It seems the share market has found a potential new driver to move forward: upgrades to earnings forecasts for resources companies.
On Sunday I was reading through various research reports, in preparation for my presentation to the Australian Technical Analysts Association on Monday, and my attention was drawn to a sector update by Citi analysts. They'd made a comparison between consensus price forecasts and present commodity prices and the differences were quite pronounced.
I am not the only one whose attention was piqued. The past few days have seen a remarkable gap in performances between bank shares and resources stocks, both in Australia and worldwide, and the banks are clearly on the losing end.
As one would expect, this has triggered some "told you so" comments from experts and market commentators who either see vindication of their negative view on banks, on the share market as a whole, or on both.
If anything, I think investors should keep the right perspective and look at what is happening in the background to cause current market developments, as these factors paint a completely different picture.
For starters, bank shares (and not just in Australia) as a group have been the best performers in the market this year, and not just by a bee's appendage. I am certain that the mere thought of having had the opportunity to buy shares in ANZ Bank ((ANZ)) -to name but one example- for a little more than $12 in March this year gives many of you mixed feelings right now.
Even in July ANZ bank shares could still be bought as cheaply as $16 a-piece.
The shares are trading above $22 today, but they have been to $25 last month. This in itself fills me with joy, because I have been positive about Australian banks for many months now, even though I know that many FNArena subscribers, as well as readers of my stories elsewhere, remained highly sceptical about the merits and accuracy of my analysis.
The good news is, however, that my positive view on Australian banks remains intact (with "Conviction" some stockbrokers would say), meaning only those market participants looking for short term (upward) momentum trades have now definitely missed out on this opportunity. If you have a longer term horizon, however, the fact that bank shares are now under selling pressure should not be a bad thing at all.
During my ongoing research and analysis I recently calculated that an investment made in bank shares in 1998 would have tripled in value (200%-plus) by 2007, just before the Great Wash Out. Mind you, this would not have required investors buy in at the low point in 1998 and manage to pick the exact peak ten years later. All this would have required is to purchase bank shares at the average share price for the year in 1998, to consistently convert all dividend payments back into shares, but above all, to put these shares in the bottom drawer and never even think about selling them.
As I have hinted at over the past weeks, I think too many investors are getting drawn to the short term momentum trades, while many of them are in essence looking for a relatively safe and solid longer term investment opportunity that will generate a good return. While on stage on Monday I stated: I think bank shares can repeat that performance over the next ten years.
That is: the next ten years, not including the gains already made since the low point in March.
Remember, back in 1998 bank shares were not climbing out of a trough, while two years later they faced recession, with a big sell-off in 2003. If you are a consistent dividend payer, and the owner of your shares knows the virtue of "longevity", the world looks a lot different than for many other stocks and shareholders/investors.
Bank shares have come under selling pressure because they performed so well throughout the post-March rally, outperforming all the rest, and at a distance. This always triggers profit taking at some point, but it would be too easy to put it down to that, and to that only.
Here are some more reasons why bank shares have come under pressure lately:
- Many market commentators only look at the share market with a view as long as their nose. On FY10 multiples it seemed like the peak of 2007 was back with us in October, while in reality FY10 earnings should mark the bottom in this cycle. Why would you (or anyone else for that matter) value something at the lowest point? If we take a look at consensus estimates for FY11, however, bank shares in Australia are not expensive at all.
It's quite the opposite, actually, as I could easily argue that instead of going back to the extremes of late 2007, bank shares in Australia seem to be going back to the mid-point of 2008, when everything looked bleak and without much hope that the world would find a solution to its troubles.
As anyone can see in Stock Analysis on the FNArena website, ANZ Bank shares are trading on a FY11 multiple of 10.8 with an implied (fully franked) dividend yield of 6.1% for the year. For National Australia Bank ((NAB)) the FY11 multiple has now fallen to 10.6 with a yield of 6.2%. For Westpac ((WBC)) the corresponding numbers are 11.4 and 6.2%. For Commbank: 12.4 and 5.8%.
(I noticed on Monday (again) many investors tend to underestimate the upside potential if both earnings and multiples rise – but I'll come back to this another time).
- Australian banks had become a toy in the global returns game played by hedge funds and international stockbrokers in that the combination of a rising Australian dollar, plus strong share price gains plus unusually high dividends (on an international scale) would generate very, very large gains.
Now that the rise in the Aussie dollar has flattened, and banks have gone ex-dividend, these investors have started to move on to greener pastures elsewhere (like: resources stocks). This is in essence a switch that had already started in October, when international fund managers started to like banks in Asia more than those in Australia, on relative valuation grounds.
- Australian banks seem like a rock in a global sector full of paper towels and this is not going to change anytime soon. In other words: the state of international banking is still very much rotten and at times signals of inherent sector weakness will flare up and cause investor angst. Meredith Whitney, currently the ultimate celebrity when it comes to analysing US banks, has declared she's back to being bearish and investors have taken note.
Last week I quoted Credit Suisse's Giles Keating in predicting it will probably take up to ten years to sort out the problems with banks in the US and in Europe. This implies that international worries and concerns will come and go, return and subside again -probably on an ongoing basis- over the next few years. This will, at times, impact on share prices for banks in Australia. Don't like it? Sorry, cannot change it.
As long as we don't fall back to Lehman-failure problems, however, the overall impact on profits and balance sheets for Australian banks should remain limited, if noticeable at all.
- The return of international concerns has also brought back widespread scepticism about how long the banks can maintain their elevated levels of profitability in Australia. Aren't regulators going to change things around? Isn't the Australian government going after the banks' fees and margins once Rudd and Co have dealt with nasty and stubborn Telstra?
While these concerns seem to have a lot of merit, this doesn't necessarily mean they will prove to be true. There are quite a few analysts around who believe the end result will prove to be relatively neutral for Australian banks. When it comes to future government intervention in Australia, one stockbroker recently summed it up as follows: the Australian government needs income as the deficit needs to be brought back to counter the opposition. Who pays the most taxes in this country? The banks. So who's going to shoot down the golden goose? Not this government, for certain.
Take into account that Australian banks are likely to end up with surplus capital; they are projected to grow earnings for shareholders (EPS) by over 30% accumulated over the next two years and several experts, analysts and strategists have already confirmed these projections seem but feasible, if not ripe for further upgrades.
It should be clear by now that the Big Four Banks in Australia are in the unique position that the longer the global credit crisis remains in place, the more they benefit (as long as we don't return to truly Armageddon days).
- Part of the banks' problem is that after such a stellar run, which culminated in yet another results season in October that led to further increases in analysts' future earnings projections, there is at present no clear catalyst in sight for the sector. The next market update will be provided by CommBank in February next year, when some analysts believe the next set of market upgrades is bound to kick in.
This was again highlighted in a sector update by analysts at GSJB Were on Wednesday morning, which the analysts used to reiterate their positive view on a longer term horizon. This view is partly based on the fact that bank shares in Australia look "cheap" on FY11 multiples, say the analysts, plus the fact that earnings risk remains firmly to the upside with upgrades to market expectations seen as likely post the interim-results next year.
- Contrary to commentators' views elsewhere, banks confirmed the rally this year was absolutely justified by releasing FY09 results that yet again beat most analysts' expectations, triggering further upgrades to future earnings projections, valuations, price targets and, in some cases, broker ratings.
Unfortunately, these upgrades were in the order of 2-3% only and thus the big boost under bank share prices was always going to fade out. In my Weekly Insights from 9 November (see "Earnings Momentum Fading") I already pointed out the trend for upgrades to earnings projections for the Australian market as a whole had started to flatten (admittedly from a very steep trend in the preceding months).
Resources stocks could be the exception from here on because, as I pointed out in the opening sentences of today's editorial, current consensus price forecasts for energy, base metals and bulk commodities are likely to move up anytime stockbrokers release their next updates. The past few days have seen exactly that by UBS (copper and oil), BA-Merrill Lynch (oil) and Credit Suisse (commodities across the spectrum).
By the way: if you are a paying subscriber and you read the Australian Broker Call Report every day, you'd already know this.
Such upgrades automatically make stocks cheaper, as earnings expectations rise and Price-Earnings Ratios (PERs) fall. Shares for BHP Billiton ((BHP)), for example, are thus cheaper today at $40.60 than when they were trading at $38-39 a few weeks ago. To put it bluntly: this is why you should ignore commentators who only look at face value of shares, and not at what lies underneath.
Whether these upgrades will be enough to keep share prices moving higher, let alone the market as a whole, remains yet to be seen as share markets continue to struggle with the loss of some clear support factors, including steep upgrades to economic growth and corporate earnings and an ever weakening US dollar.
Pure logic tells us, however, that if these upgrades to commodity price forecasts come through, share prices -all else being equal- will become cheaper, even without a possible retreat in the weeks ahead. If we do find enough reasons to rally, however, resources seem but the place to be. At least for those investors seeking to ride the momentum du jour.
Others might want to take a good look at the banks instead.
Also, don't forget BHP Billiton has the capacity to launch a share buyback that could potentially increase the value of its shares by some 10%.
With these thoughts I leave you all this week,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team at FNArena)