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Stockbrokers and market commentators elsewhere have done their best in convincing their clientele and readers that weakness experienced in prices for equities and commodities over the week past is nothing but a buying opportunity. I dare to differ. I believe what we are witnessing throughout the month of January marks a thorough and fundamental change in the underlying trend for risk assets.

While this implies that the strong uptrend in place since the first quarter of 2009 has now -abruptly- come to an end, I do not side with the army of doom and gloom preachers suggesting prices for oil and copper, as well as major equity indices are now irrevocably on their way back to pre-March-rally lows. But investors should take today's message seriously nevertheless: the trend of ongoing monthly gains for risk assets is no longer in place.

As such, calendar 2010 will bring something to the mix investors have not experienced since March last year (ten months ago, January not included): share markets will experience months during which losses will be booked on a net basis. It may well be that January, the first month of the new year, will be the first to mark this reversal in trend.

Readers who have been reading my stories and analyses this month already know I have been warning repeatedly of this reversal as valuations overall were looking rather full for market leaders in the US and Australia. On top of this, I was convinced that junior traders and hedge funds had used the quiet period between Christmas and the second week of January to push up prices for equities and commodities too far.

To put it simply: oil does not yet deserve to be trading at US$84/bbl, copper should be nowhere near US$8000/tonne and Australia's leading indices reaching out for 5000 in early January seems a bit (too) rich too.

The irony of all this is, of course, that global economies today seem in a much better place compared with last year, while US companies are finally making advances in profits again (after nine consecutive quarters of declining profits). The key phrase behind today's asset prices, however, is not necessarily "economic recovery", but rather "abundant liquidity".

Those who say that January's price weakness is but a buying opportunity focus on the first phrase. I however say: be careful, because it is the second factor that can bring potentially very damaging side-effects to this year's mix of events. At a time of elevated asset prices, all markets needed was a trigger to reverse course.

It would seem this trigger came at least in threefold: problems in Greece that in effect prove the GFC is not history just yet, tightening measures in China, and a struggling US president who declared war on greedy bankers and speculators to help turn around the political tide and his sinking approval ratings.

The Big Question that is poised to come to the fore this year is whether last year's easy speculation in risk assets will turn out to be a major negative in 2010. As far as market positioning goes: too many investors, big and small, have their portfolios weighted too much in favour of cyclical leverage, in effect going short US dollar and Japanese Yen and long (nearly) everything else from oil to copper, to gold, to the Australian and Canadian dollars, to Emerging Markets and equities on Wall Street.

Secondly, too much liquidity, in China and elsewhere, has found its way in commodity markets where a big chunk of last year's "apparent demand" has ended up in stockpiles of which nobody knows what, where and how much has been stockpiled along the way. Today's prime example of this is crude oil. The world's producers are currently producing more than what is being consumed, resulting in stockbrokers and financiers renting large ships to store oil in order to benefit from price rises later.

Under normal circumstances this would be enough for investors to push oil prices down, but in today's context wherein everybody is convinced crude oil prices will return to US$100/bbl and higher in calendar 2011 (at the latest), investors simply cannot help themselves other than to seek exposure to the simply-cannot-fail future upside of crude oil prices.

The problem is that so many investors all seek the same exposure at the same time. Sounds familiar? Think gold in October last year. Or oil in the second quarter of 2008.

This was once again demonstrated by UBS's measurement of global risk appetite. The index jumped into "extreme" territory in December last year and simply refused to come down, indicating markets overall were once again running hot on too much optimism and adrenalin. Over the past week this index has dived lower, but it still remains in positive territory.

What has caught my attention over the past ten days or so (apart from stockbrokers telling their clients this is an opportunity to buy) is that financial markets across the globe have started to break through well-established trend lines that find their origin in the first quarter of 2009. I can only describe this as a major development. It should instantly attract every investor's full attention.

For someone who doesn't see himself as a technical analyst (and I am not) I have spent an inordinate amount of time these past days, staring at one year price charts for all sorts of assets, markets, indices and share prices. The reason I did this was because I had observed that global share markets had started to break below these trend lines. As weakness has persisted, commodity indices such as the Reuters Jefferies CRB Index have now also broken below their year-long support line.

At the very least this indicates that the trend in place since March 2009 has now ended. Full stop.

Here's an example of what I am talking about:

What are the possible implications? Under the most positive scenario this break in trend could prove temporarily only. As an example, in late 2003 (late stages of the 2000-2003 bear market) the Australian share market equally broke through its longer term trend line, after which the market broadly traded sideways for a while, albeit with a slight positive bias. One year later a new bull market was born and the share market never looked back, until late 2007.

A more common scenario, but not necessarily a blue print for the future, is the one provided by the EUR/USD. The cross broke through its trend line in early December last year and it has simply moved into the opposite direction ever since. If one ever wants to see a decisive change in trend, EUR/USD is one to look at today.

An interesting alternative is provided by WorleyParsons ((WOR)). When looking at its price chart, one can see how investors for an extended time simply refused to accept that the underlying trend for the shares had changed, resulting in the shares oscillating around the rising trend line. This is similar to what happened with the EUR/USD in 2008. As one can see from the chart below, ultimately, however, this always ends with a much steeper decline. This was also the case for EUR/USD in 2008.

Conclusion: a major trend has been broken in a decisive manner. We will have to find out what exactly will be the new trend, but we know the old one is no longer in place.

Are shares and commodities now being transformed into a buying opportunity? That depends on one's horizon and goals, but I am pretty certain it won't be the case for all shares and not for all commodities either.

One observation I have made is that many leading large caps in Australia have not yet broken through their trend lines. BHP Billiton ((BHP)), for instance, is still priced above $40 and Commbank ((CBA)) remains above $52. Some stocks, such as Leighton Holdings ((LEI)) and Qantas ((QAN)) could potentially experience a lot of weakness and still remain on the positive side of their trend lines.

For others, such as WorleyParsons (see above) and Boral ((BLD)) the reversal in trend has already occurred.

Special note for paying subscribers: I will follow up on this story with many more charts and graphs, if not on Thursday, then on Friday. Check the website if you haven't set any email alerts.

With these thoughts I leave you all this week,

Till next week!

Rudi Filapek-Vandyck

(as always firmly supported by the Ab Fab team at FNArena)

P.S. For the newcomers who have yet to catch up with my track record of the past few years: in June of 2007 I warned prices for uranium had peaked and weakness should be expected. At the time, spot uranium was at US$138/lb. Today it is at US$42.50/lb.

Later that year I stated analysts and economists worldwide were severely underestimating the true nature and impact of the subprime crisis in the US. From that moment on I declared all Australian banks should be regarded a Sell.

In late 2007 I concluded the market was looking expensive, though I did not foresee the savage downturn that was about to follow.

In the second quarter of 2008 I warned everyone that oil at such elevated prices would not be sustainable. Don't buy any oil stocks, I warned readers and subscribers at FNArena. Unfortunately, most would ignore my warning and go with the ruling market view.

In late August that year I predicted the most severe correction for commodities in human memory was about to unfold. Those readers and subscribers who acted on my warning still approach me and shake my hand whenever they see me at a conference or trade show.

In June last year I turned positive on global equities, Australian banks in particular. (I had predicted a rally for March, but had my doubts whether it would prove to be a lasting one).

Now it's January 2010 and once again I had to conclude that prices for commodities and share markets had run too high, too quickly. Today I conclude the firm trend in place since Q1 last year is now broken and no longer in existence.

Stockbrokers and market commentators elsewhere have done their best in convincing their clientele and readers that weakness experienced in prices for equities and commodities over the week past is nothing but a buying opportunity. I dare to differ. I believe what we are witnessing throughout the month of January marks a thorough and fundamental change in the underlying trend for risk assets.

While this implies that the strong uptrend in place since the first quarter of 2009 has now -abruptly- come to an end, I do not side with the army of doom and gloom preachers suggesting prices for oil and copper, as well as major equity indices are now irrevocably on their way back to pre-March-rally lows. But investors should take today's message seriously nevertheless: the trend of ongoing monthly gains for risk assets is no longer in place.

As such, calendar 2010 will bring something to the mix investors have not experienced since March last year (ten months ago, January not included): share markets will experience months during which losses will be booked on a net basis. It may well be that January, the first month of the new year, will be the first to mark this reversal in trend.

Readers who have been reading my stories and analyses this month already know I have been warning repeatedly of this reversal as valuations overall were looking rather full for market leaders in the US and Australia. On top of this, I was convinced that junior traders and hedge funds had used the quiet period between Christmas and the second week of January to push up prices for equities and commodities too far.

To put it simply: oil does not yet deserve to be trading at US$84/bbl, copper should be nowhere near US$8000/tonne and Australia's leading indices reaching out for 5000 in early January seems a bit (too) rich too.

The irony of all this is, of course, that global economies today seem in a much better place compared with last year, while US companies are finally making advances in profits again (after nine consecutive quarters of declining profits). The key phrase behind today's asset prices, however, is not necessarily "economic recovery", but rather "abundant liquidity".

Those who say that January's price weakness is but a buying opportunity focus on the first phrase. I however say: be careful, because it is the second factor that can bring potentially very damaging side-effects to this year's mix of events. At a time of elevated asset prices, all markets needed was a trigger to reverse course.

It would seem this trigger came at least in threefold: problems in Greece that in effect prove the GFC is not history just yet, tightening measures in China, and a struggling US president who declared war on greedy bankers and speculators to help turn around the political tide and his sinking approval ratings.

The Big Question that is poised to come to the fore this year is whether last year's easy speculation in risk assets will turn out to be a major negative in 2010. As far as market positioning goes: too many investors, big and small, have their portfolios weighted too much in favour of cyclical leverage, in effect going short US dollar and Japanese Yen and long (nearly) everything else from oil to copper, to gold, to the Australian and Canadian dollars, to Emerging Markets and equities on Wall Street.

Secondly, too much liquidity, in China and elsewhere, has found its way in commodity markets where a big chunk of last year's "apparent demand" has ended up in stockpiles of which nobody knows what, where and how much has been stockpiled along the way. Today's prime example of this is crude oil. The world's producers are currently producing more than what is being consumed, resulting in stockbrokers and financiers renting large ships to store oil in order to benefit from price rises later.

Under normal circumstances this would be enough for investors to push oil prices down, but in today's context wherein everybody is convinced crude oil prices will return to US$100/bbl and higher in calendar 2011 (at the latest), investors simply cannot help themselves other than to seek exposure to the simply-cannot-fail future upside of crude oil prices.

The problem is that so many investors all seek the same exposure at the same time. Sounds familiar? Think gold in October last year. Or oil in the second quarter of 2008.

This was once again demonstrated by UBS's measurement of global risk appetite. The index jumped into "extreme" territory in December last year and simply refused to come down, indicating markets overall were once again running hot on too much optimism and adrenalin. Over the past week this index has dived lower, but it still remains in positive territory.

What has caught my attention over the past ten days or so (apart from stockbrokers telling their clients this is an opportunity to buy) is that financial markets across the globe have started to break through well-established trend lines that find their origin in the first quarter of 2009. I can only describe this as a major development. It should instantly attract every investor's full attention.

For someone who doesn't see himself as a technical analyst (and I am not) I have spent an inordinate amount of time these past days, staring at one year price charts for all sorts of assets, markets, indices and share prices. The reason I did this was because I had observed that global share markets had started to break below these trend lines. As weakness has persisted, commodity indices such as the Reuters Jefferies CRB Index have now also broken below their year-long support line.

At the very least this indicates that the trend in place since March 2009 has now ended. Full stop.

Here's an example of what I am talking about:

What are the possible implications? Under the most positive scenario this break in trend could prove temporarily only. As an example, in late 2003 (late stages of the 2000-2003 bear market) the Australian share market equally broke through its longer term trend line, after which the market broadly traded sideways for a while, albeit with a slight positive bias. One year later a new bull market was born and the share market never looked back, until late 2007.

A more common scenario, but not necessarily a blue print for the future, is the one provided by the EUR/USD. The cross broke through its trend line in early December last year and it has simply moved into the opposite direction ever since. If one ever wants to see a decisive change in trend, EUR/USD is one to look at today.

An interesting alternative is provided by WorleyParsons ((WOR)). When looking at its price chart, one can see how investors for an extended time simply refused to accept that the underlying trend for the shares had changed, resulting in the shares oscillating around the rising trend line. This is similar to what happened with the EUR/USD in 2008. As one can see from the chart below, ultimately, however, this always ends with a much steeper decline. This was also the case for EUR/USD in 2008.

Conclusion: a major trend has been broken in a decisive manner. We will have to find out what exactly will be the new trend, but we know the old one is no longer in place.

Are shares and commodities now being transformed into a buying opportunity? That depends on one's horizon and goals, but I am pretty certain it won't be the case for all shares and not for all commodities either.

One observation I have made is that many leading large caps in Australia have not yet broken through their trend lines. BHP Billiton ((BHP)), for instance, is still priced above $40 and Commbank ((CBA)) remains above $52. Some stocks, such as Leighton Holdings ((LEI)) and Qantas ((QAN)) could potentially experience a lot of weakness and still remain on the positive side of their trend lines.

For others, such as WorleyParsons (see above) and Boral ((BLD)) the reversal in trend has already occurred.

Special note for paying subscribers: I will follow up on this story with many more charts and graphs, if not on Thursday, then on Friday. Check the website if you haven't set any email alerts.

With these thoughts I leave you all this week,

Till next week!

Rudi Filapek-Vandyck

(as always firmly supported by the Ab Fab team at FNArena)

P.S. For the newcomers who have yet to catch up with my track record of the past few years: in June of 2007 I warned prices for uranium had peaked and weakness should be expected. At the time, spot uranium was at US$138/lb. Today it is at US$42.50/lb.

Later that year I stated analysts and economists worldwide were severely underestimating the true nature and impact of the subprime crisis in the US. From that moment on I declared all Australian banks should be regarded a Sell.

In late 2007 I concluded the market was looking expensive, though I did not foresee the savage downturn that was about to follow.

In the second quarter of 2008 I warned everyone that oil at such elevated prices would not be sustainable. Don't buy any oil stocks, I warned readers and subscribers at FNArena. Unfortunately, most would ignore my warning and go with the ruling market view.

In late August that year I predicted the most severe correction for commodities in human memory was about to unfold. Those readers and subscribers who acted on my warning still approach me and shake my hand whenever they see me at a conference or trade show.

In June last year I turned positive on global equities, Australian banks in particular. (I had predicted a rally for March, but had my doubts whether it would prove to be a lasting one).

Now it's January 2010 and once again I had to conclude that prices for commodities and share markets had run too high, too quickly. Today I conclude the firm trend in place since Q1 last year is now broken and no longer in existence.

At the start of last week (day one of my official return from holidays) one hedge fund asked me about my best trading idea. If I had a few hours to make up my mind, and I had to make one trade, which one would it be?

I instantly responded: go short oil.

It's a pity I couldn't see the faces of staff at the hedge fund, as the correspondence was done via email, but it was clear from the follow-up emails they thought I was either joking, or I had lost my marbles.

Go short oil? Had I somehow missed that the global economic recovery was becoming reality? Experts had started talking about US$100 per barrel again, just read the newspapers!

On that particular Monday, crude oil futures were trading near US$84/bbl. Last night they put in an unexpected sharp rally, but they're still below US$80 and, if my view proves correct, heading for a return back inside the US$70-75/bbl trading range. Note, for instance, that despite crude oil's rally on Tuesday, energy stocks were one of only two sectors in negative territory on the Australian share market during Wednesday's session; the other is Information Technology.

I could be wrong, of course. For all I know a sudden outbreak of extremely cold weather in the Northern Hemisphere, or an announcement by China it will further increase its strategic reserves, could easily push crude oil futures back to US$84/bbl. But the message I am trying to get across, and the reason why I use the above example, is don't just look at one key element -in this case: the solidifying economic recovery- to determine your trading and/or investment strategy this year.

Though it may be less apparent for those who only look at financial markets with a short term (trading) horizon, intrinsic valuation will come to the fore at some point, especially since most experts seem to think that excess global liquidity will be reigned in this year, implying the weight of money will increasingly play a lesser role as the year matures.

To put it very simply: higher economic growth in key regions should translate into higher corporate profits and into higher demand for energy and base materials. Thus prices for companies and for commodities should move higher. But what if these price rises have already occurred?

In the US the main discussion among investment experts seems to be whether market leaders such as Apple, IBM and Microsoft -all on a big winning streak thus far this year- still represent value beyond their present upward momentum. Short term traders might reason I'll play the stock as long as it moves, but for investors with a longer term focus the question is not that easy. If all the upside, or nearly all of it, has already been accounted for, then these stocks should no longer be bought at present levels.

Now that we're mentioning it: I wouldn't necessarily be afraid to have a higher than usual proportion of my investment portfolio in cash. It beats owning shares that seem stretched from a valuation point of view, but it also allows one to jump on any opportunities that might come along as we move through 2010.

Much has been said about the market's potential on the basis of expectations for FY11, and I myself have been a firm advocate for using FY11 projections to gauge where today's true market value is located, but most companies in Australia will only report their full FY10 numbers in August, which is still more than seven months away. In the meantime, a lot of FY11's upside potential is being priced in today.

I have observed, for instance, total recommendation downgrades by the stockbrokers FNArena monitors daily is now outnumbering the number of upgrades for the second week in a row. That's two out of two so far this year, as the first week saw hardly any research released. One downgrade in particular caught my attention: following the release of a production report that was much better than market expectations last week, analysts at Citi nevertheless downgraded Rio Tinto ((RIO)) shares to Neutral.

Their reasoning? Most of the good news is now priced in. As a token of their conviction, Citi analysts stated that in case of any meaningful rally in the shares, they would have no doubt and become sellers of the stock. Now that is conviction!

Most stockbrokers currently have a price target for Rio Tinto shares between $80 and $90. Citi itself is positioned at $83. FNArena's average price target stands at $82.64.

On pure Price-Earnings multiples considerations, Citi analysts seem a bit harsh in their assessment. After all, Rio Tinto shares are only trading on 11.3 times consensus forecasts for FY11, which is far from excessive. Consider, for instance, that BHP Billiton ((BHP)) shares are on a multiple of 12.7, Asciano ((AIO)) is on 19.4 and even Woolworths ((WOW)) and CSL ((CSL)) are both on a multiple of 15.2.

However, Rio Tinto has yet to report its full FY09 results as its fiscal year runs to December. As such, FY11 for Rio Tinto is six months further off today than it is for most Australian companies. In addition, the above mentioned FY11 PE ratio is on the basis of the average AUD value over the past twelve months. At the present AUD/USD value of 0.92-plus the implied PER for fiscal 2011 instantly jumps to 13.3.

Looked upon with a positive state of mind, this still seems to leave further room for share price appreciation, especially with iron ore prices likely to surprise this year and with most metals trading above consensus price projections. But let's not forget the start of Rio's fiscal 2011 is still nearly twelve months away. On FY10 numbers, and taking into account the present value of the AUD against the USD, the PER jumps to 16.

Add-in the fact that Rio's PER hardly ever reached as high as 14.5 (let alone 16) during the period 2005-2007 and one is inclined to have more sympathy for Citi's view. This becomes even more the case given a growing army of experts is questioning whether prices for the likes of crude oil, copper and gold have not moved too high too rapidly between December and early January.

I have already indicated in the opening paragraphs of today's story where I stand in this matter.

For BHP Billiton, whose fiscal year concludes six months sooner than Rio's, the FY11 PE multiple currently stands at 12.7 (on average FX values for the past twelve months). However, if we take guidance from today's AUD/USD value, the PER jumps to 14.5.

On a positive note, if we apply the Australian share market's longer term average forward looking PER of 14.5, then both BHP and RIO seem fully priced, but not excessively so. This, of course, on the understanding that normally the longer term PE multiple applies to the year immediately ahead, which in this case is FY10, not to 18 months into the future (2011).

One important factor for investors to watch during the upcoming reporting season is what'll happen to earnings and dividend expectations for FY11. Some experts believe there is simply not much room left for FY11 projections to rise further, which seems but a reasonable assumption given most growth expectations for the year are in between 20-40%.

Here are a few examples, randomly picked from FNArena's R-Factor on the website (with consensus growth expectation for FY11):

- Emeco ((EHL)) – 50%
- National Australia Bank ((NAB)) – 30.7%
- Qantas ((QAN)) – 74%
- AJ Lucas Group ((AJL)) – 84%
- OneSteel ((OST)) – 89.5%
- Ten Network ((TEN)) – 36.9%

The obvious question from all these figures is: does further confirmation of global economic recovery still have the potential to further increase growth projections for FY11, or have analysts already accounted for as much in their present projections?

Another way of looking at the Australian share market is that, according to FNArena's consensus forecasts, a little over half of S&P/ASX200 companies are currently trading on at least 14.5 times projected FY11 earnings per share. This automatically implies that nearly half of the companies is not.

Some of these companies come with exceptionally low multiples, like Boart Longyear ((BLY)) and Sunland Group ((SUN)) for example, with FY11 PE multiples of 1.65 and 2.89 respectively. But there are many others with less exceptional multiples (and thus likely less risks) including the likes of (again randomly picked):

- Hastie Group ((HST)) – FY11 PER 8.32
- Telstra ((TLS)) – 9.62
- Oz Minerals ((OZL)) – 9.95
- Elders ((ELD)) – 10.54
- QBE ((QBE)) – 12.37

Special mention: all banks still seem to represent good value on FY11 metrics. Only CommBank ((CBA)), which traditionally commands a sector premium, seems relatively fully priced on a FY11 multiple of 13.3.

Another group worth mentioning are healthcare stocks and other defensives. On pure PE multiples these stocks are mostly trading on above market multiples (see examples of Woolworths and CSL earlier in this story) but compared with historical multiples most of these defensive stocks are valued below the multiples they usually enjoyed prior to 2009.

One factor to keep in mind is that healthcare stocks in Australia come with lots of USD exposure.

The reason why I end on a relative value note is because have I noticed professional investors are increasingly looking into alternative value propositions ("alternative" as in "outside the usual movers and shakers that pushed the market in 2009"). It may well be that, as the usual suspects start running into valuation headwinds (RIO, BHP, CBA), the market might make a switch into lesser valued stocks, which in itself could keep the rally going for longer.

Having said this, I do think the ASX200 index undertook an attempt at conquering the 5000 technical resistance level earlier this month, and the attempt was readily and bluntly rejected by Mr Market. As far as my information goes, the market is now waiting for direction in between support at 4850 and resistance at 5000.

As far as Rio Tinto goes, technical resistance lies at $80, while for BHP Billiton it is at $44-$44.50.

All these resistance levels are near, but they still leave further room to move upwards.

More worrying is the fact that 1150 for the S&P500 in the US historically has tended to be a tough barrier to move past. And guess where the index closed at yesterday? Wham bam, right on the mark!

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)

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.

On Friday I returned from four weeks travelling through Zimbabwe and neighbouring countries. I now have first observer experience in how an economy marred by uncontrollable hyper-inflation is changing into one that is facing deflation. This trip has provided me with lots of energy, new ideas and insights. I will return to this unique experience in due course.

What has come as a surprise, however, is that investors have used the quiet period of the year, in between Christmas and the New Year and into the first trading days of January, to push up share markets and commodities, and to push them up significantly.

This, as expected, has re-ignited overall market optimism. Already in my first telephone conversations this week I picked up statements such as "it's going to take a lot to keep share markets down this year" and "it's looking mighty good for the year". Odd. My initial response is always: does it still look good AFTER such a big run? This as opposed to market optimism in general, which seems to grow as asset prices rise.

Let's have a quick look backwards, to put things into the right perspective. When I left Australia in mid-December the Australian share market (ASX200) was ostensibly going nowhere, oscillating around the 4600 level. Yet, here we are in the second week of January and if it wasn't for some disappointing corporate results in the US (Alcoa, Chevron, Electronic Arts) and a surprising policy move in China we'd probably be staring at index levels near 5000 by now.

Now that is by anyone's account a big move upwards.

BHP Billiton ((BHP)) shares were at $40-something in December. They seemed on their way to cross the $45-mark earlier this week. Similarly, the $55 level seemed a bridge too far for CommBank ((CBA)) shares in 2009. This week the shares had no trouble in crossing that line. And that's not even mentioning stocks such as WorleyParsons ((WOR)) that went from $26 to past $30 in six weeks (more about that later).

It is a similar picture among commodities. Back in December, copper futures were struggling to remain above US$7000/t, yet they stormed to US$7700/t. Nickel futures have gone from US$17,000/t to above US$19,000/t and now back to $17,500/t. Crude oil was holding firm in between US$70-75 per barrel last year, yet WTI futures almost touched the US$85/bbl price level this week.

I have no problem with either of these prices. The global economic recovery is seemingly continuing and it is thus no wonder this has translated into higher prices for levered risk assets. The problem I have, however, is that we're still in the second week of January -in other words: we have yet a whole twelve months in front of us- and a lot of the future upside appears already priced in.

Sure, there are quite a few oil bulls in the market that see prices move beyond US$100/bbl sooner rather than later. But isn't that supposed to be more of a 2011 story instead of one that comes to fruition in the first two weeks of 2010? (Not to mention the size of global inventories).

Over the past two years I have developed one simple rule: if price charts start looking like a near perfect line into the sky, it's probably not fundamentals that are driving the price rise, but money flows instead. Now, take a look at the S&P500 index between mid-December and earlier this week. One can hardly draw the line any straighter. Or take a look at crude oil prices, or at copper over the same period.

I think what has happened is too many investors have leapt into the same direction once again. This time it happened at a time of low volumes. The combination of the two leads to straight lines on price charts. And straight lines on price charts tell us things are going a bit too fast, too hard.

It's always difficult to predict exactly when and how overheated markets will correct, but it's probably a fair assumption that Tuesday's reversal for equities and commodities has longer to go still. The last time something similar happened was between October and early December for gold. Gold prices are still struggling with the fall-out of that experience.

I think it's going to take a while before we see gold printing a new all-time high. Luckily, for the many gold bugs in the market, the price of gold didn't go completely gaga last year, like crude oil did in 2008 or uranium in 2007 – or even like gold did in 1980. If it had I would be very confident in dismissing all projections of gold reaching new highs later this year.

Similarly, when it comes to equities, I would agree at this early stage in the new calendar year that investors have once again moved a bit too fast in pushing up prices for the above mentioned assets. But this is not a repeat of 2007 (at least: not yet) and thus the outlook for 2010 hasn't yet been spoiled.

I am well aware that some commentators elsewhere continue to argue that shares are too expensively priced after nearly ten months of gains. Some are using backward looking Price-Earnings (PE) multiples, others use this year's forecast PE ratio. I haven't changed my view that for the most accurate view on present valuations in the Australian share market, investors should take guidance from FY11 projections, and largely ignore the other two.

I would personally never use backward looking multiples as they ignore what lies ahead of us (and I simply cannot understand why in the present modern age people continue using them). As far as this year's PE ratios are concerned: because of the economic recovery in progress, and the natural lag to company profits, I advocated last year that FY11 valuations are the most accurate measure for longer term investors. I have little doubt that in twelve months from now this view will be proven correct.

As such, the news for investors in the share market remains positive. On Deutsche Bank calculations the average PE ratio for the Australian share market is still below 13 (FY11). Considering the long term mean of 14.5 this means there's still plenty of value to be found in the market today, even without counting on further upgrades to corporate profit expectations.

If we take Deutsche Bank's calculation as our starting point, and we assume a return to the long term mean by year end, this would imply the ASX200 index should reach 5500 this year; again, no further increases to profit expectations are included.

However, Deutsche Bank's coverage is rather limited, as the wholesale stockbroker doesn't bother to research smaller caps. If we take all consensus forecasts for all ASX200 companies the average PE ratio for FY11 blows out to 24-something. This is because there are quite a number stocks, such as Eastern Star Gas ((ESG)), that are trading on ridiculously high profit multiples (these stocks obviously trade on different metrics – in this case: take-over appeal).

If we take out these aberrations, the average PE multiple for FY11 falls to 14.5 – exactly the same number as the long term average.

What this means, in my view, is that stock selection will become increasingly important this year. Value-seekers might want to use FNArena's R-Factor to locate value in today's market.

The R-Factor was originally designed to look at the share market on a relative, two-year horizon. To increase its usefulness FNArena has now added a new tab which focuses on one thing only: what's the stock's PE ratio for FY11. The lower the better? Investors should always keep in mind that stocks with an exceptionally low valuation always come with exceptionally high levels of risk – that's simply how the market works.

But if we take 14.5 as our starting point, then ANZ Banking Group ((ANZ)) with a PER of 10.8 and a prospective dividend yield of 6.1% simply looks cheap. And the same can be said of Singapore Telecom ((SGT)) trading on a PER of 10.5 and an estimated dividend yield of 5.6%. Bradken ((BKN)) is on 10.3 and 4.9% respectively. Even BHP Billiton ((BHP)) on a PER of 12.5 and a dividend yield of 2.7% can still be regarded as being on the relative cheap side of the market. Upcoming iron ore negotiations can potentially provide the company's future bottom line with a big boost, though a stronger Aussie dollar will have some serious impact too.

As far as the discussion defensives versus cyclicals is concerned: Woolworths ((WOW)) shares are trading on a FY11 multiple of 15.6 (4.5% yield). CSL ((CSL)) is on 15.1 (2.5%) and Cochlear is on 21.9 (3.4%). None of these companies' growth trajectories over the next two years is likely to come even close to the companies I mentioned in the previous paragraph (with the exception of SingTel).

Finally, to start the new year on an innovative note: I hereby formally announce that I will no longer refer to China and India as "emerging economies". I will use the upgraded label "emerged economies" instead. I think others should do the same. For obvious reasons.

One more thing: it is my personal view that energy and materials companies will likely deliver most of the profit disappointments during the upcoming results season. Already, Alcoa and Chevron have backed up this view. Locally, Energy Resources of Australia ((ERA)) and WorleyParsons ((WOR)) have been quick in adding some local disappointments of their own.

Let me see: one uranium producer and a service provider to miners and the energy sector… I think I'll stick to my view.

With these thoughts I leave you all this week,

Till next week!

Your editor,

Rudi Filapek-Vandyck

(still struggling with jet lag and as always firmly supported by the Ab Fab team at FNArena)

Economists at Goldman Sachs published a framework to assess economic growth and share market performances throughout the various stages of the economic cycle. Understanding their work is understanding the cycle and -possibly- understanding what is happening in financial markets today.

First, let's go back one step, and concentrate on what's happening in commodity markets.

Once upon a time the size and trend in global inventories would provide investors with a fairly good indication where prices for commodities, base metals in particular, were heading to. That script was thrown out of the window this year. I have included two charts from a Calyon presentation that show the build up in inventories for aluminium and nickel since mid-last year. As clearly shown on these charts, prices for both metals moved higher from early 2009 onwards, while inventories simply kept rising.

I could include charts for other base metals, or for crude oil, but they pretty much all look similar, except for copper, which is why anyone would be hard pressed to find a medium-term copper bear with conviction these days. Copper inventories are equally on the rise but they're still lower than earlier in the year.

It is this de-coupling between commodities and their traditional link with registered inventories that fuels widespread doubts whether current prices are anything other than a liquidity (or: speculator) driven bubble that might prove unsustainable in the twelve to eighteen months ahead. Add the growing realisation that "apparent Chinese demand" means actual demand plus stocking of massive inventories in the country and it is not difficult to see why some marketwatchers feel commodity markets are treading water.

Strictly taken, prices for the likes of copper, oil and nickel should be heading lower. Not only is such the usual seasonal pattern, but Chinese inventories are now believed to be filled and actual demand in the country is traditionally weak this time around. Recent import data from China have indicated as much.

Yet the majority of investors and market commentators appears convinced we will see higher prices, and higher share prices, before moving into 2010. How to explain this dichotomy?

One word: hope.

Prices for commodities continue to track global risk appetite, and global risk appetite is now built on the premise that global economies, including those in the US and Europe, will gradually recover from their trough in the quarters ahead. Many an economist will tell you: this seems but a reasonable assumption to make. After all, economic data and indicators continue showing improvement from Beijing to New York and from Tokyo to Berlin.

Don't forget also: economies are cycling relatively weak points of reference. It'll only get tougher as we move further into 2010.

The overall expectation is thus that apparent market demand for commodities will drop between now and February next year. From then onwards expectations start diverging. Chinese imports should pick up again, though likely not with the same strength as we've seen this year (would that be possible?) But demand in Europe and the US should pick up too because of the re-stocking cycle.

This is why current views about the outlook for 2010 are so diverse. If Chinese demand proves strong and Europe and the US jump on board this could give commodity prices a big boost next year. This is what makes some market experts quite excited about what might happen in the year ahead. (I already received emails with questions what I thought about predictions that crude oil prices might be back at US$147/bbl in a year from now).

There are, however, plenty of other scenarios possible. Many of these should still turn out a net positive for commodity prices next year -such as weaker Chinese demand compensated by re-stocking elsewhere- but some won't be positive at all.

In essence, the story for commodities in 2010 looks pretty similar as for equities in general. Both are being supported by investor hope that economies are now on the road to sustainable recovery. If correct, this means stocks priced on elevated FY10 multiples are not expensive and FY11 valuations will become "de rigeur".

Similarly, prices for copper and crude oil and nickel won't turn out expensive at current heights, and they all should be higher by the end of next year.

This is also why investing in the share market, and in commodities, at this point in the cycle continues to require a leap of faith. As shown last week when a tiny Muslim state on the big Arab peninsula asked for a temporary moratorium on billions in debt, investor confidence in positive scenarios next year remains low, vulnerable and fragile. Back in the previous bear market of 2000-2003 all it took was one relapse in one quarterly US GDP release and risk appetite instantly took a significant step back.

There are no guarantees the present recovery will develop smoothly and without encountering any barriers.

According to research conducted by economists at Goldman Sachs we are now in the transformation phase when "hope" will start materialising through increased earnings and returns for companies worldwide. This should confirm that asset prices have not run up too high thus far.

Let's take a closer look into the framework devised by these economists, who are based in Europe and whose work is based on historical analysis of economic cycli since 1970. Specifically they zoomed in on earnings momentum and share market multiples throughout the various stages.

The worst stage of the cycle is the one we experienced from late 2007 onwards: the economy is weakening and equity markets fall into despair in response. This is the worst stage, when both earnings and multiples take a dive, and share prices follow suit.

Then comes "Hope" – the stage we've experienced since March this year. This is when share prices move up because multiples rise (on hope) but earnings have yet to follow. Ironically, this is, from an investment return point of view, the best stage in the cycle. Uncertainty is highest, but so are the returns that can be achieved.

After "Hope" comes the actual "Growth" stage when economies do post positive numbers and companies can finally start releasing growing profits. This is the stage we should be moving into right now. Mind you, this is the second least profitable stage of the cycle as far as share market returns are concerned, because now company earnings have to play catch up with expectations. Multiples no longer expand in spectacular fashion.

After the Growth stage comes "Optimism", which other people would refer to as "Exuberance". I think we all know very well what that stage looks like. It's the second most profitable stage in the cycle. Of course, after that we go back to the beginning and things start all over again.

Goldman Sachs believes the transformation into the next stage will take place in 2010.

Market strategists at GSJB Were in Australia have adopted the work done by Goldman Sachs economists in Europe and put it to work in Australia. Their conclusion: the Australian share market is likely to gain some 24% between now and December next year (ASX200 index at 5700). One year later the index is projected to reach 6100 (implying a return of 33% over two years).

In terms of earnings growth projections, the minus 15% for industrial companies in FY09 should be followed by a mildly positive 5% average gain in earnings per share this year (FY10). After that we should see 17.5% growth in FY11, followed by 10% in FY12.

For resources companies the numbers look a bit different: minus 40% (FY09), minus 10% (FY10), to be followed by a positive 45% growth in FY11.

In terms of duration, stage "Despair" lasts on average 26 months, stage "Hope" 10 months, stage "Growth" 33 months and stage "Optimism" 14 months.

It turns out we left stage one sooner, but what does this tell us about the duration of the second stage?

In stage three, argues Goldman Sachs, commodities will outperform both equities and bonds, and individual stock picking will become key, instead of the all-encompassing sector rotations we witnessed over the past nine months.

Stocks likely to do well are those likely to gain most from the economic upturn: think transport, media (through advertising), employment and inventories (re-stocking), plus building and mining. GSJBW still likes the banks (as does the R-Factor on our website) and has started to look for more exposure to USD leverage. The reasoning is that if the US economy surprises to the upside, the USD will do so too and this will reverse the current one-way relationship between the Australian dollar and the greenback.Commodity experts at Citi, on the other hand, warned this week that investors are likely to overlook the fact that costs continue rising for mining companies. This would suggest earnings disappointments will follow during the upcoming results season.

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)

P.S. I – Adopting the Goldman Sachs framework in Australia has led to some changes in GSJBW's Model Portfolio. The strategists still like Downer EDI (DOW) and Boral ((BLD)) but they have now added Amcor ((AMC)) while getting rid of OneSteel ((OST)). Exposures to REITs and consumer staples champion Woolworths ((WOW)) have been reduced. Instead came Computershare ((CPU)) and Macquarie Group ((MQG)).

P.S. II – To stay with the theme: GSJBW also updated its Conviction List this week. No changes were made, but it was noted the list once again outperformed the market in November. Current Conviction Buys are Aquarius Platinum ((AQP)), Bradken ((BKN)), Downer EDI, National Australia Bank ((NAB)), News Corp ((NWS)), Seek ((SEK)), Ten Network ((TEN)) and Wesfarmers ((WES)) while Macquarie Infrastructure ((MIG)) and Paladin Energy ((PDN)) are the only ones on the Conviction Sell list.
 

I picked up an interesting observation this week in a report from commodity analysts at Danske Bank (not part of the Super Cycle religion). Having conducted a historical analysis into economic cycles and commodity prices, the analysts observed that commodities used to be late-cycle performers during cycles, but in more recent times they have grown to become early cycle performers.

I like this type of research. Too many experts treat history like an exact copy of the future, while to the contrary, circumstances and contexts are constantly evolving. That's why "Sell in May and go away" no longer works (see what happened this year) and that's why commodities, as we have discovered over the past months, have been strong performers this early in the cycle: they have moved up the time-scale.

To put it in a more academic framework: were we to divide one economic cycle into four clearly distinguishable phases they would be called recovery, growth, slowdown and downturn. It used to be that commodities performed best during periods of growth and economic slowdown. That has now moved forward, making the recovery and growth phases of the economic cycle the two top phases for commodities.

What this implies is there should be more to come yet, as we've arguably only had the recovery so far this year, which only now moving into the transition phase that should see economies across the world start expanding again. However, the real world never follows any textbook guidelines and Danske Bank analysts, in another report, predict prices for commodities are likely to continue rising in the early months of 2010.

But as we move through next year, say the analysts, headwinds will likely build for commodities, especially in the second and third quarters, making price prospects gradually and increasingly tougher.

As world economic growth experienced its nadir in the first half of 2009, one can expect the numbers should still look promising in the first half next year (idem dito for corporate profits), but as the year matures some real progress will then have to be booked, or disappointments will start becoming reality again.

But there's more to this story than meets the eye at first.

Analysts at US Global Investors also did some excellent research lately. While their historical data analysis focused on the price and prospects of oil, I think we can safely assume their work is important for the understanding of commodities in general.

Say the analysts at US Global Investors: the market tends to look at oil from a rather narrow viewpoint, one that, loosely formulated, is determined by how much of it we can get out of the ground and how much demand is out there to buy and consume it. And whenever there's a terrorist plot or geopolitical tension that could possibly impact on supply or trade in oil we price in a risk-premium.

But here too the market dynamics have changed. In more recent years the driver behind oil markets has become less about supply and demand and more about how much spare production capacity there is across the world.

But above all, reports US Global Investors, history shows the price of oil has a strong correlation with the US dollar, as well as with money supply across the globe, as well as with infrastructure spending. And now a new important factor has emerged: the rise and rise of a new middle class in emerging economies.

All these factors have contributed a great deal to price movements for oil throughout the years.

Say US Global Investors analysts: the underlying dynamics for global oil changed in 2006 when -completely hidden to most of the world- for the first time in history the contribution to global GDP (as measured in USD) by the middle class in emerging countries (including the Middle East) exceeded the contribution to global GDP by the US. As you would expect, the difference between both contributions has widened further since and next year should simply see a continuation of what appears to be an ever widening gap.

In general, point out these analysts, the world population is much better off than used to be the case even as recently as the year 2000. One stand out feature from the changing consumption patterns in developing economies is that most purchases are done in cash, while in developed economies, with the US being the prime example, the majority of all consumer purchases involves credit.

This is why, say these analysts, the lack of credit will be less of an impediment to further growth and changing consumption patterns in emerging countries, unlike the developed countries where the scarcity of credit should keep a lid on economic expansion.

But don't underestimate the impact of money supply. According to US Global Investors' analysis, global money supply pre the collapse of Lehman Brothers was contracting and this caused economies to freeze and demand and prices for commodities to fall off a cliff. Post the Lehman disaster, however, we have landed in the opposite situation: money supply is expanding, and strongly so.

While the world's focus seems limited to what happens in developed countries such as the US and the UK in terms of increasing the supply of money, the analysts point out the average increase in the M2 measure of money supply in the G7 thus far stands at 7.5%. The number for the US is 9.5% year-on-year. Canada stands out with an increase of 14.2%.

The average money growth in emerging economies, however, has been far greater. China beats everyone with an increase of 25.7% year-on-year, but what about India (20.5%), Indonesia (18.4%), Brazil (16.9%) and Mexico (14.7%)? You'll notice that all these numbers are far greater than those in the developed countries.

Oil, and commodities in general, respond very favourably to extra supply of money in the global economy. There has been plenty of it over the year past.

Interestingly, analysts at Danske Bank have tried to model what an appropriate price level for commodities would be at this point of the economic cycle -which in their view is the early stage of economic growth- and their admittedly incomplete and flawed model came up with the suggestion that prices overall might have run up a bit higher than where they should be, but not dramatically so.

The best way to view all of the above, argue analysts at US Global Investors, is that prices for oil, and commodities in general, will remain supported at much higher levels than used to be the case. It does not mean that prices will only rise and rise and rise into eternity.

In fact, one can easily build a case in support of Danske Bank's prediction of growing headwinds throughout 2010 (which in essence can also be formulated as: less and less support) as central bankers will increasingly start looking into winding back the enormous stimulus that is flowing through global economies, and with the US dollar possibly going through a phase of recovering strength from the moment US interest rates start rising.

US Global Investors is bullish on oil and copper, with the latter seen returning to US$4 per pound sometime in 2010. Its forecast for crude oil, in year-average terms, stands at US$75/bbl in 2011, and a little less for 2010. This, explain the analysts, doesn't mean the price won't go higher at various times, but it is likely such temporary spikes won't prove to be sustainable.

The analysts also highlighted a strong seasonal pattern for oil prices, one they label "unusually predictable". In essence, this pattern means that investors who are long oil between December-May each year make far better returns most of the time compared with the remaining June-November period. Their message is thus: use the anticipated price weakness in December to get settled.

Commodity analysts at GSJB Were, proud members of the Super Cycle Commodities Club, updated their price forecasts this week. The exercise was, as admitted in the research update, simply a catch-up exercise as most prices have risen higher than thought possible. Mind you, their last update occurred in September.

GSJBW believes prices for commodities are inflated, as in: they have drifted too far off from underlying market fundamentals. Picture this: GSJBW is a long standing favourite of platinum, which the analysts believe is the most supply-constrained commodity of all. Yet, platinum remains the only one that is still trading at a price below the analysts' long term average price assumption of US$1500/oz.

Nobody ever said predicting prices for commodities was easy!

Most commodities have rallied pretty much in line with each other this year, but if Danske Bank's prediction of increasing headwinds proves correct, one can assume that differences across the complex will become more apparent next year and differences in performance should be the result.

GSJBW's preferred exposures are, in order of preference, metallurgical coal, iron ore, platinum, copper, gold and thermal coal. The broker states that on a twelve-month horizon, the fundamentals look absolutely unattractive for aluminium, nickel and zinc.

Danske Bank believes oil can surge to US$90 per barrel over the next three months, but that is likely to prove unsustainable. The analysts have an average price forecast for 2010 of US$83/bbl, which is higher than US Global Investors.

Copper is expected to rise steadily throughout next year, with an average price forecast of US$6900/t. In general, it appears Danske Bank is more optimistic than GSJB Were for most commodities, including aluminium, zinc and nickel.

GSJB Were is at present even worried about the immediate price prospects for copper, widely regarded the stand out among base metals. The analysts suggest the fundamentals for all base metals simply look "weak". Whether we will see a big correction remains yet to be seen, advocate the analysts, as that will be dependent on overall investor behaviour and funds flows.

None of these analysts mentions the revaluation of the Chinese currency as a potential new factor in the game. China remains an ever-important factor when it comes to commodities. The Chinese government is expected to put a lid on speculative commodities buying, but we have as yet to find out what will happen when the renminbi is allowed to appreciate again against other currencies. Will the jump in purchasing power lead to an equivalent jump in Chinese purchases?

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)

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)

"In the market, perception is reality".

(BTIG Chief Market Strategist, Mike O'Rourke)

As far as market symbolism goes, one would be hard pressed to find a better example than Tuesday's announcement that Warren Buffett's investment vehicle, Berkshire Hathaway, wants to gain full ownership of US railway company Burlington Northern Santa Fe Corp. As far as symbolism goes for the much doubted US economic recovery, a company that facilitates goods transports across the US must be pretty much in the bulls eye of the discussion. And as far as investment nouse goes, Warren "the Oracle of Omaha" Buffett is pretty much the Champion amongst Champions in our life time.

Buffett's status was again confirmed in a poll conducted by Bloomberg last month, when professional investors voted him number one in the world as "the best assessor of financial markets", beating Bill Gross, the founder of bond manager Pimco, billionaire investor George Soros and reputed market bear Nouriel Roubini.

As far as Buffett's target is concerned, The Los Angeles Times reports "Burlington Northern is the nation's largest rail transporter of coal and grain and provides a vital link for consumer goods from Asia to the Midwest".

At a time when equity and commodity markets look very vulnerable, America's number two richest man (only preceded by Microsoft founder Bill Gates) is prepared to spend some US$27bn on an old school rail-transport company that will only flourish if the US economy heals from its present wounds.

Note: the widely reported US$34bn is the total value that reflects back on the company as a result of the public offer made. Berkshire Hathaway already owns a sizeable equity stake, so it only has to fork out US$27bn to achieve full ownership. You can blame the confusion on lazy journalism and the fact that nobody in the finance sector seems to have a natural urge to check such details, it's all just copy and reproduce these days.

In fact, digging down into the finer details of the deal teaches us that Berkshire Hathaway's intention is to only pay US$9bn in hard cold cash from its own funds. If the deal goes through, Berkshire would assume US$10 billion of BNSF debt, leaving it to pay some US$17 billion in cash, of which US$8bn would come from debt.

The symbolism doesn't stop here, not yet. The deal, if successful, will be Buffett's biggest-ever acquisition. Some commentators have already started to speculate that, because this deal is so big, it may prompt Berkshire Hathaway to sell some of its other investments. The statement issued to announce the deal stated "It's an all-in wager on the economic future of the United States".

There you have it, all the symbolism you ever wanted at this point of the cycle in one sentence to explain the "why" behind what one commentator described as the "greatest investor of the past half century placing the biggest bet of his career".

Berkshire Hathaway's takeover proposal offers a premium of 31.5% over BNSF's closing stock price on Monday, valuing the railroad at US$34bn. According to Thomson Reuters, this equals close to 20 times estimated 2010 earnings. More importantly, maybe, is that the offer trumps the mean price target set by some 18 stockbrokers covering the stock in the US. Most of them rated the shares Hold/Neutral. No doubt, all this will help to convince the likes of Capital Research, Vanguard, Barclays, UBS and State Street to hand in their shares in exchange for an unexpected, quick double digit-profit.

Some more details to lend more insight into Buffett's thinking: Burlington Northern has a fiscal year that runs until late December. So it is still in its fiscal 2009 year. On this year's forecasts, the Price-Earnings Ratio is 15.3. For 2010 it is a little less than 20 (19.8) – in other words, company profits are likely to take another dive first. On 2011 estimates Buffett is still paying 17.5 times consensus earnings per share. The number drops to 15.2 in FY12.

Note the similarity between PERs in 2009 and 2012.

Warren Buffett is a value-investor. The Bloomberg poll confirmed him as "the best assessor of financial markets", not as the world's greatest market timer. In October last year Buffett wrote a personal statement for the Op-Ed page of the New York Times. It was titled "Buy American. I Am."

I remember many stockbrokers in Australia sent it around to their databases in order to convince their clients that sitting on cash was not the smart thing to do. I doubt whether these stockbrokers had any success with their intentions at the time. After a brief uptick -some people called it a rally- the US share market tanked once again during the first two months of calendar 2009.

But we all know what happened after that.

Buffett's Op-Ed contribution last year starts with the sentence: "The financial world is a mess, both in the United States and abroad." But, continues Buffett, I have been buying American equities. Why?

"A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful."

"Fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now."

"Let me be clear on one point: I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month – or a year – from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over."

Those who want to read the whole piece, they can at: http://www.nytimes.com/2008/10/17/opinion/17buffett.html.

Because of its wider-reaching symbolism, it is probably fitting that Warren Buffett announced the deal of his life, with the usual inherent characteristics, at the same time as Dalbar Inc released the results of its annual Quantitative Analysis of Investor Behavior in the US. It is my understanding that each and every survey since 1994 has shown that investors are by far not achieving the returns that market indices suggest they should, simply because they don't have the nerve to sit tight and wait for time to perform its wonders on sound investment decisions made. Instead, most cannot help but jump from momentum to momentum and collect so many costs in the process, or become one of the Johnny-come-latelies, they end up achieving lousy returns.

The financial sector had ultra-conveniently gone well overboard in its short-USD, long everything else market positioning. Global equity markets are at present paying the price for this. Investors should ask themselves whether this is the right message to take guidance from?

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)

P.S. I – The no longer weakening US dollar remains the main game in town, as again illustrated by the chart below (thanks to BTIG Chief Market Strategist, Mike O'Rourke). To read more about the how and what about the US dollar's devastating role this time around, see various of my Weekly Insights and Rudi On Thursday-editorials over the past months in the FNArena archive on the website.

P.S. II – I note that on Wednesday's closing share prices, ANZ Bank ((ANZ)) shares are trading at 11.2 times FY11 consensus earnings per share, CommBank ((CBA)) is at 12.5, and National ((NAB)) is at 10.4. Westpac's ((WBC)) forecasts will rise over the next few days post its FY09 report. BHP Billiton ((BHP)) is at 13.9 at today's AUD/USD value. Bradken ((BKN)) is at 10.2. Orica ((ORI)) is at 11.6. Downer EDI ((DOW)) at 12.6. For more insights see Stock Analysis and R-Factor on the FNArena website.

P.S. III – This one is for the momentum seekers among you. Analysts at RBS Morgans are keeping a close eye on any announcements by Silex Systems ((SLX)). At present, their price target of $8.11 is well above the share price, but… a decision on the commercialisation of the company's Uranium Enrichment program by Global Laser Enrichment (GLE) is expected before Christmas. If positive, RBS Morgans expects the shares to re-rate well past its present target. As always, no guarantees are included. Only investors with a big appetite for risk need to consider.

P.S. IV – The TechWizard confided to me on Wednesday morning he's concerned investors in the share market may miss out on the end of year rally for a third year in a row. From a technical point of view, says the Wizard, the Dow Jones Industrial Average has now tried to puncture four times through a support line that dates from August this year.

This seems to indicate that the bears will continue trying and that at some point technical support will give in. Such event will trigger a wave of selling, predicts the Wizard, not only because many short term traders will instantly reverse their attitude towards the direction of market, but so too will all automated trading programs that have been supporting US equities throughout the post-March rally. This could get ugly, says the Wizard.

For good measure: the Wizard believes one more rally that will take the market to a new high seems the most plausible scenario, but after that it might get really ugly.

I ran into one of the widely known household names in the Australian financial sector recently. I know he is a paying subscriber to FNArena and I am always proud to know that the size and the quality of our readership has continued improving throughout the years. Certainly, the presence of high profile investment experts in our database of readers only further highlights our achievement.

We exchanged a few comments about financial markets. I asked a few questions, he provided some answers, then fired a few questions back. I suspect he probably wouldn't appreciate me quoting him from that conversation, and as I haven't told anyone about it, not even the people who work at FNArena, I can share some snippets and observations, while retaining our market expert as an anonymous source of wisdom.

It's all about the message, not about the messenger.

The two key points I took home from that brief conversation was that he seemed to have few doubts, if any, about the medium term prospects for the Australian share market. Buy good companies, with good management, that pay good dividends, at not too expensive price levels, and stick to it and your portfolio should be all right – that probably sums it up quite nicely.

Similar to other experts, this one is a firm believer that the US economy should not be underestimated, but above all that global momentum is swinging towards India, China and the rest of Asia, and Australia is going to benefit, big time.

What I also picked up, however, is that he seemed less confident about whether the share market could avoid another sell-down in the shorter term. This certainly took me by surprise – all this happened before this late October share market weakness kicked in. Though he quickly indicated that any such weakness would only make the long term valuation bargains even more attractive.

I concur.

Amidst a barrage of media reports and commentaries about how expensive the share market looks this month, and about whether we have returned to the 2007 Great Bubble Heights in terms of overall valuations, I remain of the view that investors who are looking into investing in the Australian share market with a longer term view should focus on FY11 consensus forecasts.

While I personally came to this approach by analysing and thinking about the prospects of the share market earlier this year, I do note a growing number of market experts have since started to suggest similar approaches, or come out publicly in support of current FY11 expectations. That second element is important, because this market approach would crumble to nothing without confidence in these estimates.

If anything, say these experts, current analyst forecasts for the years ahead are probably too low. This for the simple reason that, coming out of the trough of what could be a crisis much, much worse, all analysts probably prefer to remain on the safer side for the time being. They all remember having been wrong for too long during the downturn between late 2007 and early this year.

One such expert is chief investment officer at the Commonwealth Bank, Ron Bewley. Another one is Head of Equity Research at ING Investment Management in Australia, David Langford.

Both Bewley and Langford have come out in public these past few days and advocated that:

- analyst forecasts for FY10 and FY11 are probably too low
- the share market only looks fully priced on FY10 forecasts, but still represents good value on FY11 estimates

Normally, such prospects would act as natural support for the share market, preventing it from falling too far as investors who missed out on the rally thus far this year would be keen in getting in at lower levels. This has been the main reason (the combination of these two factors) why I believed the share market was likely to remain well-supported in the months ahead, and any correction/pull back would remain nimble.

There is one big factor that can still prove me wrong. The reason why some experts, such as my anonymous source at the beginning of this story, are less sanguine about the underlying strength/support in global share markets is because there is still so much scepticism out there about whether the economic recovery will prove to be sustainable.

While this is understandable after what we've all witnessed over the last year plus given the many problems that are still hanging over governments, central banks, consumers, banks and businesses in large parts of the developed world, it has turned a big representation of the investment community into momentum traders. These "investors" -maybe we should call them traders instead- have been happy to buy shares here and there as long as overall momentum was onwards and upwards. But what if momentum evaporates?

This is the concern that is currently spooking the global investment community. It doesn't necessarily mean the global recovery story will be in tatters any time soon, but the point is it doesn't have to be to trigger some more serious losses than what we've seen thus far. Of course, the irony of it all would be that share markets would be recording losses at a time when overall confidence amongst strategists, economists and central bankers seems firmly on the rise.

I know I have said this many times before, but: watch the US dollar.

Most other investors across the globe are doing exactly the same thing.

Of course, if you are amongst those investors looking to buy into the share market, and you don't have a short to very short time focus only, most of the above should have the same effect as heavenly music on a lazy Sunday morning. As long as you can detach yourself from those commentators who are still looking at FY10 metrics only, and from the mainstream and financial media who essentially always operate behind the curve, no matter what. (By the time these sources of commentary catch up with the theme it is probably time to start exiting the market).

When I look at FY11 consensus projections, I see many industrial companies still trading at multiples of 9-10, I see dividend yields of 5-6-7% (not even mentioning Telstra ((TLS)), I see miners and mining services providers at multiples below 10, I see banks at multiples below 12 (not all of them though) and with dividend yields above 5% (all of them).

If you are an investor looking to join the ride on the premise that share markets should be higher in the year ahead, even if they can go lower in the short term, I strongly suggest you centre your research around FY11 estimates. All this information is available on the FNArena website. I am not using anything myself that is not available to all paying members.

At the end of the day, beauty (in this case: value) is in the eye of the beholder.

When I read through today's Australian Broker Call Report, my attention was immediately drawn by two very positive reports on McPherson's ((MCP)). I spotted the term "re-rating", in combination with strongly upgraded earnings forecasts, and price targets around 20% above the present share price.

I am not saying I would rob the bank tomorrow and put it all into McPherson's shares, but it's this type of information that can be found in the daily Broker Call Report at least a few times per week. And unless I have prior knowledge that would deter me beforehand, I would most certainly consider this as worthy of my attention, and of further research into the stock.

On another note, I was reminded recently by a few readers of this weekly editorial that I highlighted young and upcoming internet infrastructure provider Pipe Networks ((PWK)), now a few months ago already. You'll probably immediately understand why I was reminded about this if I tell you that the share price has appreciated by between 38-52% since (depending on what date exactly one takes guidance from).

I am obviously pleased that even after such an outstanding run, management has guided towards further upgrades for market expectations for the years ahead. The average price target is still double digits above the share price (even after those gains), though I must admit the Price-Earnings ratio (at above 15) is no longer as attractive as when I first pointed at the stock (dividend yield is 1.5% and 1.9% only). I would still think Pipe remains worthy of my attention, though.

I think Prime remains a prime candidate for further upgrades to FY11 estimates. Here's why ING's David Langford thinks the same applies to the market in general: companies have been relentlessly cost cutting and are now reporting earnings in line with market expectations on marginal growth in revenues (at most). Once top line growth starts to improve (hopefully in 2010) this will provide greater leverage to earnings than is currently projected by analysts.

Here's one reason why you all should remain cautious nevertheless: market consensus is always wrong, according to the anonymous source mentioned earlier, and it's probably fair to say current consensus is still on the cautious side, as illustrated, for instance, by earnings projections in Australia that assume no growth on average for companies this fiscal year compared to FY09.

But that still means that if consensus is wrong we can still go either way: to the downside as well as to the upside.

What did our expert say again? Buy good companies, with good management, that pay good dividends, at not too expensive price levels, and your investments should do all right.

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)

P.S. I – I thank ING Investment Management for the beautiful historical overview depicting the average PE ratio for the Australian share market. Previously, I pointed out that calculations and historical references vary between 14.5 and 16 for this measure. I think I am going to refer to 14.5 from now on.

As a day-to-day consumer there can be no doubt: I deserve the label "value-minded". For example, on my recent trip to Perth I walked past a shoe shop that had a special discount on offer for already heavily discounted shoes. Did I need a new pair? Not necessarily, and certainly not necessarily right now. But hey, what are the chances I can buy a nice looking pair, robustly built, with a solid feel, at a doubly discounted price, at any other time in the future?

And so it was that I returned from Perth with a new pair of shoes. They fit nicely, walk great and look good. Above all, they were good value. Just like the pair I was wearing when I travelled from Sydney to Perth. That pair was purchased at a discount as well. As was my all-time favourite pair of boots, purchased years ago during a visit to Melbourne.

The trick is, I found out long time ago, to wait for opportunities to come along and to avoid being put in a position of pressure. I never planned to buy those boots in Melbourne, and neither did I think about it in Perth, until I walked past the shop and saw what was on offer. When the day comes that you need to buy a pair and you only have half an hour to do so, that's when you likely will pay top dollar and wonder where have all the discounts gone? A few years ago I ended up at a rugby tournament with my youngest son, in Canberra. Two hours before the first game we discovered we left his boots at home. That's one of those pressure shopping experiences one should try to avoid, at all times.

As an investor one should abide by the same basic principles.

Avoid putting yourself under any pressure. You will raise your risk profile, and thus the chances of making mistakes. It'll only cost you money, even if it appears to be going okay at first. Everyone long enough in the market knows the day will come that you will regret having taken this decision, or another one, for all the wrong reasons.

That's one side of the story.

The other one is that, as a consumer, we all know when a bargain is on offer. As an investor, it is more likely that we have no clue whatsoever. "The share price moved up" is probably the main reason behind our decision to step in. This is, I believe, partly because we are all constantly misinformed. Instead of reporting "BHP's share price went down by 8 cents to $39.83 today", I believe media and commentators should tell us "BHP's implied Price-Earnings Ratio improved today, as both the share price and the Australian dollar fell slightly".

Spot the difference?

Of course, journalists and publishers will argue they have no readily available information to switch to this type of reporting, and they certainly don't want to pay fatcats such as ThomsonReuters and Bloomberg for it, or FNArena for that matter. But I think at some point in the future, no matter how unlikely it may seem today, this type of in-depth information will be more readily available to share market investors. By then, hopefully, the overall knowledge and insight among media staff and investors about how to deal with this type of information will have significantly improved as well.

When I arrived in Australia, now more than nine years ago, there was virtually no up-to-date reporting on broker research. Not in the Australian Financial Review. Not on radio, or television (there were no finance channels in those days, though that wouldn't have made one single bit of a difference). Not even by news wires such as Reuters, Bloomberg, AAPT or Dow Jones. And look where we are today: brokers cannot put out an important report without investors hearing about it the very same day. If it's not through FNArena, it will be through the above mentioned news services, on FinanceTV, or maybe even via one of the online newspaper websites.

Maybe, in a few years from today, we will all learn that the Australian share market is now trading at more than 16 times this year's average earnings per share (in addition to: the market lost a few points and closed at 4838 today), while the average dividend yield has fallen towards 3.5%. The first ratio is above the market's historical average, the second one is below the historical average.

Both types of value-information suggest the share market is rather expensive.

Of course, investors will still need the analyst and the commentator that is smart enough to tell them that as long as economic data continue pointing to the direction of economic recovery, investors with a longer time frame will likely take guidance from FY11 instead of FY10, but certain things will never change, no matter how sophisticated we all become as a whole.

In case anyone wonders: the implied PE ratio on the basis of FY11 consensus expectations is a little less than 13, which is still below the long time average of 14.5-15 for the Australian share market. The implied projected dividend yield on FY11 estimates is 5%, which is above the long term average of circa 4%.

That seems to suggest there's still value around in the share market, even though, of course, the value gap is no longer as big as it was only a few months ago.

This is why "value-oriented" fund managers will still tell us: the trend remains up. The market won't continue rising month after month after month, like it has done since March this year, but on a medium to longer term horizon, which would have to be at least one year or so, the Australian share market should be higher than where it is today.

Unless the economic recovery takes a big stumble between now and then. There are never watertight guarantees in life. If my shoes from Perth fall off my feet next week, I will feel angry and embarrassed, but there's little I can do about it. Right now they seem fine and I think I bought an absolute bargain.

The bottom line is, however, I would not have bought these shoes if they weren't available at a discount.

Professional value investors, with many years of experience in the market, will tell you this is exactly the attitude long term investors should have when deciding which assets to buy for their portfolios. Still got cash on the sidelines? Don't let it burn into your psyche. Simply tell yourself this is the tool you need for when an opportunity comes along.

If I hadn't had the money, I couldn't have bought those shoes in Perth, no matter how deep the discount on offer.

I agree, BHP Billiton ((BHP)) is a great company. But those investors who bought above $40 last year (or the year before) are still sitting on a paper loss. Great company, but not so great value at the time of purchase makes for a less than great return. Unless you sold somewhere in the high-thirties and bought back in below $30 – but that's a completely different investment approach (even though still centred around "value").

A true value investor, however, is someone who completely ignores the share market momentum of the day. These are the investors who buy into stocks that don't go up at all. At least not now. But they know from experience that if they do their homework well, buying stocks at deep value will bring great fortunes, over time. It's always difficult to predict when a company like CSL ((CSL)), or Amcor ((AMC)) or Origin Energy ((ORG)) will re-find investors' focus ,but when it happens, rewards for those who bought at yesterday's prices will naturally flow.

The problem is, however, one cannot time these things. Right now investors don't see value in CSL, they don't feel any urge to stock up on Amcor and they don't have any patience when it comes to Origin. That's good, say these value investors, because these are all good companies, led by good management and they are completely missing out on the share market rally. Because no-one is interested, these value-seekers can buy these shares at today's neglected prices. When the day arrives that the wheels of fortune turn, they know they'll be happy chappies.

Mind you, the turning of market focus can take a while, and investors have to hold on to their conviction even though the market will do its best to make them look foolish in the meantime.

Investors also have to have a good insight into what their risk profile is. Stocks such as Macquarie Infrastructure ((MIG)), Boart Longyear ((BLY)) and Telstra ((TLS)) look very cheap, but they come with above average risks. That's why they are cheap in the first place.

Earlier today, I witnessed an interview with Kieran Kelly from Sirius Funds Management, one of the value investors in the Australian share market. Kelly admitted his funds have not been buying any shares for the past six weeks. He doesn't see much value at present share prices.

Kelly also acknowledged someone among his staff told him recently: You have been waiting for a pullback since April, but we're still waiting.

So he was wrong, as were so many others. But think about it this way: he didn't lose any money because of it. His funds simply didn't make any profits. It's the opposite that hurts, and will continue doing so for a long time ever after.

If the Australian share market does go to 5000, and beyond, which remains a real possibility in the months ahead, maybe investors shouldn't ask whether 5100 could be on the cards, but whether the stocks they own still represent value. Maybe that's a question they should start asking right now?

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)

P.S. I – It has been pointed out by others as well, but financial markets trading guru Dennis Gartman is genuinely worried about the lack of volume behind this ever-lasting share market rally. Abiding by the old rule that volume should follow the trend, and vice versa, the US share market should either see trading volumes pick up, or the trend should ultimately fall in line with volumes, which would be negative.

P.S. II – Gartman's worries are being echoed by the TechWizard's view this week. The Wizard reports he's becoming a little uncomfortable too. He suspects investors are becoming complacent once again, and that always opens the door for an unexpected surprise. The VIX, also known as "fear index", is close to low levels suggesting complacency is once again creeping into the market, says the Wizard. As he would like to see an end-of-year rally take place, he obviously hopes he's wrong in his assessment of the VIX.

P.S. III – As long as the economic recovery remains on track… unless you have been asleep over the past year or so, you know by now the GFC has opened up a Great Divide amongst the world's economies and Australia has become the poster child of the Asian recovery, while Europe, Japan and the US still have to keep their fingers crossed. The chart below shows the remarkable recovery of the Westpac-Melbourne Institute Leading Index for Australia over the past months. Of course, the flip side is that the RBA is now on a tightening path, which won't be a problem at first, but as interest rates creep closer to the neutral level, this will change.