FYI | Apr 12 2010
FNArena editor Rudi Filapek-Vandyck shares his insights and analyses on a regular basis with paying subscribers via stories labeled 'Rudi's View'. On occasion, one of these stories is shared with non-paying members and with readers elsewhere. This is one such occasion. The story below was originally written and published on Wednesday, April 7, 2010.
By Rudi Filapek-Vandyck, Editor FNArena
It may not always be readily apparent in daily life, but in financial markets too much of a good thing definitely turns into a negative.
A few weeks ago I predicted the share market would likely reach for new highs and as I write this story on Wednesday afternoon, both major indices in Australia have been trading firmly above their January highs, but they once again seem unable to hold on to those levels.
If anything, given the strength of economic data and indicators that have been released across the globe this past week, one would have assumed an even stronger advance would have occurred by now.
The problem is, however, one of share market valuations. Sure, we're all aware that equities are trading on lofty multiples if we look at FY10 profit predictions alone, but even on FY11 forecasts the share market is now reaching out for a pretty full-looking valuation.
On my previous calculation, which remarkably has not changed to date, the Australian share market would be fully valued on FY11 profit estimates if and when the ASX200 index would reach close to 5200. With the index edging ever closer to 5000, this level is now almost within 200 points.
That calculation is based on 14.5x times consensus FY11 EPS forecasts for the main ASX-listed companies. If we apply a more cautious multiple of 14, then this market has about 40 or so points left.
Note: this is on consensus forecasts for FY11. We will only receive detailed insights into FY10 results in August, at the earliest.
None of the above is on its own sufficient to trigger a correction, but it will keep the less trigger happy investors at bay.
Here's another observation I have made this week (and the previous one): stockbrokers and other advisors have started to switch preferences and exposures. Changes made vary from going Underweight base metals (in plain English: reducing exposure) to going Overweight Healthcare stocks (increasing exposure).
With regards to the first group, there is now a widely carried view that investor sentiment, or call it market momentum, has taken the lead in most commodity markets, and not demand-supply dynamics.
As I have pointed out repeatedly in the past, this in itself does not mean current momentum cannot carry these markets any higher. In fact, there's probably a reasonable chance we might yet see higher prices for copper and oil and the likes because technical analysis points towards higher targets. (When investor sentiment rules, technical trading rules threefold).
It does indicate that when market momentum reverses, any losses will quickly develop into a much larger correction than seems justified on the basis of what happens in the real world. We've already seen one such example this year. We might yet see another one.
As far as Healthcare stocks in Australia are concerned, I think every investor should be aware of two very important observations:
1.) many healthcare stocks look fully valued at present share prices
2.) many healthcare stocks are beneficiaries of a stronger US dollar
As such, I wouldn't be surprised if healthcare stocks turn out the outperformers if and when risk assets make a turn for the worse, but it won't be because of intrinsic valuations. It will be because of their direct link to a strengthening US dollar.
(All this, of course, on the general assumption that the greenback will stick to its safe-haven status in times of diminishing risk appetite).
Against this background I have found it very curious that a growing number of market experts is turning positive about gold again. Last week (on April 1 I kid you not) the team of highly regarded chartists at Citi warned their clientele the next upturn for gold was now “imminent”. Their target? US$1300/oz.
For those who are not avid followers of gold priced in USD: the current price is around US$1134/oz and gold has remained in a tight trading range since correcting from its mini-bubble in December last year.
This week US based market trader Dennis Gartman joined the Citi team by turning more positive on gold's outlook, observing the recent price chart pattern seems to point into the direction of an imminent break out, possibly to levels last seen in December (that's above US$1200/oz).
Yesterday, Craig Ferguson, market strategist at Australian hedge fund Antipodean Capital, reported to his clientele he had now turned “Super Bullish” on gold. Even if the US dollar were to strengthen over the weeks ahead, Ferguson still maintains gold will perform well.
He predicts gold will soon rally to prices”well above” US$1230/oz (December reference target).
Previously, Antipodean Capital had positioned itself short crude oil on the same basis as many other experts did: market fundamentals are still a bit weak for these high prices and technicals initially seemed to start breaking down as well.
But things have changed rapidly in the light of ongoing better-than-expected economic data releases. Market momentum is now pointing to higher prices for copper, for crude oil, and for various other commodities, suggests Ferguson – better to listen to what the market is telling us.
At least for now.
Beyond the immediate horizon Ferguson believes the US dollar remains poised to stage a significant come-back on the back of strongly rising US bond yields. That'll be the trigger to push risk assets, such as equities, into a serious correction.
Economic developments since the start of the year have forced him to push out this moment of reckoning. At this point in time, he believes it won't occur much later than half-way this calendar year.
While I do not necessarily agree with Ferguson's view of a significant market correction ahead (I'd rather let economic data and corporate profits do the talking), I do agree with the view that market momentum has improved considerably over the past weeks. To the point that any correction in the short term is likely to remain limited in size (maybe similar to what happened between mid-January and mid-February?).
I do agree with Ferguson's view that economic momentum seems poised to take a few steps back from the third quarter onwards and it remains yet an open question how financial markets will respond to this.
I guess it'll all depend on how big the loss in economic momentum will turn out to be. Economists at IHS Global and at the Economic Cycle Research Institute (ECRI) -two leading indices I have been following closely since the beginning of the year- are both sticking to their forecasts the US economy will slow down from around mid-year onwards, but neither of them foresee any real disasters.
I suspect that by then Chinese attempts to slow down economic activity will have started to gain more traction as well. In Australia, a higher proportion of too optimistic home owners will be in more pain by then as well.
All in all, not much has changed since I wrote my story titled “Short Term Momentum, Longer Term Worries” (March 22, 2010), but there are a few changes since then that deserve every investor's attention.
1.) The distance between various equity indices and their 50 day moving average has again ballooned to levels that in the past more often than not preceded a pull-back. If you want to see this for yourself, simply go to Yahoo! Finance and look up the All Ordinaries in combination with the 50 day moving average on a twelve month price chart
2.) The TechWizard reports there is now clear divergence between price action for the Dow Jones Industrial Average and the MACD indicator – history shows this is often a leading indicator for a pending retreat
3.) I am a close follower of global investor risk appetite as measured by economists at UBS and according to their latest update (this week) risk appetite is once again stretching out into extremely bullish levels. While historically this index has seen higher levels, these all-time peak levels were not much higher than this week's reading. This would suggest we are close to a peak and thus steering towards a general retreat in risk appetite once again
Craig Ferguson will from now onwards be sharing his thoughts and views on a more regular basis with us. Those readers with long and good memories might remember his previous appearances in a few stories over the past few years.
Anyone interested in becoming a subscriber to Antipodean's market views can send in enquiries at info@antcap.com (only serious enquiries please – this type of market research does not come cheaply).
P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.
