AS the resource sector tumbled through late September and into early October, the Australian stock market appeared to be in a final capitulation mode.
AS the resource sector tumbled through late September and into early October, the Australian stock market appeared to be in a final capitulation mode. Yet the market is still in decline.
Following an incredible period, during which we witnessed the depths of the 'day of no hope' and utter despair, the bear market now appears to be in the final death throes of debt reduction. The market has taken on board the valuation consequences of a long period of weak economic activity while corporate risk profiles have been largely re-priced.
Most stocks are now priced for a likely severe deterioration of earnings into 2009 and beyond, including a period of losses in some cases and the reduction or cancelation of dividend payments in others. In many cases, stocks with an otherwise reasonable earnings outlook have fallen to levels which represent value well below the replacement cost of their assets and often below cash asset backing, simply because investors are still being forced to sell assets to cover debts.
This market is being driven much more by a flight to liquidity by some cash-strapped investors than by any reference to earnings or even yield. But remember - for every seller there is a buyer.
Briefcase believes that investors who are able to take up beaten-down investment opportunities today will do extraordinarily well over a three- to five-year investment horizon. The corollary to this advice is that if you do not need to sell and if the company in which you hold shares can survive a couple of poor years, holding investments for longer-term growth is generally the right thing to do.
The level of crossover between property debts and share portfolio holdings appears to be much higher in today's market environment than ever before. An expanding number of properties for sale indicate that a new round of property asset sales has begun, as a falling stock market interacts with property prices. Early this year, after a trip to the US, Briefcase remarked at how high Australian housing prices were compared with those in the US. It is thus no surprise that local property prices are tumbling. Briefcase expects that, overall, Australian housing prices have about 20 per cent further to fall over the coming year, but houses in the plus $3 million dollar range are likely to fall upward of 40 per cent across the board. There has already been evidence of falls of 50 per cent in some instances.
At annual general meetings across the country shareholders, who have endured a huge collective deterioration in the value of their investments, are showing that they are not in a mood to allow the people running their companies to profit from inappropriate remuneration deals.
The boot is now firmly on the owners' foot. If management and other employees take the sort of attitude, which is against the best interests of the business owners, then they should be replaced with managers who have a stronger commitment to protect and enhance value for shareholders.
Signs of economic stress abound. While picking off the horror stories has a somewhat macabre feel about it, Briefcase believes a bit of reality can set the scene for more informed investment decisions. One story involves a Perth house, on which an offer of $6 million was refused about six months ago, but is now on offer for $4 million while the owner is thought to be willing to take $3.2 million. Many other stories along this line have been noted from first-hand sources. In the UK, house prices have fallen 50 per cent in some areas over a two-year period and no end to the carnage is in sight as jobless numbers rise.
Just as in the movie of Robin Hood, Christmas has been cancelled in Croatia. Well, actually, to be more accurate, the Croatian government has banned Christmas and New Year's parties in public sector offices.
Senior members of Australia's corporate elite are privately talking about more dark clouds on the corporate horizon. The 'big end of town" is definitely preparing and talking of tough times to come.
This is not just a bear market; it is a lifestyle event, which will alter the way we live for many years. At one end it may mean long periods of unemployment, and at the other it may mean fewer days skiing in Europe and fewer meals out. But inevitably, it is going to change spending habits in a huge way. The loss of many hundreds of billions of dollars in wealth, from both the stock and the housing markets, will trim net wealth and reduce consumption much more savagely than did previous price rises. Briefcase has seen the advent of two-course meals for $20 and is waiting for coffee to be advertised at $3 per cup, down from the exorbitant $4 going around in many places.
Sad so say, but nature has its own way of dealing with things. The Los Angeles bushfires could be seen as nature's way of dealing with the Californian housing surplus and, once the insurance money begins to flow, may have some ameliorating impacts in that state.
Recent primary equity issues are acting to kill secondary trade in an already skittish stock market. New issues by the likes of Mirvac, National Bank, and possibly Transfield and others are acting to kill daily trade as institutions hang back or even sell ahead of a mooted new issue.
Despite its current relative strength, the US dollar faces huge challenges. The US economic rescue package currently being implemented holds potential to significantly expand the US's money supply, which would ultimately be inflationary and lead to a falling US dollar. In the short term, contraction of wealth from falling stock and property markets is likely to offset the inflationary effects of pump priming, but this remains a risk going forward.
If the US currency were to be encouraged to fall, say, 30 per cent, it is likely that, over time, house prices in the US would stabilise and begin to rise as debts remain steady, thus restoring positive equity to many mortgages. Briefcase believes it is not a matter of if the US dollar falls, but when and by how much. Perhaps a 50 per cent fall would not be beyond reality.
In the long term, the fundamentals for commodities remain solid. Going forward, a rising global population combined with increasing wealth, especially in developing countries, will continue to lead to a rising intensity of commodity use.
Despite cost efficiencies rendered by advancing mining and metallurgical technologies, new production of most commodities now involves constantly rising capital and operating costs associated with a combination of lower grades, deeper mining, more isolated locations, higher fuel and labour costs and often smaller deposits of most commodities.
Reserves and resources are in decline, certainly on the hydrocarbon front, while gold production peaked in 2001 and oil production is likely to have peaked by 2012, at the very latest.
The current economic turmoil will halt and postpone many new resource project developments, resulting in even greater shortages of supply, once economic growth recovers, most likely by late 2010.
- Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au