Groundhog Year

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This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, Editor FNArena

It has been one of my favourite expressions this year: "looks a lot like 2010, doesn't it?"

Earlier in the year, when I first started making suggestions 2011 might look a lot like 2010, I had stockbrokers up in arms and market experts pointing at projections the ASX200 would rally to 5500-5600 by year-end. Now that we've had two unsuccessful attempts to break the 5000 barrier, and overall sentiment is notably weak as we enter the sixth month of the calendar year, it has become almost impossible to ignore the many references to how similar 2011 has become to events and share market movements last year.

All in all, the timing has been a bit off in the first months of the year. We had a first "correction" in February compared with January last year, followed by a rally into a second "correction" in April. So far, the fall hasn't been as steep as last year, which explains why the index is around 100 points higher than where it was last year, but with economic data in key countries weak, and expected to remain weak for a while yet, it would be a brave man (or a fool) who dares to predict we won't be catching up on last year in the following weeks.

For the record: whenever I made those predictions, I always added this didn't necessarily mean 2011 would become an exact carbon copy of 2010. What I meant is that the underlying dynamics looked eerily similar and that the trading pattern for the share market this year might thus -in rough terms- mimic the patterns that characterised 2010. So far, this is exactly what has materialised. Two rallies, and two sell-offs with loss of risk appetite, uncertainty and underlying weakness characterising the post-April share market.

This is not bad news.

If anyone wonders why the VIX in the US has, throughout the turmoil this year, remained at exceptionally low levels, levels that usually reflect "calm" and "complacency" as opposed to "panic", then the similarity with last year's pattern, I suspect, goes a long way explaining it. There are quite a few economists, analysts and market strategists around who have come to agree on one thing: markets are likely to remain wobbly for a few more months, but then improvement should be seen. Did anyone mention August? September?

Last year, admittedly through Fed intervention, share markets fell until July, bottomed, then stabilised, and by September they were firmly in rally mode. At least in the US. In Australia a similar pattern was seen but less so to the upside as earnings growth for ASX-listed companies remained far below growth levels seen elsewhere. Indications are that 2011 will not deliver the big turnaround with earnings growth in Australia likely to disappoint again. Single digit growth in earnings per share (EPS) is not enough to create an environment that is going to excite investors who now prefer the sidelines.

While there should be little doubt that forecasts for an average EPS jump of 19% in 2012 will not hold up and cuts are happening already, there's still a good chance 2012 might mark the turnaround for Australian equities. After all, the share market is all about underlying trends and positive comparisons. How do you think overall sentiment might look like if average EPS growth would finally print double digits after two long years of low single digit growth stories?

The irony is thus that today's cuts -to economic growth estimates, to projections of interest rates and to margins and earnings forecasts for companies- will likely create the launch pad for the next share market recovery. Remember, markets can rally on sentimental triggers any time (Greece? China? QE3?), but ultimately there needs to be sustainable support from corporate earnings, or any progress made will ultimately falter.

Many investors and market commentators have grown ostensibly frustrated by the share market's persistent range-trading since Q3 of 2009 (22 long months, and still counting) but they also fail to acknowledge that if we place the share market's performance within the context of near-absent EPS growth over the period, the market has done the right thing. No growth in earnings makes it much harder to justify why prices should go up. Just ask shareholders of Telstra ((TLS)) and Tabcorp ((TAH)) who have seen their investments being derated over the past years.

Or did anyone mention Toll Holdings ((TOL))? Leighton ((LEI))? ResMed ((RMD))? CSL ((CSL))? Woolworths ((WOW))? APN News and Media ((APN))? Fairfax ((FXJ))? OneSteel ((OST))? Lend Lease ((LLC))? ANZ Bank ((ANZ))? JB Hi-Fi ((JBH))?

The list of derated stocks in Australia is painfully long. The good news is many of these stocks are not priced for a resumption in solid earnings growth. Another positive is that dividend yields have seldom been as high as they are today. In both cases, a resumption of growth will translate into gains for investors. The problem is that not every company whose share price is down today will be achieving solid, quality growth in fiscal 2012 and beyond.

So how do we pick tomorrow's winners, while avoiding the losers?

I now pass the baton to market strategists at leading stockbrokerages in Australia. They all claim market-beating calls and performances over the years, and they are all aware of the issues I discussed and outlined in the preceding paragraphs. Many have updated their model portfolios and key calls post the April correction recently. So where exactly lies their "conviction"?

At Macquarie, "conviction" has found its way to Macquarie Airports ((MAP)), a company with relative predictable earnings that is anticipated to stand out in an environment that will be dominated by lowered forecasts in the weeks and months ahead, suggest the strategists. It goes without saying the shares are cheaply priced as well. On Friday, MAp joined ten other stocks on Macquarie's list of Marquee Ideas, essentially ratings that come with extra conviction. Those ten stocks are (in no particular order): Atlas Iron ((AGO)), Origin Energy ((ORG)), QR National ((QRN)), Rio Tinto ((RIO)), CFS Retail ((CFX)), Lend Lease, Bradken ((BKN)), Beach Energy ((BPT)), Mineral Resources ((MIN)) and SAI Global ((SAI)). For those investors also interested in Kiwi stocks, Macquarie's list also includes Sky City ((SKC.NZ)).

Subscribers to FNArena will have noticed many of these stocks appear cheap on valuation metrics such as Price-Earnings ratio and the gap between share price and consensus price targets (which can be accessed daily on the website). The notable exception would be QR National. Macquarie recently changed its view and has now become very positive on QRN's prospects.

Over at BA-Merrill Lynch, market strategist Tim Rocks who has stuck to a rather subdued outlook for the Australian share market while others were much more positive, recently revised his outlook with the prediction the ASX200 will close 2011 at around 4800 (considered "fair value"). Rocks believes forecasts for FY12 are too high and could potentially be all-wiped out (meaning another year of low single digit growth is not inconceivable). As one would expect, BA-ML's list of conviction calls looks a lot different from Macquarie, and it does contain a few negative convictions (stocks that will decline in price).

Positive convictions at BA-ML lie with AMP ((AMP)), National Australia Bank ((NAB)), Mirvac Group ((MGR)), Oil Search ((OSH)), Transurban ((TCL)) and Newcrest ((NCM)).

Negative convictions rest with Boral ((BLD)), Woolworths ((WOW)), Telstra ((TLS)) and Wotif.com ((WTF)).

What stands out is that all negative calls are with stocks that have already been heavily derated over the years past, and Rocks obviously remains convinced this process has much further to go, still.

Market strategists at Goldman Sachs proudly reported May had provided their selection of conviction stocks with the second best positive performance ever (6.3% better than the share market). Goldman Sachs currently has no negative convictions, but in a positive sense sticks with Acquarius Platinum ((AQP)), BHP Billiton ((BHP)), CFS Retail, Iluka Resources ((ILU)), National Australia Bank, News Corp ((NWS)), PanAust ((PNA)), UGL ((UGL)), Wesfarmers ((WES)) and Woodside ((WPL)).

At the same time, Goldman Sachs made a few changes to its Model Portfolio for Emerging Companies, which saw the removal of Talent2 ((TWO)) and PanAust and the inclusion of Kingsgate ((KCN)) and Skilled Group ((SKE)).

Goldman Sach's Emerging Companies Model Portfolio also includes Bradken. The portfolio overall contains mainly industrials, smaller financial companies and mining consultants, including Alesco ((ALS)), Flexigroup ((FXL)), Iress ((IRE)) and Premier Investments ((PMV)).

Over at Credit Suisse, the small caps specialists have now removed Bradken from their selection of preferred stocks. CS also likes Alesco and SAI Global. The analysts anticipate the smaller caps will continue to suffer from heavy cuts to earnings forecasts for months to come, while noting small caps have been hit the hardest in terms of readjustments in expectations over the year past. As Credit Suisse's list is value-based, it should be no surprise it contains retailers, media stocks and smaller financials, as well as service providers to the mining sector and some miners.

The latter group consists of Bathurst Resources ((BTU)), Kula Gold ((KGD)), Industrea ((IDL)), Mirabela Nickel ((MBN)) and Mermaid Marine ((MRM)).

Investors should note Credit Suisse's selection is not so much based on conviction as it is on apparent value (which is not the same thing as every value investor who has jumped on cheap stocks over the years past will assure us).

Market strategists at UBS have now scaled back their target for the ASX200 to 5200 from 5500 previously. UBS acknowledges earnings forecasts still need to come down and banks and resources, combined more than 50% of the Australian share market, will attract most of the cuts. UBS remains confident FY12 should still see double digit EPS growth for Australian companies overall. The strategists believe once the RBA has moved to a neutral stance (from tightening bias right now) and the Australian dollar manages to stabilise (instead of rising further) the ingredients are in place for higher share prices in Australia.

Australia has now entered the Top Five in preferred country selections at Citi. Australia replaces Belgium because of its high dividend yield (emphasis mine). Germany (1), France (2), Korea (3) and the UK (5) retain their top ranking as most attractive looking equity markets. For those investors who have been eyeing the performance of the Canadian share market with envy lately; Canada has now been added to the list of least preferred markets.

A trend change in the making?

See also recent related analyses:

– Australian Earnings Are Telling The Story

– Not Just About Economics

– April Sent A Message

– Lots Of Pain, Little Gain

– How Much Upside Is There?

(The above story was originally written on Monday 6th June 2011. It was published that day in the form of an email to paying subscribers at FNArena).

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