The Australian economy is something of a bright spot in the developed world but its stock market is not. One reason may be that about two fifths of the ownership is foriegn and the high currency is a disincentive. Foreign investors are much more confronted by the effect
of the Great Recession so more inclined to sell. Still, with the funds flows from super continuing on, it might be expected that there would be less pessimism. A Deutsche report notes that last year earnings actually grew in the ASX; the negativity is not based on fundamentals.
“While persistent earnings downgrades over the past 18 months have attracted much attention, it is worth noting that actual earnings have grown. The market has failed to rise in tandem because of a steady fall in price-earnings ratios (both trailing & forward). Absent the 2011 de-rate the ASX200 would be ~5000.
– The global environment remains uncertain, but a lot is priced in.
Over 2011, the trailing PE de-rated by 20%, and the earnings yield-bond yield gap has risen by 3ppt, to around record highs. Other episodes like this in the past 40 years have seen the market rise 15-20% over the following year.
– Economic surprise indices have improved markedly, and earnings revision ratios are off their lows. Both have historically been good for equities. Further, investor positioning is defensive and should be unwound at some point.
– We forecast the ASX200 to reach 4700 by year end. This is predicated on earnings being downgraded as much as 10%, and the PE re-rating to ~12x. This scenario essentially envisions 2012 making up the losses of 2011.”
The negativity is priced in so long as Europe doesn’t throw a Lehman. Having survived the first wave in 2008 — somewhat surprisingly — the second wave may prove more damaging, especially given the fact that governments do not have many shots left in the locker. It has been a unique financial debauch, far worse in many respects than crises like the S&L crisis or the Japanese asset bubble, because it was Russian roulette with money. The second assumption, that China will also engineer a soft landing, Deutsche take shead on:
“We expect resource stocks to outperform, buoyed by Chinese growth
Commodity prices have corrected substantially relative to the slowing in global growth, taking resource stocks with them. With Chinese growth close to bottoming, we are comfortable being O/W resources now. In the last cycle commodities & resource stocks bottomed as Chinese growth did – not after. With inflation pressures in China quickly easing, we see scope for policy easing. Amongst industrials, cyclicals look cheapest but need to be selective
– Cyclicals appear to be trading cheaply compared to defensives but we advise being selective given a range of sectors have ongoing challenges. Consumer spending is growing at normal rates, so it is not a reluctance to spend that is hurting retail & related sectors, it is a preference for services (+7% on pcp) over goods (0%). We see this as a structural trend, and thus prefer the services exposure on offer in air travel & gaming.
– We continue to favour resource capex exposure – while the pipeline of work has been evident for some time, it is only recently that projects have begun to ramp up. We also see opportunities in offshore cyclicals (solid US growth, though tempered by AUD strength) and stocks with financial market leverage.”
With BHP on an earnings multiple below 10, and with the company about to participate in the the gas revolution — which will change the world’s energy balance for decades — one would have to think it is coming close to representing value.