Rudi On Thursday

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

(This story was originally published on Wednesday, 6 May 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere.)

As most of you would be aware by now, I have been travelling these past eight months to present my insights and analyses into what is happening in share markets and what possibly lies ahead. I have some exciting news about these presentations (more about this below).

On Tuesday, I ended my presentation in Sydney with a question I have been asking almost continuously since gold failed to post a new record high in February: “Is there a message in gold we should all pay attention to?”

By coincidence, technical commodities analysts at Barclays Capital today asked the same question, and they came up with a pretty similar answer as what I told my audience on Tuesday. The analysts also used the same technical signal as I did.

Some things in life you don’t question, you simply use them because you know it works. As I have pointed out on various occasions over the years past, whenever a trend change occurs this often leaves a so-called head-and-shoulders print on price charts. Why? I don’t know. But I have observed it often does.

As such, I reported earlier this year several base metals had printed a reverse head-and-shoulders formation on price charts, signalling a bottoming process had taken place and the trend of falling prices, in place since August last year, if not longer, should now have reversed.

This is what Barclays analysts reported this morning:

“Over the past two months as equities turned trend, commodity markets did little more than chop sideways. This is not surprising as commodities often lag in the market cycle. However, over the past several days, the equivocal tone in commodity indices has revealed itself to be a base building process, now being completed. Various bullish chart signals are being triggered (break of the daily clouds and head and shoulders bottom formations) and suggest further upside potential for the DJ AIG and CRB Indexes (targeting 127 and 257, respectively). We believe this is net supportive of our ongoing call for higher global equities and a positive sign for risk appetite generally.”

Similarly, the analysts share the same opposing view when it comes to what has been happening in the gold market lately. Gold had become too expensive relative to other assets. Those other assets (platinum, equities, base metals) have started to outperform gold and the analysts believe they are likely to continue doing so.

Where we differ in view is that I suggested on Monday that only if the price of gold would break lower, would I be confident the current share market rally has much further to go still. I also observed that while gold has pulled back below the US$900/oz again, the precious metal continues to resist further price declines.This signals to me the market remains deeply divided on the matter. Or maybe it is too early yet for the next sustainable leg up for share markets?

Barclays analysts have no such doubt. They simply suggest it remains possible gold might resume its previous price uptrend. It’s just that gold’s relative underperformance is to remain intact. (In other words: other assets such as base metals and equities will simply rise harder than gold).

On Monday I wrote the Coppock Indicator has confirmed a bottom should now be in place for Japanese and Chinese equities. A mere stabilisation of share markets is needed elsewhere to confirm that any near term retreat should not push equity indices below the levels of early March. (See Weekly Analysis “After The Bottom, What’s Next?”, May 4, 2009).

It’s probably no coincidence then that market strategists at GSJB Were and at Macquarie have revised higher their targets for the Australian share market for the year ahead?

If Macquarie’s revised calculations turn out correct, the Australian share market should book a further net advance of some 14%, of which a little over 3% would come in the form of dividends. Macquarie sees the S&P/ASX200 index at 4,196 by the end of April next year.

Don’t get fooled by what appears to be a positive projection, as the details behind these revised expectations make for a chilling read. Total shareholder return for Industrial stocks in Australia is expected to accumulate to +24.6%. For Resources, on the other hand, Macquarie anticipates a total return for shareholders of minus 21.4%.

The differences are even more pronounced for small caps with Macquarie projecting shareholder return in the year ahead will be a positive 4.7% for Small Industrials, but a negative -54.4% for Small Resources.

The strategists have a new target for the Small Ordinaries of 1,514, which translates into a total shareholder return of minus 17.2%. The number is derived from an implied capital return of minus -20.0%, partly compensated by a dividend yield of 2.9%.

Given the choice between banks and resources, Macquarie strategist would seem to have no doubt: banks. (In a separate assessment Macquarie analysts highlight how their revised market forecasts will have a beneficial impact on earnings for the likes of QBE ((QBE)), AMP ((AMP)) and BT Financial ((BTT)).

Interestingly, Macquarie strategists believe it is dangerous to think economic recovery in Australia will come at a moderate and gradual pace, pointing out every major downturn in Australia since the 1960s has been followed up by a short and sharp V-type recovery.

Strategists at GSJB Were have become increasingly confident global economic recovery will occur in 2010 and that deserves a higher target for the share market. On revised projections, GSJBW believes the S&P200 could well be at 4010 by June this year. Six months later, by the end of December, we could see the index at 4370.

Add another six months and the index could be at 4560 (June 2010). By the time 2010 comes to a close the index could be at 4700. Interestingly, while nearly all targets have been lifted by 15% or more, the increase for the index target by late 2010 is only 1%, implying it will all happen sooner than previously expected, but the end outcome by late next calendar year should not be so different from previous assumptions.

Contrary to what Macquarie strategists seem to suggest, GSJBW strategists can see cyclicals outperform longer still. The projected return of 20% over the next twelve months implies 15% capital appreciation, higher than what Macquarie is prepared to put into its models.

GSJBW’s favourite top five blue chips are AXA Asia Pacific ((AXA)), Boral ((BLD)), News Corp ((NWS)), Orica ((ORI)) and Wesfarmers ((WES)).

Interestingly, GSJBW has further cut earnings forecasts for resources and now expects on average resources companies will report EPS declines of some 40% for fiscal 2009 and another 15% the following year. But because of improved investor sentiment, overall PE ratios are expected to increase.

I reported on Monday already UBS had held on to its share market target of 4400. But UBS strategists make a few interesting observations that are worth pointing out. PE ratios for risk sectors have run well ahead of earnings, but the strategists maintain a case can be made these stocks are not necessarily yet “expensive”.

On the other hand, banks deserve, on pure PE-metrics, the label “expensive”. However, add the strategists, Return on Equity (ROE) for the sector is well below trend, thus the bank sector’s price-to-book does not yet look stretched in a historical or local relative context.

Standout sectors are energy and metals and mining in that both sectors look the most expensive in the market. As far as energy is concerned, UBS warns the sector looks poised to deliver some serious disappointments in the year ahead as PERs have run up high, implying the price of oil will have to surge past US$70 per barrel, or else.

Defensives, healthcare in particular, still look relatively expensive, even after the recent underperformance, argue the strategists.

UBS has been calling for a temporary retreat as the sudden rally since March has been both fierce and long, by historical standards.

More and more market watchers have joined that call this week. On Wednesday afternoon the TechWizard pointed out the Japanese Yen was strengthening on all major FX-crosses, indicating global risk appetite is, at least temporary, retreating. It’s probably no coincidence this happened on the same day the Wall Street Journal reported Bank of America is in need of another US$34bn in fresh capital.

Maybe that is the message behind gold’s resilience since February: maybe share markets are not ready yet to move full force ahead. But if and when they retreat, it will open up a buy-in opportunity, said Dennis Gartman yesterday. It is not the first time, and it certainly won’t be the last, that I agree with him.

In his daily newsletter, The Gartman Letter, he reports today: “we get the sense that the run to the upside is over, at least for the next several days and we shall not be at all surprised to see the Dow Industrials slip back toward 8000 over the course of the next week or so, taking the market from being rather egregiously over-bought to over-sold in the process. It has become too easy to be long of late, and that is always worrisome.”

With these thoughts I leave you all this week.

(see further below for a some extra-announcements)

Till next week!

Your editor

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

P.S.1: China is increasingly becoming more important for the world, and for Australia. FNArena is pleased to announce we have established a partnership with ChinaeconomicScan, a news service focused on tomorrow’s new super power. We are currently testing technical systems on our website, and expect to start adding the first stories on China on our website shortly. (Ominously, maybe, our new partner reported today the largest stockbroker in China is warning about a potential pullback for the Chinese share market).

P.S.2: In response to the many enquiries and requests received, FNArena has now decided to investigate whether we can organise live presentations in Melbourne and Brisbane. An invitation for me to fly to Perth has already been received, I will soon accept and put a date to it. FNArena will shortly send out an email to the database to see whether commitment is strong and large enough to schedule trips to Melbourne and Brisbane. My gut tells me the answer will be yes.

Feedback received from Tuesday’s presentation in Sydney has been very positive. Here’s an example of emails we received on Wednesday: “Hi, I attended last night’s event and want to thank Rudi Filapek for his extremely valuable and honest insights into the markets.”

Here’s another posting from our website: “Gents, tks for the presentation last night – it was very informative and focused on a lot of ‘behind the scenes’ information that main streem [sic] commentators don’t give much emphasis on, or even look at.”

P.S.3: FNArena has many readers in many places, some of them far away overseas. One of our readers has asked to mention the following conference in the US.

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