After 3.5 years of an excellent bull run, it is now time to gamble with money that one can afford to lose, without losing the house, to pass the sleep test every night. (imo only - but people will do whatever they want to do).
Deal of fortune: market has big players in a spin April 29, 2006 (The Age)
MALCOLM MAIDEN: The Australian sharemarket took only a year to rise from 4000 points to 5000 points on March 20, and it has risen by more than 5 per cent since then. It's a breakneck pace — can it continue?
CRAIG DRUMMOND: Well in recent times the equity market has been driven by sharp rises in commodity prices, but if you look at it since the recent bottom in March 2003, corporate earnings are the main driver, and they are feeding off a range of things including the strength of the domestic economy, commodity prices and a robust global economy.
Since early 2003, industrial company earnings have shown a compound per share growth of 11.5 per cent a year, and the ASX 200 Industrials has recorded compound annual share price appreciation of 14 per cent.
Companies in the ASX 200 Resources Index have shown compound earnings per share growth of 18.5 per cent over the same period, and the ASX 200 Resources Index is up 18.6 per cent compound. It's still very much an earnings story. On our profit projections, the ASX 200 Industrials is valued at about 15.5 times prospective earnings in 2007, compared with an average of the last 20 years of 14.6 times. If you adjust that for inflation, the industrial part of the market is reasonable value.
MARK O'BRIEN: The resources story has been a very exciting one and it has created a real glow, but the Australian market is still quite soundly based in terms of its valuation measures at the moment. There's been solid profit growth over the last few years, and Australia has also become a lower-inflation economy, which has allowed some price-earnings multiple expansion relative to international shares. Our market underperformed global markets for a reasonable period since the late 1990s. The catch-up we've seen since then has made it look like it's outperforming.
CLARK MORGAN: Over the last 12 months the market is up 37 per cent, resources up 79 per cent, the banks up 38 per cent. But within that, there's still large-cap industrials whose shares have underperformed. It's now not just a case of looking at the overall market, but looking at sectoral performance, looking for opportunities.
DRUMMOND: Seven key stocks — the four big banks, BHP, Woodside and Rio — account for 34 per cent of the ASX 200 Index's value, and generated 50 per cent of the return.
MORGAN: BHP are up something like 30 per cent over the last month. It accounts for 10 per cent of the market, so there is a concentration of performance.
MAIDEN: Local banks are trading at a P/E premium of more than 40 per cent over the UK banks, and more than 20 per cent above the US banks. For that matter, you can buy Wal-Mart for 15 times its expected earnings now, and it will cost you 21 times to get Woolies in Australia. Does that make sense?
DRUMMOND: There's a bunch of things to consider, including the growth options that companies such as Woolworths have and the strength of the economy that they operate in. We're still reasonably comfortable with the Big Four banks. Their dividend payments are generating yields that are still moderately attractive versus other asset classes, and we feel that their earnings projections are likely to, if anything, surprise modestly on the upside over the next 12 months.
MAIDEN: Saul Eslake, the economic outlook here and overseas is positive for the markets right now isn't it?
SAUL ESLAKE: The International Monetary Fund is now talking about a fifth consecutive year of 4 per cent-plus growth in the world economy. I don't think that has happened since the first oil shock of the mid-1970s. It's a remarkable combination of events, and one from which Australia is almost uniquely placed in the advanced world to benefit from.
The benefits of the resources boom for Australia aren't confined to resources companies. They spill over into other parts of the economy, through the impact they have on employment and house prices in places close to the centre of the resources action, but also because the Federal Government rakes off company tax — 30 per cent of every additional dollar higher commodity prices deliver to companies like BHP and Rio Tinto — and then, through tax cuts and cash handouts, hands that to households who spend the money.
That's a difference between Australia and the UK. The UK had a housing boom like Australia's, which was terrific for all the things that hang off it, like retail sales and consumer spending. But when the UK housing boom peaked, the UK economy came to a halt. It grew by less than 2 per cent last year.
The US may be approaching a similar position: consumer spending there is still quite robust, but there are signs the US housing market is peaking — and when it does, there is no stimulus coming from the resources boom as there is in Australia. That's one reason why the US Federal Reserve's Open Market Committee is talking about an end to the tightening process being in sight. And it helps explain why Woolies and the banks here are more highly valued than their American and British counterparts.
MAIDEN: With 4 per cent-plus growth, one obvious risk to the markets is rising interest rates.
ESLAKE: The major central banks cut interest rates to extraordinarily low levels and created enormous amounts of liquidity to ward off the fear of deflation a few years ago, and the liquidity found its way into financial markets and brought yields on the whole spectrum of risky assets down to record lows.
Money-supply growth has actually slowed dramatically in the major economies over the past year, and government bond yields have risen as markets anticipate further increases in short-term interest rates, more outside the United States now than in the US, where short rates have returned to normal. What we haven't seen yet is any corresponding diminution in the appetite of investors for riskier assets, be they equities, be they corporate bonds, or commodities.
In fact you've seen an increase in speculative interest by investors in commodities including agricultural commodities lately, and if sustained that would feed more powerfully into the consumer price index than things like oil, aluminium, nickel and zinc.
MARK O'BRIEN: Share price volatility is a measure of risk and at the moment this volatility is unusually low. It's been about 11 per cent in standard deviation terms in the past decade compared to the world at 16 per cent. There's risks out there: some are the kind that are talked about but are quite hard to quantify — a hard landing in China, another terrorist attack, a bird flu pandemic or some geopolitical instability. All would cause the liquidity that's driving prices to be reallocated. As a result, some hedging within a portfolio is appropriate. Having said that, a lot of the risk factors are common factors. They affect all asset classes.
MAIDEN: Craig, that's a good point isn't it? Shares might look a little bit risky, a little bit pricey, but the real question is, compared with what? What would you actually swap into?
DRUMMOND: Yes, on a relative asset class basis, Australian equities still offer reasonable value.
MORGAN: Complacency is another risk. Some private investors might be seduced into thinking recent returns are going to occur quarter in and quarter out. You only have to look back to 2002, and the Australian market returned a negative 8.5 per cent. Cash levels are still reasonably high though, and that suggests investors continue to take a cautious rather than overly optimistic approach to the market. They are also diversifying holdings into global markets, a sensible strategy given the performance of the local market.
ESLAKE: One of the other important risk factors for the global economy that I think is underappreciated by investors and commentators is the growing accumulation of surpluses — not in East Asia, where history tells us that they will be smoothly recycled back to the US, but in oil-producing nations, which are both politically unstable and wary of, or in many cases hostile to, the US.
The US will be running a current account deficit of over $US800 billion this year and the oil-producing nations will generate a surplus of almost $US500 billion. In the past they recycled oil proceeds into US dollars, partly because dollar-based investments have given them much higher returns than anywhere else, and partly because many of them have used their surpluses to repay large debts they ran up when oil prices were much lower. But the indebtedness of the oil producers will shrink rapidly if the oil price stays high. People need to think about that.
Will Russia hold its surpluses in US dollars? Will Venezuela, which is now run by a crackpot who fancies himself as the 21st century's answer to Fidel Castro? Middle Eastern nations this year will be running surpluses of close to $US300 billion. Will they continue to keep their dollars in accounts where they might be sequestered under the Patriot Act?
O'BRIEN: We should recognise some investors continue to chase more and more aggressive and risky positions in assets even as central banks take liquidity off the table. I think the surpluses and deficits are unlikely to be the factor at the margin that causes us to lose sleep right at the moment.
DRUMMOND: I believe the issue that will really mess the market up is if we have a significant disappointment in earnings. It's been an earnings-driven market where interest rates have been relatively benign — the so-called Goldilocks scenario.
Now we know that housing in the US is starting to weaken. Could we see US economic growth go back closer to trend or slightly below trend growth for a period, take the pressure globally off rates, but still strong enough to keep Japan and China strong, and the global environment for Australian companies relatively robust? If that scenario develops and we have a continuation of the Goldilocks scenario of the last several years where growth is neither really hot nor really cold, interest rates will be effectively out of the equation, and it will come back to earnings.
If it does, Australia is well placed: the economic outlook for the next 12 months is encouraging, and corporate balance sheets are in good shape.
MAIDEN: What's the growth outlook here, Saul?
ESLAKE: Growth here was slightly below trend last year but two things are taking us back towards trend. We are starting to see at least the early signs of the long-awaited upturn in real export volumes: the billions of dollars that have been spent over the last few years by mining companies and by companies and agencies that provide resources industry infrastructure is starting to bear fruit. If the downturn, such as it was, in property prices since the end of 2003 has run its course, which recent data is suggesting, you should see some modest pickup in consumer spending and housing activity.
MAIDEN: Is the housing recovery a bigger plus for consumers than the negative of higher petrol prices?
ESLAKE: I would argue yes, although I don't doubt that if oil prices do spike suddenly higher, we will have the sort of temporary interruptions to an upward trend in consumer spending that we saw around September or October last year.
MAIDEN: I sound like Dr Pangloss here, but we've mentioned external threats such as avian influenza, but agreed that they would affect all investment assets, not just shares. We've noted inflationary pressure on interest rates, but decided it's not yet out of control. There's a risk as oil surpluses build in places that might not favour investment in the US economy, but it is not dominating market psychology. Corporate earnings meanwhile are strong, and underpinned by solid global economic growth …
DRUMMOND: We've got 10 per cent earnings growth forecast for the 2007 period in the industrial market, to give you a flavour.
MAIDEN: … so to quote Dr Pangloss, is this the best of all possible worlds?
MORGAN: It's important to be wary of complacency. So far we have seen an attitude of proceed, but proceed with caution, among our private investors. There's been an enormous amount of wealth created, and plenty of it is still in cash: cash and cash equivalents are sitting between 20 and 22 per cent of our clients' portfolios, which is higher than our recommended weighting.
The fundamentals do look good, and so far investors have not been swept up in the euphoria, with the possible exception of the resource market. This measured attitude suggests there is scope for further gains in equities.
DRUMMOND: And they're likely to get more with the M&A activity that's still pending.
MORGAN: Absolutely. Investors are looking for opportunities, they're looking at alternative investment classes, as we've discussed — but there is a degree of caution.
MAIDEN: The caution itself is encouraging isn't it, in that we don't have the bullish consensus that often signals a top?
O'BRIEN: That's right. We're still climbing the wall of worry. But as we discussed, volatility in this market is historically low, and we can see the conditions emerging which could cause disruption out there — you can see what might cause investors to re-price risk, and this could mean a correction.
Our view is that investment conditions are likely to be more volatile in future, and while we can still generate returns with a reasonable degree of comfort if that occurs, we need to be prepared for more conservative pricing of risky assets.
DRUMMOND: I agree with Mark, particularly given the run we've seen recently in the resource stocks, there will be pullbacks, and volatility may well go up. But it's still hard to see materially better investment options to domestic equities.
MAIDEN: Should investors stay in the miners?
DRUMMOND: We can debate short-term price movements, but you either believe in what's going on in China, in India, in Russia, in Brazil and what it means for demand, or you don't. We do.
O'BRIEN: Demand for commodities from developing economies can underpin solid profits from resource companies for some time. The supplier response that brings supply more into line with demand will occur, but it takes some time to get going.
MORGAN: Our view is that the banks have run hard. There's no obvious switch out of them, but there are some leading industrials that might have been left behind and are worthy of consideration. … Foster's and Suncorp, Transurban, PBL, Woolworths, Coles Myer, Lend Lease, Promina, Amcor, Qantas, Macquarie, Macquarie Airports, Tabcorp, Fairfax, Wesfarmers, IAG, Coca-Cola and Telstra. Some of these companies are trading on lower P/E multiples now than they were a year ago, and if you look at their earnings, perhaps that isn't justified.
ESLAKE: Provided the world and Australian economies continue to perform in the way the IMF is predicting, then I'm sure there is more there to be had for investors. But we are now in the part of the cycle where excess liquidity is being withdrawn by the world's central banks … Japan, Europe and East Asia are now barking on that part of the cycle, where liquidity is starting to be withdrawn. Historically these are the circumstances when financial accidents have tended to happen.
(20min delay)