Synchronised Optimism

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

By Rudi Filapek-Vandyck, Editor FNArena

Financial markets are like a congregation of gold fish, swimming around in a bowl. Once the circle has been completed, everything looks like new and exciting again.

I borrowed this week's opener from a hedge fund manager who was recently quoted in one of the newspapers comparing his peers to gold fish. I believe the gold fish analogy does not just apply to the hedge fund industry alone.

Speaking of hedge funds, surely someone at the AFR must finally be starting to question why a story about US hedge funds shorting Australian banks as a proxy for the emerging markets slowdown still makes the front page of Australia's sole financial newspaper? Printing stories like that proves two points:

– There's no financial intelligence at the AFR, or at the very least it isn't present when decisions are being made about what appears prominently on the newspaper cover
– There's no intelligence among US hedge funds when it comes to Australia and Australian banks

Let there be no mistake: Australian banks are by no means cheap. Not by their own historical standards. Certainly not by comparison with offshore peers. But most are about to report reasonable financial results, pay out an above-market average dividend and inform shareholders there might be some encouraging signals around the corner, even though complacency is still best to be avoided.

There remains a strong underlying expectation among analysts that banks will pay out bonus dividends to shareholders in the years ahead.

Price targets will probably move up a notch or so next month, while ex-dividend share prices will automatically put some breathing space in the sector.

I wouldn't chase CommBank ((CBA)) shares at a PE multiple above 15 and a raw dividend yield of only 5.1% (at $74) but it's not necessarily the ultimate proof either that investor exuberance has once again taken over the Australian share market.

As I concluded earlier: valuations are no longer "cheap". The easy gains are behind us as equity valuations have normalised since mid-2012. None of this means there's no value to be found for investors who are adopting a positive view and are ready to allocate more funds back into the share market.

As a matter of fact, it is renewed optimism that is currently ensuring a positive mood wrapped around global equity markets. It wasn't that long ago the world was still fretting about low growth in the US, structural problems inside the political framework for the European continent and more cautious than hoped for government support for a sluggish economy in China.

Now the most used term, or so it appears, in strategy and research reports across the globe is "synchronised growth".

Even those strategists and economists who remain a bit skeptical, vis-a-vis predictions that the only way is up from here for the global economy, have started to acknowledge the months ahead are looking a lot better than the months behind us. Even in Australia, where economists at UBS on Monday put forward the point that, with global momentum picking up, it is likely Australian exports will receive a boost from foreign demand, likely keeping doom and recession predictions post the mining capex peak at bay.

One obvious point to make against this newfound optimism is that the many problems fundamental to precipitating the GFC, or that were painfully exposed in the aftermath of the Lehman Bros collapse, have not genuinely been addressed. As a matter of fact, one could successfully argue that Main Street in most developed countries has suffered serious setbacks, without real relief to date. Think sharply reduced labour market participation. Think unprecedented youth unemployment. And it's not like the Chinese have as yet properly addressed the potential threats inside their opaque shadow banking system either.

Right now, none of these background negatives appear to matter. In fact, they don't seem to be on anyone's mind, really.

US-based Global Investment Strategists at BA-Merrill Lynch issued a timely reminder on Friday that investors and advisors, especially those who are calling for the next "Mother of all Bull Markets", seem too eager to forget that the past five years have been characterised by never-before-in-history-witnessed global liquidity stimulus. This is about to change, albeit through baby steps at first. There are no two ways about this, pulling back from excess liquidity is going to impact on financial assets. It's the 'how" that remains as yet undetermined.

BA-ML strategists' advice to global investors is to expect lower returns. The next five years are not going to be a copy of the past five years, they predict. Investors in Australia will be hoping this applies predominantly to gold, treasuries and US equities. It's not like the Australian share market has rewarded every loyal shareholder in spades since the initial QE-inspired rally in 2009.

Below is a brief overview of what BA-ML strategists think about global asset allocation for the five years ahead.
 

Partially offsetting concerns about reduced liquidity around the globe is the fact the world seems to be on the verge of several technological breakthroughs that each will prove disruptive to established old legacies, but at the same time beneficial for the global economy overall. The latest example is the surge in mobile phone apps in Australia targeting cheaper and easier access to cab bookings. If market dominatrix Cabcharge ((CAB)) wasn't under enough pressure already, the company certainly is now.

For Australian investors, one of the key questions will be as to how the newly discovered global optimism is going to impact on commodity prices? After all, and as I have been arguing since last year, most markets don't seem to be in any shortage of supply. Commodity specialists at Goldman Sachs here in Australia have added yet another interesting twist to the sector's outlook story, predicting further cost-out measures by major producers such as BHP Billiton ((BHP)) and Rio Tinto ((RIO)) will effectively lead to downward pressure on prices (as the so-called cost support drops by a few notches).

Goldman Sachs recently dropped exposure to smaller, single commodity producers for exactly this reason.

Another intriguing observation is that analysts at UBS have been preparing their clientele for a correction in the iron ore price -potentially greater than 10%- at some point in the weeks ahead. in line with their peers at Goldmans, UBS analysts maintain the view that major producers will continue to enjoy big cash flows in the years ahead, so even with a declining iron ore price these shares continue to look good value on a longer term horizon.

Explains UBS: "We are currently neutral the mining sector (& overweight energy) based on a view that iron moves lower in coming months, albeit the sector looks good value based on our expected average prices of the next 12-24 months".

What could potentially give this market a real kick in the buttocks would be a swift correction to the tune of 5% with potentially more for commodities stocks (because, well, you know, they are commodity stocks). Goldmans Insto icon Richard "Coppo" Coppleson has been warning for weeks such a correction may be on the cards for September-October this year. His theory seems based upon the fact that, historically, the second week of September until mid-October tends to be a time when corrections usually take place.

We'll simply have to see about that. We do have "Septaper" this week. Valuations are no longer cheap, but they are also not excessive. Maybe too many people are waiting on the sidelines, hoping there will be a correction this month or next?

Markets tend not to listen to hope from tyre kickers on the sidelines.

(This story was written on Monday, 16 September 2013. It was published in the form of an email to paying subscribers on that day).

P.S. To all those getting fired up about the ASX200 surging to a new five-year high: including dividends paid out since 2008, the index has effectively already surpassed its all-time peak from 2007 (again proving the importance of dividends for long term investors).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

This story contains one chart. If you are reading this through a third party channel and you cannot see the chart, we apologise but technical limitations are to blame.

Recent Weekly Insights that might be of interest:

– So, We're Becoming 'Normal' Again?

– Big Rotation (But Not The One You Expect)

– It's A Stock Pickers' Challenge

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July this year forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January this year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

Ignore at your own peril.

This eBooklet was released in January this year and is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

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Rudi On Tour

– I have accepted an invitation to present to ATAA members in Canberra in late November

– I might give my final presentation for the year at the ASA's Sydney Investor Hour in December

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