Bear neccessities


Published in the Sunday Age, April 2009

Opportunities are emerging for cautious investors, writes David Potts.

The sharemarket has already hit its bottom in this bear market but it's going to be a long haul up again. Indeed there's already talk of a correction, as if we haven't spent the past year in one long one. "The market has come back up so hard and quickly, especially the banks, it's like a straight line up at the moment, which is unsustainable," says Kristian Dibble of tipsheet The Rivkin Report.

The sharemarket is some 500 points above the low it hit just over a month ago.

Investment manager and share trader Dale Gillham, until recently warning that buying shares in this environment was akin to catching a falling knife, is back buying – though very selectively, it must be said.

"It's quite possible the market has gone as low as it will. But it hasn't been tested. It's going too fast - at the speed it was going prior to the pullback in November," he warns.

The speed might be the same, only this time there are more travellers.

Even some of the so-called hybrids, a cross between equities and bonds usually known as preferred or convertible shares that bore the brunt of falling interest rates, have doubled in price in just a few weeks.

At least nobody thinks the market is overvalued. Most experts think it's a screaming buy especially the blue-chip stocks offering double digit returns from dividends, even after expected cuts, when the 30 per cent franking credit is taken into account.

"The market is genuinely cheap," says the chief investment officer of Platypus Asset Management, Don Williams. He even predicts the ASX200, which is about 3600, will hit 7000 by 2015-16. But don't get too excited: he also expects a savage downturn, though not dropping to as low as it did last month, by this time next year.

CommSec's Craig James predicts the index will rise to 3800 by the end of the year but is having second thoughts. It might be a lot sooner.

Another telltale sign of growing, if still fragile, confidence in the market is an increase in the daily volume of shares traded, which the head of equity research at Centric Wealth, Paul Zwi, says shows some panic buying for fear of missing out on bargains, plus a rising number of takeover rumours. Bull markets invariably start with a spate of corporate takeovers.

While it seems strange that the experts are becoming more optimistic just as the economy seems to be getting worse, you've probably already twigged why.

The daily gloom and doom, which has been turned up several decibels with the release of the figures for new job advertisements, or rather the lack of them, is old news.
It's where the economy is going that counts.

Enter the Government's various economic stimuli packages plus the slow-moving effects of the Reserve Bank's 4.25 percentage point cut in interest rates since September.

Besides, even some of the old news hasn't been so bad. Not much was expected of the half-year reporting season and it would be fair to say that profits were generally under estimated. But that owed a lot to the fact that half of the half-year wasn't in recession.

The next reporting season, beginning in August, will reveal the real damage and is expected to bring another round of dividend cuts. It will also take into account the 40 per cent to 50 per cent slump in the prices of our major export commodities - iron ore, nickel and coal - from which we've been shielded by contracts signed this time last year.

Fortunately the dollar has since fallen about 20 US cents, bringing the real fall in commodity prices to more like 25 per cent to 30 per cent. But then our dollar is likely to do anything. No, it's the US dollar that is likely to do anything as the market gets more nervous about the US Federal Reserve printing money.

This lagged effect of the commodity slump is behind what Perpetual's portfolio manager, Matt Williams, calls the "Indian summer recession". He says: "We've been waiting for the economy to weaken significantly. We expected poorer economic data than we've seen."

But he warns brokers are too optimistic about the next reporting season.

A survey by Macquarie Equities shows analysts expect earnings per share to grow by 11 per cent next financial year.

"History has shown an earnings decline is not a one -year phenomenon. A recession hits earnings for at least two years," he says.

Or as the tipsheet Wise-owl's Imran Valibhoy puts it: "We don't know how many skeletons are in the cupboards."

This is all the more so with US banks, the root cause of the financial meltdown that triggered a synchronised global recession. Enough money has been thrown at them to keep them solvent but it could take years for their problem loans to wash through the system. And the fact that everybody is in recession at the same time does not augur well for a quick recovery.

"We know the economy will be awful for the next 12 months," says Brian Parker, investment strategist at MLC.

But we also know the sharemarket will anticipate a recovery well before it shows up in the statistics. And, as the head of investment strategy at UBS Wealth Management, George Boubouras, says, this is the biggest bear market rally since 1983.

One curiosity of this rally is that it's moved so quickly from financial stocks, normally the first to recover, to other industrials. `I’m happy we went overweight in February in equities but it didn't look so good then," he says.

Based on the key price earnings ratio, which shows how many years it will take a share to recoup the original outlay, Boubouras says the market needs to rise 16 per cent to get back to the historical norm of valuations.

And for Wall Street make that 30 per cent. "This is a market where it's three steps forward and two steps back," says Parker. "It's not two steps forward and three back like it has been."


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