(TUESDAY 18TH OCTOBER - JAMES GERRISH - 8.44am)..The DOW JONES lost -247pts overnight while the S&P 500 fell -1.94%. European mkts were mostly lower while locally, the SPI FUTURES mkt is pricing a drop of -70pts when trading kicks off here this morning.
Yesterday, the S&P/ASX 200 put on +69pts to close at a fresh 6 week high of 4275 and is now +435pts or +11.2% from the intra day low of 3840 set on the 4th October. Clearly, the mkt has turned positive and we've now got more confidence that the low we saw back on the 9th August (3765) will be the overall pivot point in the mkt.
The main issue we've got in the mkt at the moment, (and we saw it last night) is that we'll get shocks based on political incompetence from Europe and as one commentator put it in the AFR this morning, be wary of a rally that is underpinned by a rubber stamp.
That comment certainly has some validity but its not the only reason the mkt has rallied off its lows. Sure, positive developments from Europe provided the catalyst for the mkt to turn more positive but buying has progressed on the back of extremely attractive company valuations.
As we've been saying for a while now, the mkt was pricing in a US recession and a lack of credible plan coming from Europe. Clearly, the data coming out of the US is not indicative of a recession and we've had some strong indications coming out of the G20 meeting over the weekend that a solution in Europe was close.
Last night we had the German Finance Minister (Wolfgang Schaeuble) put come cold water over the timing of the European fix saying that a solution wouldn't be reached till well into next year...Great! I'm sure I'm not alone thinking that next week seemed a long way off in this crisis and I certainly don't want to be focussed on Europe next year.
Still, I wouldn't want to base my view of the current situation on Schaeuble given he continues to talk down any hope of a resolution and at times recently, has contradicted Chancellor Angela Merkel.
Adam Carr in the Business Spectator this morning said it pretty well....
"The real tragedy is that growth is actually doing well despite all the pessimism and claptrap over a double dip and the ongoing incompetence of policy makers. Indeed the global economy is clearly accelerating after significant disaster-induced distortions.
So we saw some US industrial production data last night, and it was pretty solid, which alongside other decent data has defied all the recession talk.
The only real threat to growth comes from clearly deranged European politicians and unfortunately this latest rhetoric isn't promising. It's doubtful that the world can put up with this endless uncertainty 'well into next year'.
This isn't an option - is Germany really that dumb? It's hard to tell whether this is just an exercise in expectations management, a negotiating strategy or genuine stupidity though. We just don't know, nothing has been made public yet. So we'll see what happens over the next week.
Here is what we wrote back on the 4th October which proved to be the most recent mkt low (about 11% ago..!)
________________
We've said before that volatility is typical of a mkt low and for now, we retain this view more so based on our assessment of the news flow coming from Europe + the US rather than the technical set up that's obvious (in the mkt).
and on valuations....
"Companies in the benchmark gauge for American equities trade at 10.2 times 2012 forecast earnings, compared with the average in economic contractions since 1957 of 13.7, according to data compiled by Bloomberg.
S&P 500 profits fell an average of 12 percent on a yearly basis in the nine recessions since the 1950s, according to data compiled by Bloomberg. Should earnings drop by the same amount from the estimated $99.17 a share this year, profits will total $87.59 in 2012. Based on the S&P 500's Sept. 30 close of 1,131.42, that would imply a multiple of 12.9.
Should S&P 500 earnings hold at $99 a share next year, stocks would be trading at a 30 percent discount to the average multiple since 1954, according to Bloomberg data. The index is priced at 12.3 times earnings in the last 12 months, down from a high of 23.9 in December 2009.
MY TAKE OUT FROM THIS
It looks like the mkt is pricing in a recession yet history shows that earnings multiples, even during a recession are not at the levels they are now. If US corporate earnings do drop by 12% (the average of the last nine recessions), the S&P 500 would still be considered cheap.
So in Europe, it appears we're pricing ineffective action by leaders in solving the debt issues whilst in the US, we're pricing a recession. If we get progress that steers us away from these scenarios then we're likely to get some strong relief in the mkts....
We retain this view
______________________
Chart of the Day put out an interesting one on the weekend and the main take out here, is that equities in the US are trading at their cheapest levels since 1990.
Today's chart illustrates how the recent rise in earnings as well as the recent stock market action has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). As a result of the recent spike in corporate earnings as well as relatively lower stock prices (e.g. the S&P 500 currently trades 11.7% off its April 2011 post-financial crisis highs) the PE ratio has dropped to a level that has not existed since 1990.
VOLUME
There has been a lot of talk around current mkt volumes being light. That's certainly true (value yesterday of $3.4 billion) but what it means for future prospects is a little less certain. Some would say that light volume indicates a lack of conviction from the institution's, but it also means that we're unlikely to see high volume when selling hits.
I think its been more of a case that insto's mostly missed the initial leg higher and have been waiting for some type of correction before deploying cash. Its difficult to put any meaningful amount of money to work after a mkt has rallied +11% so I think this sets up for buying of any type of dip.
If we look at other asset classes we've seen that the big money has started to come out of US Treasuries (10 year yields from 1.67% to 2.27%) yet we haven't seen the funds hit equity mkts as yet. I think this will happen.
We discussed some other reasons for continued support in equities last week and they're reprinted below...
...."This is what gives validity to the old saying of 'markets climb the walls of worry'... because the reality is that the start of a bullish move is built on a foundation of scepticism derived from a recent mkt shock. This has been amplified even more so this time around because of the fresh memories surrounding the GFC where we saw equity mkts fall 30% post Lehmans collapse.
Believe it or not (now), its different this time around for a couple of key reasons:
1. Companies are flush with cash and if the mkt doesn't price assets realistically, corporate s will. We've seen this activity increase recently with FGL, HUN, CSV, SDL etc etc under take over.
2. There is a massive amount of cash on the sidelines that is going to be earning less if interest rates are cut (as expected). This cash has just witnessed a 10% rally in equities in a little over a week. That's 2 years worth of cash returns since last Tuesday - which certainly gets attention.
3. So, the recent mkt bounce is probably short covering, but instos are cashed up + they are massively underweight equities. Don't under estimate the old Fear Of Missing Out type event. Any pullback I think serves as a buying opportunity and we should trade this view for the remainder of the year.
4.. Fixed interest yields have been pressured in recent times given higher demand for safe haven assets. They now offer a relatively unattractive comparable return. (example - Bank Shares yield 10+% in a super fund while a comparable bank hybrid yields 7.8% - or Telstra yields +10% against a 3 year term deposit yielding 5%.
5. Coppo also sighted yesterday the reduced ability of Hedge Funds to short stocks given Funds Under Mgt have dropped significantly (MAN Financial an example of this). So the fact that hedge funds were bigger in 2008 and there were more of them, they had more clout. Recently, the sector has been performing fairly poorly so they'll be tentative to make those larger calls, and less tolerant for positions that go against them.
MODEL PORTFOLIO UPDATES
Non today
AUSTRALIAN STOCK PRICES OVERNIGHT
In New York, News Corp fell by US$0.36 to US$16.93, equivalent to A$16.67, A$0.20 below its last close on the ASX.
ResMed fell by US$0.75 to US$29.66, equivalent to A$2.92, A$0.06 below its last close on the ASX.
In London, Rio Tinto fell 43.5 pence to £33.02, A$0.67 lower in Australian currency terms.
BHP-Billiton fell 37.0 pence to £19.10, A$0.57 lower in Australian currency terms.
Henderson Group Plc rose 2.9 pence to £1.24, A$0.04 higher in Australian currency terms.
