Australian Market Summary (Issue 399) – 13 May 2016
WE ARE SHIFTING OUR TONE ON EQUITY MARKETS TO ONE OF CAUTION
Another seemingly encouraging grind higher for the week. The market is looking to be up nearly 1.5% for the week, and the ASX 200 Accumulation is indeed up on the year now by about 3%.
Not bad going given the panic we felt back in February.
The rate cut has definitely helped matters.
Since early May, Australian government bond yields have rallied to historic lows (10-year yields from 2.55% to 2.25%) and the Australian Dollar is down from 78c to 73c.
All’s good then, right?
Not so much.
We are actually turning modestly more bearish after having seen the market rally back as well as it has.
Slowly turning more bearish on shares …
Whilst we are still yet to really turn pessimistic, the rally in share prices has made us take stock of valuation and the financial environment around us and to make some consideration of risk & reward.
The balance of risk & reward is everything and right now the market is offering up increasingly little reward for what seems to be an elevating level of risk.
First and foremost, Australian share price valuations are leaving me little reason to be excited.
Those stocks with attractive business models and longer term growth – let’s cite the likes of CSL (CSL), SEEK (SEK), Carsales.com (CAR) and NAVITAS (NVT) amongst a much wider list – are looking very fully valued.
The share price upside just doesn’t seem material from current P/E and price-to-cash-flow multiples.
The big-cap, blue-chips look fair-to-middling – banks are OK, miners we flagged as expensive and though we love Telstra (TLS), it too has rallied nicely into the high $5’s making its share price upside increasingly limited.
Historically whenever I have found it tougher to find value, it has ordinarily foreshadowed a sell-off, mainly because of the fact that if I am finding it harder to identify value, then chances are so are other brokers and fund managers.
The reward on offer seems diminished.
Risks emerging … China specifically.
What then about the risk we are taking in owning shares?
On that front, too, I am starting to sit a little uneasily in my chair.
The situation in China has been discussed, dissected and prognosticated on for over 5 years insofar as the country’s enormous reliance on fixed-asset investment and the longevity of this strategy.
In this time, the Chinese government and financial authorities have successfully averted any major crises and have nimbly enacted policy in such a way as to release pressures as they have built up.
However, increasingly the policy tools available to the Chinese authorities are seeming as blunted as those being used in the West.
Pumping the economy with liquidity is increasingly having a diminished impact on private sector economic activity. In fact, not only is it not stimulating the growth seen in the past, it is actually inciting irrational and unhealthy behavior amongst both corporations and individuals alike.
Much has been made of the rampant speculation to have occurred on Chinese commodity futures markets this past month – we noted it specifically in our downgrade of BHP last month. For those that didn’t note it, steel and iron ore futures leaped 40% during April, but have since given back the entire rise during the last 4 weeks.
Within the corporate sphere, the liquidity tap has encouraged unprofitable or insolvent companies to continue operating long after they should, racking up greater indebtedness and delaying the purge of excess capacity needed to reinstate profitability in many sectors.
This last point is an increasingly substantial concern for global markets since the scale of corporate debt extended by the banking system to so called ‘zombie companies’ is seen as being so great and so perilous as to be able to derail the entire capital base of China’s banking system. Reports from the IMF and Bank of International Settlements in recent months speak to the enormity of China’s corporate debt issue and reputable brokerage CLSA also reported last week the potential for bad debt losses of US$1-1.5trillion – equivalent to 5-8% of China GDP.
Whilst this issue has been bubbling away for some time now, we think timing-wise it is rapidly coming to a head and that the authorities are indeed acknowledging the need for more rational policy here.
Our conclusion …
All things being equal, we are now saying it is time to be less greedy and more fearful.
We think the risk/reward balance for Australian shares has now tipped over to the point where the attractions are diminishing.
We are not fear-mongering, simply opting for future prudence.
Our concerns are unlikely to play out overnight or in days, but are genuine concerns.
It is important we begin to mount this case for caution as we stare into the northern summer and the second-half of this year.
Our equity managed accounts both hold reasonable cash balances (8-10%), but can hold more. We hope and expect to be able to find reason to raise these cash balances in the weeks ahead toward our maximum allowed cash weight of 15%.
We would expect to send a more detailed note out next week to you, with some advocacy on shares to hold or lighten on as appropriate.
NEXT WEEK’S NOTE WILL OUTLINE MORE PRECISELY OUR EXPECTATIONS FOR SHARES, HYBRID’S, THE CURRENCY AND INTEREST RATES.
IT WILL ALSO PROVIDE EXPLICIT DIRECTION ON HOW TO POSITION YOUR PORTFOLIO TO WEATHER THE COMING 6 MONTHS.
For now, please treat this as something to consider over the weekend and please expect to read more from us next week
This information has been prepared by Primestock Securities Limited ABN 67 089 676 068, AFSL 239180 (“Prime”). Prime accepts no obligation to correct or update the information or opinions in it. This information does not take into account your objectives, financial situation or needs. Before acting on this information, you should consider whether it is appropriate to your situation. It is recommended that you obtain financial, legal and taxation advice before making any financial investment decision. Prime is bound by the Australian Privacy Principles for the handling of personal information.
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