Rudi On Thursday

This story features NATIONAL AUSTRALIA BANK LIMITED. For more info SHARE ANALYSIS: NAB

There are many ways to look at the current share markets. To some experts the current market gains are nothing but a temporary bounce before markets will be heading towards new lows. Many of them use technical analysis as a directional tool and it is not difficult to see why they believe share markets are not done correcting yet. Take a look at a price chart for the ASX/S&P200 index over the past six months (preferably even longer): such charts clearly show how the market fell off a cliff in November and accelerated its fall in January. Unfortunately, the intermediary bounce only generated a top that was lower than the previous one and a subsequent fall that ended below the low point in January. In simple terms this means this market is still registering lower peaks and lower troughs; not a good sign.

It means the overall trend is still directed south. In addition, the 5500 level about which we wrote many a story when the index was trading above it as it marked a significant support line is now acting as a barrier for the index to move beyond it, so with the ASX/S&P200 closing not far from 5400 on Wednesday this would indicate further upside seems limited from here. (Most chartists will tell you markets seldom steam through key resistance levels at first approach).

And yet, there’s a small army of market experts who dares to believe that what we are experiencing right now might be the start of something bigger. Could it be that we have seen the lows in this bear market, they ask out loud?

As per usual, there are always arguments and indications in favour of such a view. The most convincing one, in my view, stems from an inhouse indicator by Credit Suisse. A handful investment banks across the globe has its own formula for measuring and keeping track of global investors’ appetite for risk. They like to stay on top of this as it usually provides them with an indication how certain assets will perform and how some will fall out of favour or risk becoming the flavour of the month. UBS has its own risk appetite indicator, so has Merrill Lynch. Credit Suisse has one too. They are all a bit different as they tend to be based upon different methodologies, but they should, over time, ultimately all converge at key points.

I have no idea where risk appetite as measured by UBS, Merrill Lynch or others is pointing at the moment, but according to Credit Suisse it recently sank into what the investment bank’s strategists would call “panic territory”. This usually indicates markets will move up, pulling the indicator back into the “neutral zone”. Historically, this is a fairly safe bet to make as every time the indicator fell out of the neutral zone into the panic zone this was followed up by a swift recovery in global risk appetite.

I have used the Credit Suisse index of global risk appetite in the past when the level of investor appetite shot through the roof into what Credit Suisse strategists would call “euphoria” – because every time that happens markets tend to start retreating soon. I have never used this index to predict the opposite. The reason for this is very simple: the last time it sank into the “panic zone” was in 2003, at the lowest point of the previous bear market (I had yet to become the editor of FNArena at that point in time).

So at first sight the Credit Suisse index seems to confirm what some market commentators are cautiously suggesting: the market has become too bearish, most sellers are done selling, this might be the point from where the only way is up, even though the recovery may not necessarily be swift and decisive.

However, if one studies the movements and patterns of the index more closely since its inception in the late eighties, it holds true that risk appetite tends to bounce from such extreme lows; often it has marked the transformation into a new bull market with the index ultimately reaching into extreme risk appetite, otherwise known as “euphoria”. Often, but not always.

In January this year, for instance, the index sank deep into “panic” – it fell to its lowest point ever since January 1987- and true to history it subsequently recovered as did global share markets. Less than two months later, however, the index is again in the panic zone. There’s no guarantee the current recovery won’t be as temporary as the previous one which would bring us back at this point, or even lower, two months down the track.

Remarkable: Credit Suisse strategists made no prediction whatsoever this week about any sustained recovery in global markets or global risk appetite.

Nevertheless, here’s another factor in favour of a more optimistic view: banking stocks have finally recovered from their ultra-low share price levels. As we have stated in the past, here at FNArena, global share markets need the problems in the banking sector to be solved before they can start functioning properly again. No doubt, part of the investment community has now taken the view that with the Federal Reserve bailing out and assisting US investment banks as well as it can, and with Europe likely to sing from the same song sheet soon, some major leaps have been made in normalising the international banking system.

There’s no point in arguing about this: banking stocks globally have posted significant jumps in share price since last week. Australian banks have done exactly the same.

Equally important: two of Australia’s leading stockbrokers have now turned more positive on the banks; GSJB Were on Friday and Deutsche Bank this morning. This can serve as an indication that investors are warming towards the sector again. Mind you, Deutsche Bank only went back to Neutral after five years of maintaining a negative view on the sector, but I’d still say we have a new trend: in combination with surging share prices one can only conclude that overall sentiment towards banks has become less bearish overall.

I already tried to explain in my Weekly Analysis on Monday (See “Resources Out, Banks In (For Now)”) why banking stocks were likely to take the lead in the coming market bounce: they are the downtrodden losers who are simply offering the most upside potential in case of any relief from the persistent doom and gloom that has been hitting the sector since June last year. What I found interesting is that, in line with GSJBW’s assessments last week, Deutsche Bank’s revised forecasts for the sector paint a rather modest profit outlook for Australian banks.

The current stand out, on Deutsche’s estimates, is National Australia Bank ((NAB)) – the only one with a Buy rating in the sector and the only one that is expected to achieve double digit EPS growth -once- in the next three financial years (the current year included). Deutsche Bank forecasts NAB will achieve 11.2% EPS growth in FY10 – it’s the only double digit growth figure mentioned in the broker’s spread sheet for all five major banks in Australia for the period FY08-FY10. As NAB comes with relatively high risks (UK exposure, rumoured higher risk takings last year) such an outlook hardly seems like an inspiration to push banking stocks much higher from here (though, admittedly, never say never and no doubt stranger things have happened before).

To be fair to those in favour of more bank stock buying in the next days and weeks, the overall trend for the sector is likely to remain closely linked to developments overseas. So if US investors all of sudden decide to go stir crazy about their JP Morgans and Bank of Americas the argument of further risks to FY09 growth figures, or even of single digit EPS growth projections, will matter not much. Well, not for the time being anyway.

Probably the most convincing argument I saw this week opposing the idea that the Australian share market is now looking towards a gradual recovery was from technical chartists at Barclays Capital who believe commodities in general are still in for more pain and losses in the weeks ahead (see our story today “Barclays Chartists Call Commodities Correction”).

The chartists’ view comes on top of other commentators and experts predicting global deleveraging still isn’t finished, and it will hit commodities the most (as most leveraging ultimately ends with exposure to commodities). I found out this morning their view corresponds with what the team of technical chartists at Credit Suisse predicted one week ago already. I can assure everyone who has been piling up on resources stocks recently, the Credit Suisse report simply reads like a little book of horrors.

A few snap shots from the predictions made in the report: spot gold could well correct as low as US$743/oz in the weeks ahead, while silver needs to remain above US$16.22/15.00/oz or it would likely experience a pullback towards US$13.00, “and possibly as far as [US$]11.00/10.50”. Aluminium on the other hand seems poised to test key support at US$2400/2370/t while the price of copper could well be written with a 6 in front instead of an 8 by next month. The next target for zinc is believed to be US$1800/t.

Credit Suisse strategists summarised it as follows on Wednesday: oil could be at US$80 per barrel soon in conjunction with gold at US$800 per ounce. Even if these projections may turn out to be too dire, the underlying message is clear: deleveraging has some way to go still and -all things being equal- it will take its toll from lofty prices across the commodities spectrum.

It’s the most convincing argument I have come across against any notion that the current recovery in the Australian share market might be a sustainable one. You have all been warned.

Till next week,

Your editor,

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

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