Returns Take Flight So Sit Tight
The Age
Saturday March 8, 2003
Shares may be cheap but they are cheap for a good reason, writes Richard Salmons.
The threat of war and a further slowing in the global economy have already taken a heavy toll on investors, helping to wipe $157 billion from the value of Australia's biggest companies.
The losses equate to destroying three of the Australian Stock Exchange's largest companies combined - NAB, BHP Billiton and News Corporation.
The figure represents the fall in the investment benchmark, the S&P/ASX 200 Index, in just one year. Since reaching a closing high of 3497.6 points on March 7 last year, the index has lost 21 per cent of its value.
The rout has been precipitated by the threat of war in Iraq and by growing concerns about a long-term economic slowdown.
``Every valuation signal is showing the market is cheap, but it is cheap for a reason; because there is a lot of risk around," said Macquarie Equities strategist Tim Rocks.
As if to exemplify the fears in the market, the sharemarket slumped another 1.2 per cent yesterday, after US President George Bush again stated his determination to go to war with Iraq. The S&P/ASX 200 lost 32 points to close at 2744, and the broader All Ordinaries Index fell the same number of points to 2715. Japan's benchmark Nikkei 225 Index tumbled 2.3 per cent to 8178 points - a 20-year low.
Certainly, the Australian sharemarket has until now performed better than most other major markets. The Wall Street benchmark, the Standard & Poor's 500 Index, is down more than 45 per cent from its record highs three years ago. Indices for European stocks show a 55 per cent fall from their peaks.
Similarly, Rocks said he was reasonably optimistic that the All Ordinaries could recover to 3000 points by the end of December, albeit with most of the recovery coming after June. Stockbrokers JBWere estimate that the market indicator is worth 3485 points based on its value relative to fundamentals - such as forecast profits.
But, while there is some consensus that the market is being depressed by the immediate prospect of war, investors aren't prepared to bid stocks higher unless the situation is quickly resolved.
HSBC chief economist John Edwards has pointed out that wholesale political upheaval in the Middle East - from Saudi Arabia to Turkey and Iran - could stifle an investment upswing in the US, Japan and Germany, leave oil expensive, and embroil US troops in a long occupation of Iraq.
"The US budget deficit would be higher than otherwise, and the current account deficit wider," he said. ``That would probably mean the US dollar would be weaker, world growth would be slower, the Australian and New Zealand upswings at the end of this year less pronounced."
The main alternative to a quick war would be ``a prolonged crisis, which will keep oil prices high and rattle investor and household confidence".
Economists already expect the economy to slow down this year to 3 per cent growth, from growth of 4 per cent or more over the past three years.
"The weight of geopolitical concerns, drought, and a housing downturn . . . remain a drag on growth," fund manager ING Investment Group said in a report released yesterday.
"Retail sales and job vacancies are softening from their peak levels seen in 2002, however a number of indicators remain robust. Taken together, the evidence is that the Australian economy is adjusting towards a slower and more sustainable growth path," ING said. It listed employment growth, investment spending and planned capital expenditure among those positive indicators.
By contrast, the stock exchange's record a year ago was driven by the momentum of strong economic growth. The economy had shrugged off the terrorist attacks in the United States to grow 4.1 per cent in the final quarter of 2001, and analysts were upgrading profit forecasts for Telstra and bidding up News Corp in anticipation of another buoyant year.
Now, however, investors have witnessed a decline in the sharemarket to its lowest level in 3 1/2 years. What was at the height of the dotcom boom the most spectacular bull market in history has given way to what turns out to be a decade of anaemic returns. By February 1994, the All Ordinaries Index had hit 2340 points. Nine years later, it has gained just 375 points - an inflation-lagging compound interest rate of less than 1.5 per cent. (Of course, this scenario assumes unlucky timing. An investor who bought 10 years ago and sold one year ago would have made an annual return of 9 per cent. Neither figure includes dividends.)
HSBC equity strategist John Banos expected the All Ordinaries Index could reach 3500 by December, based on a pick-up in profits in the second half and cheap prices. Banos warned that Australian consumers were heavily borrowed, thanks to the property boom. Instead, he leaned toward stocks built around business spending, such as infrastructure, steel, media and insurance companies.
Macquarie Equities also has a focus on infrastructure and insurance, as well as defensive consumer sectors such as gaming. It favours stocks such as Origin Energy, Macquarie Infrastructure Group, Tabcorp, Westfield America and QBE.
However, Rocks warned that the current reporting season had proven slightly disappointing, and even more of a concern in terms of the number of companies warning of weak trading conditions. ``There is way too much complacency about the weak conditions over the next 12 months," he said.
Stockbroker Merrill Lynch has also added Tabcorp, QBE, and Westfield parent Westfield Holdings to its model portfolio for the Asia-Pacific region. In the media sector it favours John Fairfax Holdings (owner of The Age), and it also likes Lion Nathan, St George Bank, Amcor and BHP Billiton.
But Merrill is cautious about the profit outlook. Following the current reporting season, it notes that consensus profit forecasts for the 2002-03 year have fallen to 10.2 per cent, from 12.8 per cent before the season began. Compared with last September, forecasts have been cut by more than a third.
Merrill Lynch's Australian economist, Trent Barnett, pointed out that a major driver of the local sharemarket's retreat since the start of the reporting season in January had been falls in major stocks on the day of announcing results. That companies' outlook for profits were lagging the outlook for sales suggested that business expected increased pressure on profit margins in the months ahead, he said.
This defensive mood has ensured that many of the large firms are gravitating toward the same popular stocks. ABN Amro recommends utilities such as AGL, Foster's in the food and beverage sector, gambling stocks and also Telstra, now seen as attractive for its dividend yield. UBS Warburg is another BHP Billiton supporter.
In a recent report, Merrill noted that Westfield, for example, was attractive for its simple, focused business model: ``One of the most solid earnings records in the market and barely affected by economic cycles."
That sort of resilience will be necessary if the market faces challenges as great as the past year. Of the Australian Stock Exchange's 10 industry groups, only the Utilities Index, dominated by the likes of United Energy and AGL, rose. The others all fell by at least 12 per cent, and as much as 60 per cent in the case of the hapless, but mercifully small, Information Technology Index.
Macquarie's Rocks said a strategy of investing in sectors and stocks with
high yields would have outperformed the market by 5 to 10 per cent over the past
12 months. But he emphasised the current market's risks, at least until the
result of the Iraqi standoff was clear. ``If I were a private client, and I am,
I would be steering clear of the market for the next three months. Come
June-July, I'd start to rethink things then," Rocks said.
AUSTRALIAN STOCK EXCHANGE INDUSTRY GROUPS Percentage gains or falls from March 7, 2002, to March 7, 2003. Utilities +6.8 Consumer staples -14.1 Materials -15.4 Energy -15.7 Financial services -18.3 Telecommunications -26.6 Industrials -30.3 Consumer discretionary -30.7 Health -43.5 Information technology -61.7 Overall return (S&P/ASX 200 Index) -21.6 SOURCE: ASX/BLOOMBERG
© 2003 The Age
