Volatility offers value for astute


Published in The Australian, July 2006 

In mid-March, the Australian share market hit a record 5000 points, climbed as far as 5333 in May, then in mid-June corrected to 4926.

In fact, following a retreat in global share markets, Australian shares have fallen by as much as 10 per cent, with the resources sector falling 20 per cent.

It has been a volatile ride for investors. The market appears to be on a slow climb up again, though whether this is to new highs or merely sideways is anyone’s guess.

Whether to invest or take a breather, or where to invest if you think there are buying opportunities, are the key questions for investors.

The unknown “X factor” is global share markets. Chief economist at Prescott Securities Darryl Gobbett, says that, barring outside shocks, the Australian share market is primed to reach 5600 points by June 2006 and he expects companies to report “a solid set of numbers when they begin reporting their full-year results in coming months”. His immediate concern is the US hurricane season.

“A report of last year’s devastating hurricane season could blow our share market off its growth course, albeit temporarily,” he says.

In Australia, rising interest rates and petrol prices are about to be offset by tax cuts which come into effect from today. More money is also swishing around in superannuation to underpin financial markets – super assets hit the $900 billion mark for the first time this week.

The Australian share market itself remains firmly in the fair value range – that is, it is not in bubble territory. CommSec notes that, while the price-earnings ratio of the Australian share market has edged up from 14.64 to 14.71, it is still below the long-term average of 15.75.

“The PE ratio lifted to a high of 16.27 per cent on May 9, just ahead of the recent correction in share prices,” says Craig James, chief equities analyst at CommSec.

The Australian Stock Exchange’s view tallies with that of CommSec. “Company valuations today are not overstretched, unlike in the dotcom boom of the late 1990s,” says Tony Hunter, head of ASX Investor Education. He says the market was more expensive last year, when it traded at 20 times earning.

“When the market is falling, experienced long-term investors typically acquire stock in the knowledge that there are bargains to be had,” Hunter says.

The thinking is that tax cuts will offset other negatives here. This will be important for investors wanting to invest in stocks sensitive to consumer sentiment, such as retail stocks.

Elio D’Amato, director of research at stock research house Lincoln Indicators, characterises the mood of the market as “edgy and unsure.”

“I have not seen this sort of volatility for a long time - where the market rises and falls by a full 1 per cent or more in a day.”

In the lead-up to results season in August, he expects “more of the same as some local companies seek to lower their earnings expectations”.

“The positive side of this correction is that solid companies are the same businesses as they were two months ago but they are cheaper,” D’Amato says.

For example, BHP reached a record hight of about $32 in mid-May, fell to as low as $25 in mid-June, and has now edged back up to $28.

That said, there is a air of “buyer beware” in the air. There is a view that smaller, speculative mining companies are not the place to be, even if they are theoretically “cheap”.

“Before the correction, shares of several speculative mining companies rose on all the talk about uranium mining, but most had not yet found anything in the ground,” D’Amato says.

“They are the types of stocks small investors should be exiting in this sort of market as they are less robust when there is volatility.”

He also sees the retail sector as vulnerable due to the potential for higher interest rates and higher petrol prices. “Ordinary mum and dad spenders (who are the majority) are thinking twice about discretionary spending.”

There are always exceptions and in this category, budget fashion retailer Noni B has defied the trend and appears to have maintained sales and margins, D’Amato says.

For value, investors should target stocks with low gearing ratios, strong earnings growth and which have shown efficiency in how they run their businesses.

CommSec chief equities economist Craig James says some retailers have shown they can maintain margins in the face of falling prices in the technology sector, where iPods and plasma screens are falling in price as they become commodities. “There are pockets of opportunity in companies such as JB HiFi, Harvey Norman and David Jones who can manage their way through economic and business issues. The tax cuts, which kick in from July 1 will also be a positive surprise to consumers who after pulling in their belts, may find they are OK.”

The tax cuts are particularly generous to above-average income earners; someone on $80,000 gets a $40 a week tax cut; someone on $100,000 gets a $51 a week tax cut and someone on $150,000 gets a whopping $120 a week tax cut.

James also remains bullish on the resources sector where he says long-term demand from emerging economic powerhouses such as China and India will continue to fuel demand for cars and whitegoods, regardless of market hiccups.

“The demand from China and India is not going away anytime soon – there are 13 billion people in China and 1 billion in India and all of them will want cars and fridges one day. So the demand for resources such as copper, aluminium and iron ore that make it all happen are not going away. That puts BHP, Rio Tinto and Woodside petroleum in a good position for long-term investors.”

James also notes that consolidation in the global resources sector is ceding more power to larger, established incumbents who can better control supply and pricing.

“We have not seen a flood of copper hitting markets and driving down prices,” he said.

In the banking sector, James likes National Australia Bank, whose restructuring efforts are paying off, and Adelaide Bank, whose inroads into the home lending sector, in particular low-documentation home loans, are paying off.

Bridges Financial Services equities head Peter Hilton says it is common for corrections to occur in a bull market and that investors should expect more. “The recent one was a 10 per cent pullback, but we have also had 7-8 per cent pullbacks just in the last 12 months.

“There has been a move back to defensive stocks such as utilities, while food retailer Woolworths has gone to record highs since the correction.”

Hilton says buying opportunities are good in a volatile market and suggests a mix of solid long-term plays and defensive stocks. Bridges likes Woolies, ANZ, St George, Foster’s and in the small-cap sector, Program Maintenance Services. He notes that the correction has made the utilities and infrastructure sector more attractive.

“Companies such as Challenger Infrastructure, SPN and Spark Infrastructure are all yielding in the 8-9 per cent range,” he says.

By contrast Dale Gillham, chief analyst at private investment firm Wealth Within, believes the current bull market is ending and says investors should adjust their expectations accordingly: “We have had a 36-month bull run up to March and a 39-month run up to June. The longest bull markets in Australian history have only run that long, so we are now in uncharted territory.”

He expects the share market to trade down or sideways for the foreseeable future.

“It does not mean the market will crash, it just means now is a time for astute buying. You can’t just throw a dart at a dartboard and expect the stock it hits to perform the way that you would have expected it to over the last three years.”


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