Rudi On Thursday

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

(This story was originally published on Wednesday 27 May 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

If this were a standard recovery in a standard recession, share markets would probably have run much higher by now. As pointed out by market strategists at UBS in Europe this week, when the tipping point arrives from pure misery to the first greenshoots of economic recovery, that’s when equities are at their best. Or at least, they should be.

The problem is, say the strategists, this is not a normal economic recovery. It is thus not inconceivable that global equities, having rallied between 20-40% from the second week of March until the third week of May, have already recorded most of their gains for the time being. A conclusion that was backed up by market strategists at Citi in the US this week.

Citi’s argument is very basic and very simple: let’s assume equity markets have another 10% in upside left. Well, we’re already up by 30% from the bottom in March (US indices) so this means not only that the worst is behind us (in terms of economic devastation), but also that the best is behind us too (in terms of share market potential).

Bummer.

(Especially since only a small minority of investors seems to have participated in this rally).

Both teams of market strategists have problems with valuations at current share price levels, a fact that has been pointed out repeatedly by FNArena since March: blue chips are not cheap, investors should not chase them at these levels. I note, for instance, that Commonwealth Bank ((CBA)) shares are still at $35-36, which is effectively where they were in March. BHP Billiton ((BHP)) shares are still around $34 (unchanged from levels reached in February, then again in March, and then again in April).

While these market leaders have gone nowhere, indices have added another 10% or so. It is not difficult to guess what has happened: investors have started to ignore the fuller priced stocks and have gone on the hunt for bargains elsewhere. One could argue this is also reflected in broker’s ratings and price targets. BHP Billiton shares currently enjoy only one single Buy rating (GSJB Were) among the ten experts monitored daily by FNArena. Its average price target of $31.71 is nearly 10% below the current share price.

Commonwealth Bank shares still enjoy two Buy ratings, out of ten, so nothing flash here either. Its average price target is close to where the share price is right now.

Remember that I warned in March bank shares had run up too high and they were likely to retreat? Well, I was wrong. They did not retreat, but they didn’t advance further either. The same applies to BHP.

This is why market strategists at JP Morgan in Australia suggested this week that share indices may well trend lower over the weeks, and maybe even months ahead. It’s time for investors to start ignoring the index, argued JP Morgan, and start zooming in on where there’s value left instead.

According to the FNArena Sentiment Indicator, which effectively reflects the views of nine leading equity researchers in Australia on individual stocks, there’s still plenty of value around on the Australian stock market. It’s just not where most investors would look for it: no blue chip companies are included among the highest ranked stocks.

The seventeen highest ranked stocks, all 0.8 on the Indicator or higher (+1.0 is the maximum), contain a remarkable representation of oil and gas stocks. Origin Energy ((ORG)), Oil Search ((OSH)), Australian Worldwide Exploration ((AWE)) and Santos ((STO)) are all included. The list also contains a few healthcare stocks – CSL ((CSL)) and Primary ((PRY)); two media companies – Consolidated ((CMJ)) and Austar ((AUN)); two infrastructure trusts – Spark ((SKI)) and DUET ((DUE)); one gold miner – Lihir ((LGL)); plus various representations of what I would call beaten down industrial stocks, such as Super Cheap Auto ((SUL)), The Reject Shop ((TRS)) and Cabcharge ((CAB)).

Also, this week FNArena published the June edition of its monthly Australian Super Stock Report. All selections in this Report are based on ten experts, instead of nine (GSJBW included) and this always makes for small variations.

Top ranked stocks in the Australian Super Stock Report (that are not in the top of the Sentiment Indicator on the website) include the former Realestate.com.au REA ((REA)), Navitas ((NVT)), Charter Hall ((CHC)), Austal ((ASB)) and Premier Investments ((PMV)). All these small caps come with a higher risk profile, but their average target prices also suggest potential returns could be high as well.

Of course, the whole idea about these companies catching up with the more solid, less risky stocks in the market is premised on the fact that share markets will experience no major shocks in the short to medium term and thus they will have no genuine reason to retreat in a disorderly fashion. JP Morgan strategists believe it is well possible that fully priced blue chips will start experiencing some weakness, but that the value laggards will nevertheless close the gap that had blown out to seldom seen proportions in March.

The above mentioned strategists at UBS, however, suggest it is more likely share market indices won’t go anywhere but sideways from now on, and for a prolonged period of time. This is why they have cut back on their higher risk/cyclical equity exposures. UBS would normally advocate investors move full power into equities at this point of the cycle, but as this is not a standard boom-bust-recovery scenario, they believe it is safer to adopt a more diverse portfolio allocation.

UBS advocates a combination of corporate and government bonds plus cyclical commodities (all Overweight); plus equities, REITs, and inflation linked bonds (all market-weight); plus a large underweight position in cash.

UBS is far from the only one who believes share markets might be poised for extended range trading. Readers who have read my Special Report “2009 Outlook”, released in December last year, would be familiar with the theme, as well as those who have attended my recent live presentations. Marc Faber, publisher of the Gloom, Doom and Boom Report, said in an interview with Bloomberg television today share markets were likely to range trade for years, but while doing so they might move up and down by 30-40% each year.

I think the message from all this is clear: timing has become more important than ever, as is an active watch over anyone’s investment portfolio. Plus blue chips do not always tell the complete story.

With these thoughts I leave you all this week,

Till next week!

Your editor,

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

P.S. I: strategists at Citi in the US came up with a rather unique piece of research this week. I had certainly never seen anything like it before. They calculated the US market’s (trailing) Price Earnings Ratio and compared it with historical precedents. What they found is that the rally since March has pushed US shares into less favourable territory. Trading at a PER between 16-18 shows that historically, investors should not expect more than around 7.5% in further upside in the twelve months ahead. Their research goes back as far as 1940.

P.S. II: in addition to point I – averages only tell half of the story. If Marc Faber is correct, there will be plenty more potential upside for those investors who look beyond the index, and who get their timing right.

P.S. III: one of the reasons why share markets are not expected to recover in one straight line from here onwards is because the economic recovery in important countries such as the US, UK and Europe and Japan will be much slower, and patchier, than usual. (Feel free to disagree). Have a look, for instance, at the following chart, courtesy of David Rosenberg at Gluskin Sheff. While US banks have started lending again, the level is still at very depressed levels and well below the historical norm. (Apologies to those who may read this column through a third party channel and miss out on the chart).

P.S. IV: Bloomberg television reports that whenever US consumer confidence made a big jump in the past, in 87% of occurrences the US share market rallied higher the following month. US consumer confidence recorded a very big jump in May, it was reported this week.

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