Bull run close to expiry date Malcolm Maiden February 26, 2007
BOND STREET
THE auction of the Coles group gives investors another reason to believe the sharemarket can defy history and keep rising.
By historical standards this market is due for a fall. It has risen by more than 25 per cent in the past year, twice as much as America's S&P 500 index, and almost three times as much as London's FTSE 100. Its top 200 shares are priced at 17 times earnings, about 20 per cent above the long-term average. Industrial shares in the basket are valued at close to 20 times their expected earnings in the next 12 months; similar shares are available in America for around 15 times expected earnings.
Earnings reports for the December half have been good. By the close of business on Thursday last week about half of the top 300 companies had reported, and profits were 30 per cent up on the December 2005 half. Resources groups led the way with a 47 per cent lift, and industrials posted results that were up by 10 per cent. Goldman Sachs JBWere's estimate on Thursday was that 44 per cent of the profits were at least 2 percentage points better than expected. The external environment is also better than benign. Europe's economy is in its best shape for several years, Japan is accelerating, and growth in the US and here is close to the long term trend.
Even so, share prices are at a valuation level that history tells us precedes a fall, and possibly a sharp one. It hasn't happened yet because of the sheer volume of money that is pouring into the market looking for a home, and that's where Coles comes in.
Perpetual's chief investment officer, Emilio Gonzalez, outlined the supply-demand equation in a speech to an investment conference last week. The stock of superannuation assets has grown more than sixfold in Australia from $160 billion in 1992 to more than $1 trillion today. The pool has expanded by more than 18 per cent a year in the past three years, mainly because of stellar returns on shares, and Australia now has the fourth largest funds management industry in the world.
As the super system continues to direct savings to the fund managers, the kitty will grow; Gonzalez said last week funds should be $1.8 trillion by 2011 and $3 trillion by 2016. The question is whether the supply of shares will meet that growing demand, and in the short and medium term, the answer is that it will not. Net new demand for Australian listed securities is expected to be about $42 billion this calendar year, the Perpetual exec says, and around $30 billion worth of new paper is expected to be issued. That would leave a "supply gap" of about $12 billion, which would be closed by higher share prices, as fund managers competed with each other to get their surplus money into the market.
But Gonzalez was speaking before Coles announced that it was on the block, and if Coles goes off, there will be even more demand-supply pressure. Coles chairman Rick Allert claimed on Friday that the Coles board did not have details of possible offers, but behind the formal process, and behind arguments about whether Coles is fielding unsolicited offers or ones it has fished for, two paths are open now. The first, if taken, would see Coles accept the offer it prevented the Kohlberg Kravis Roberts consortium from making last year. Price would be subject to negotiation, but all the existing Coles shareholders would receive cash for their investments. In those circumstances, at least $18 billion would be freed - and the vast bulk would then need to be socked away into other Australian industrial shares.
The second path is offered by rival private equity firms, including Pacific Equity, and if taken would see Coles shareholders get a mix of cash and new shares, as the supermarket business was joint-ventured with private equity, and the remaining businesses were hived off in separate floats.
It's believed that initial sums on those proposals predict that more than $10 billion in cash could be liberated. Once again, that dough would have to be reinvested in the sharemarket. Either way, the end of Coles would widen the demand-supply gap, and increase the price-push on Australian industrial shares.
It would be postponing the inevitable, of course. Anyone who has been around the sharemarket for longer than a decade knows that when values get to where they are now a correction at the least is due. Coles and deals like it can extend the bull run but the rally is close to its use-by date.
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