Rudi On Thursday

This story features RESMED INC. For more info SHARE ANALYSIS: RMD

In what has probably been one of the most popular documents travelling around the Australian internet recently, the institutional desk at stockbroker GSJB Were has built a case for a relief rally for Australian shares, one that would be triggered by cheap valuations for everything outside resources (and related) stocks, and one that could possibly be sharp (like rallies in a bear market tend to be) and last for up to 2-3 weeks.

Certainly, such a rally would lift overall spirits of investors and professionals who are following developments on the Australian Stock Exchange on a daily basis. Fact remains, however, that instead of a rally – widely forecast to take off as soon as tax related selling would stop, which should have been on Monday – Australian investors have been forced to witness another extension to the share market slump. To be honest, I never bought into the tax relief rally in the first place. But as with everything in finance, one can never be too certain about these things; better to wait and see how much truth there is in the theory. So far, it turns out there wasn’t much truth in it at all.

The Australian share market is now close to its lows from March this year and it would take a brave man, or a genius, or a fool, to guarantee anyone this market will not fall lower at any time in the sessions ahead.

There’s more bad news to come still, plenty of it. The few companies that have come out with profit warnings recently -Just Group ((JST)) was the latest today- are only an indication of what investors should expect for the upcoming results season. The main question is, however, and this will be the one that will co-determine the outlook for the share market in the year ahead is: how much of this negative news is already priced in?

The second question, which is equally important, is: what will be the catalyst for higher share prices?

Until this week, my answer to everyone in my surroundings who would ask me the second question was without the slightest hesitation: a fall in the price of oil. Those among you who have been reading my Weekly Analyses and this weekly column will have picked up that I have done my best to point out that a persistently high oil price would push the Australian share market towards 4900. We’re not that far off anymore and it is no coincidence that oil has refused to retreat.

As far as the first question is concerned: part of the answer will be provided during the upcoming results season in August. Securities analysts have been arguing for weeks that many industrial stocks are being treated too harshly, and thus stocks such as Fairfax Media ((FXJ)) and ResMed ((RMD)) are seen as being valued too cheaply. However, and I cannot stress this often enough, at times of overall bearish investor sentiment, valuations don’t count for much, if they count at all. It is far more likely that investors – cautious as they are – seek safety in the momentum trades of the moment. At this moment the momentum trade du jour is still energy, even with all its negative consequences for all other sectors in the market.

Here’s an interesting observation I made over the past week or so: most technical chartists seem convinced US shares are at the beginning of another serious leg down, but they appear to have a less sanguine view on the direction of the All Ordinaries or the ASX/S&P200 index. The way I understand it the Dow Jones Industrial Average has already confirmed there is going to be another leg down, but other major US share indices are on the brink of yet generating a similar technical signal.

In the meantime, various markets across the globe have already joined the Dow in shaping another bearish movement, such as indices in France, Italy, Spain, Sweden, India and China. As far as the Australian share market is concerned, some chartists believe there’s room for a relief rally.

This still leaves us with the second question: what will be the catalyst?

Bell Potter Securities head of research, Peter Quinton, believes the catalyst will be an intervention by the US government sometime between now and the end of the year. Quinton takes the view that the global credit and debt crisis will go much deeper than where it already has gone, up to the point where the US authorities will decide: ok, this is enough. The next step is for the US government to buy circa US$400bn in troubled sub-prime mortgages off the US banks and save the world, and global equity markets, from the abyss.

Quinton sees the ASX200 index at 6500 in twelve months time.

Others, such as Greg Goodsell, chief strategist at ABN Amro, are not so sure the US government will actually come to the party and save the US banking sector from further balance sheet damage. Goodsell sees volatility and uncertainty continuously dominating share market trading until the market has wrestled itself through the various headwinds that lie ahead. All in all, predicts Goodsell, the end of the year may well turn out the best part of calendar 2008. He believes the ASX200 index could be at 6000 by the end of December.

This, of course, is way too positive a scenario for Gerard Minack, ex-strategist ABN Amro and nowadays entertaining all the local bears at Morgan Stanley. Minack is a big fan of the stagflation scenario for the Australian economy, one that sees spending, growth and employment fall of a cliff while inflation will reach higher levels than anyone wants to see. The result, Minack predicts, will be an ASX200 index at 3500 by mid next year. This would be close to half of where the index was at its peak in November last year.

The Australian newspaper lined up a few expert projections on Tuesday which, in essence, all fit in between the views expressed above. It will come as some relief for investors that nobody else’s share market projections are close to Minack’s. Paul Xiradis, from Ausbil Dexia, is the low marker in the newspaper with an All Ordinaries projection of between 5300-5700 by mid next year. Chris Caton (BT Investments) and Shane Oliver (AMP) are the most optimistic ones forecasting an All Ords index at 6375 and 6500 respectively in a year from now.

When I carefully studied some of the other predictions in the newspaper, I could see a clear relationship between oil price expectations and share market forecasts. Paul Xiradis, for instance, has an oil price forecast of US$120 per barrel for next year. Chris Caton sees oil at US$100 by then.

To my surprise, however, this relationship is not universal. Adnan Kucukalic, strategist at Credit Suisse,  sees oil falling back to US$80-100 per barrel and yet, says Kucukalic, the All Ords is unlikely to reach higher than 6000 in the year ahead. Shane Oliver, on the other hand, has the highest oil prediction of all: US$125 per barrel. And yet his forecast of an All Ords at 6500 is also at the top of the table.

So there is another catalyst possibly at hand?

It’s called interest rate cuts. Judging from the input provided by the various share market experts the outlook for the share market doesn’t have to remain as gloomy as it currently is. Some kind of stimulus appears inevitable though. If it’s not US authorities helping out US banks, it will be a significant fall in the cost of oil. In case neither of the two eventuates we will all have to rely on the Reserve Bank cutting interest rates.

Till next week!

Your editor,

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

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