Those who have seen the Bill Murray movie ‘Groundhog Day’ will understand how we currently feel about equity markets at Platypus!
Each day, it seems as though we are waking up to the same old news and hearing the same conversations, while continually seeking a way to break out of the repetition.
The good news is that, just as Murray’s character does escape from the groundhog day pattern at the end of the movie, at some point equity markets will start a sustained rally. It’s just a question of when.
A number of companies have already indicated that they will have profit downgrades, and some of the results are likely to be even worse than the reporting season in February.
In the meantime, it’s a case of ‘same old, same old’. Bad news from Europe and the US, concerns about China’s growth, the stubbornly high Australian dollar, a seemingly endless stream of profit downgrades, and ongoing political drama domestically, means that we expect very little to change in the short-term – i.e. the next six months or so.
At time of writing, the August reporting season is about to start and we anticipate little good news will arise. A number of companies have already indicated that they will have profit downgrades, and some of the results are likely to be even worse than the reporting season in February.
The Australian sharemarket has continued its pattern of trading within a narrow range, and has also continued to underperform overseas markets – indeed, even the growth-challenged European markets performed better than the local market in June.
As Chart 1 shows, Australia has lagged other markets since the low of equity markets in February 2009.
It seems that the Australian market has developed a track record of participating in global risk aversion sell-offs along with international markets, but not participating to the same extent in any rallies.
Over the last few months, we have seen further evidence of slowing global growth, with manufacturing data in both China and United States weakening. A number of market commentators are now predicting additional quantitative easing in the US as well as further monetary and fiscal stimulus in China, although the forthcoming election in the US could mean any definite plans are put on hold.
Europe continues to be a major concern, particularly now that the European summer is approaching – a time when most politicians and policy-makers go on holiday.
Nonetheless, some progress has been made recently. In late June, political leaders at the European Union summit finally agreed to try to break the negative feedback loop between banks and sovereign bonds by allowing the European Stability Mechanism (ESM) bailout fund to directly recapitalise European banks instead of lending to individual country governments to then lend to banks.
This is definitely a step in the right direction, although the measure will only occur once a single bank supervisor is put in place. In addition, the European Financial Stability Facility (EFSF) and ESM bailout funds will be allowed to purchase Italian and Spanish debt on the secondary market (subject to ratification by member countries), thus helping drive yields down in the secondary market. So there have been steps in the right direction, albeit nothing definitive to suggest that an end to the turmoil is in sight.
Ultimately, we see the issuance of Eurobonds (or a version thereof) as the only lasting solution to the European fiscal problems. Once the Eurozone can be seen as a combined fiscal entity, its indebtedness will compare more favourably to other (indebted) developed nations.
Australian share market is cheap at the moment
In the short term, we are expecting the challenging conditions experienced in the last two to three months to continue. Our view is that the next financial year (i.e. up to 31 June 2013) is likely to be a ‘transition’ year for the Australian share market. First half results are likely to be poor given the low earnings run rate going into the year and the persistent macro headwinds affecting many sectors.
All these challenges are now pretty well understood by the market. And on the bright side, we are significantly more optimistic about the medium to long term, and we think that by this time next year, markets will have turned a corner and things will be looking much more positive. We anticipate that the second half of the 2013 financial year will show some recovery as we see more benefit from lower interest rates and (hopefully) a better outlook for global growth.
Currently, the equity market looks attractively priced at approximately eleven times earnings and is very cheap compared to bonds and cash. In particular, dividend yields on banks, industrials and utility stocks are also compelling when benchmarked against these asset classes.
However in terms of achieving profit growth and capital gains, the market is hamstrung by the heavyweight financial and resource sectors where the macro outlook is poor and, in the case of mining stocks, deteriorating.
If 2013 is a transition year then 2014 is when we expect to see a stronger market performance, as the full benefit of lower interest rates comes into play, better global growth is likely, and we could see a federal election (and probably a change in government) that will remove some of the uncertainty and unnecessary distractions for companies as well as investors.
Having said that, in the current market there is the opportunity to buy quality shares at low prices.
A good illustration of where we think the market is heading is to compare the All Ordinaries Index between 1987 and 1995, with that of 2007 to today (Chart 2).
Currently the equity market looks attractively priced at approximately eleven times earnings and is very cheap compared to bonds and cash.
History suggests markets go through either six to eight year cycles, or 20 year cycles. Spain and Greece may be looking at a 20 year recovery period but in Australia we are more likely toward the end of a six to eight year cycle.
As Chart 2 shows, the index for the six years following the start of the 1987 recession is very similar for the index for the six years following the start of the GFC. If this similarity continues, we can expect to see another 12 to 18 months of sideways tracking, followed by a sustained upwards track for the years following.
^ Donald Williams is chief investment officer at Platypus Asset Management, an Australian equities joint venture partner with Australian Unity Investments
Source: Personal Financial Services e-newsletter, MoneyInsights, August 2012