and 8.2% above Wednesday’s closing share price. It is an extremely low price target by JP Morgan that keeps the average around the current share price. The numbers for Westpac ((WBC)) and ANZ ((ANZ)) look even better.

What this means is that the market still has enough room to move – if it wants to diversify away from the usual suspects. You can bet your money that some investors will already have spotted the trading opportunity. ANZ received two recommendation upgrades to Buy already this week.

There is a genuine possibility that the reversal in recommendation changes will provide investors with plenty of fresh ideas. Over the past week upgrades have outnumbered downgrades by 43 to 16 – most of these upgrades (circa two out of three) have been from Neutral to Buy, while most downgrades were to Hold/Neutral.

Apart from ANZ, other stocks that received upgrades to Buy this week were Lion Nathan ((LNN)), Asciano ((AIO)), David Jones ((DJS)) and Orica ((ORI)). How do their share prices compare with average price targets?

The suggested further upside potential is 6.4%, 25%, 4.4% and 9.7% respectively (dividends not included).

A number of market commentators and analysts has repeatedly pointed out this year that only ten stocks have been responsible for nearly all of the Australian share market’s gains this year. These stocks are BHP Billiton, Rio Tinto, Woodside Petroleum ((WPL)), Fortescue Metals ((FMG)), Newcrest Mining ((NCM)), Leighton Holdings ((LEI)) and WorleyParsons ((WOR)) – plus the banks (with the exception of ANZ).

How do these stocks compare with their average price targets?

BHP still has more than 13% to go, but this is obviously dependent on how much the company will ultimately have to pay to win over the board and shareholders of Rio Tinto. Don’t expect anything flash in the short term, however.

Woodside shares have been trading consistently above their targets as crude oil seemed to be heading for US$100 per barrel but the gap has closed over the past few sessions. If oil declines further, and there are quite a few experts who believe the odds are in favour of more crude spot price weakness, the shares are likely to fall below their targets again.

Fortescue is purely driven by overall sentiment towards global growth, China and demand for iron ore. Better to ignore any price targets as the stock is still hardly covered by securities analysts in Australia.

Newcrest Mining has obviously surfed the waves of the incredible ride that spot gold has enjoyed on the back of the US dollar thrashing since September. The shares are double digit percentages away from any price targets in the market. With gold declining, and experts such as the precious metals desk at UBS believe we could be at the beginning of a two-week long price correction, the downside risks for Newcrest shares would seem to outweigh any upside potential in the short term. (It has to be noted that Dennis Gartman disagrees – he has decided to add to his gold exposure this morning US time).

We cannot even remember when was the last time Leighton Holdings traded below its average price targets as securities analysts have constantly played catch up over the past year or so.

And WorleyParsons? Yep, same story as Leighton, Woodside and Newcrest.

Viewed from this perspective, it would seem that the leaders of the past year have become tired of leading the pack. For some like Woodside and Newcrest short term risks might well have shifted unfavourably.

This means that the main question regarding the outlook for the Australian share market hasn’t really changed since last week – or since all previous five attempts to push the S&P/AX200 index beyond 6700 without falling back: are investors willing to jump on other opportunities outside the happy few?

Meanwhile, the background behind all these developments hasn’t changed either, or as JP Morgan Chase economists pointed out earlier this week: global economic growth (GDP) is likely to fall to its lowest level in four years during this final quarter of 2007 while global consumer price inflation is expected to reach its highest level in more than ten years.

Even if this doesn’t necessarily imply what some doom thinkers are suspecting right now, it sure as hell makes for an uncomfortable outlook – especially for the next two quarters or so.

Sorry, I didn’t intend to spoil your party this week, but I thought you should know.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always supported by the Fabulous team of Greg, Chris, Joyce, Pat, George, Grahame, Sophia and Paula).

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