14/02/2006 - 21:00

Slow strangle as the bears awaken

14/02/2006 - 21:00


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Slow strangle as the bears awaken

Hands up anyone who expects the stock market to rise between now and Christmas? Unless Briefcase has gone blind he can’t see many readers raising their arms, and those who are probably suffer from a case of perpetual optimism; or were born on this side of 1980 and have never seen the slow strangle that marks the start of a bear market.

Warning signals are flashing everywhere that a peak has been reached, and that now is a time to consider cash as a safe alternative, and for more risk-prone assets to be quietly sold.

Two areas stand out as the place most likely to trigger a wholesale correction:

• resources, where there was a nasty scare last week when a pile of hot money was suddenly withdrawn by commodity focused hedge funds, sending metal and oil prices tumbling; and

• financially engineered invest-ments, which have been designed in a boom to pay huge manage-ment and incentive fees that will not survive when the going gets tough.

In case you think Briefcase is alone in tossing a bucket of cold water on the market, you’re wrong. About two weeks ago, one of the senior chaps at UBS, Paul Fiani, was astonishingly frank in tipping a big market correction.

Mr Fiani is the head of Australian operations for UBS Global Asset Management, and while people from UBS normally avoid the media like the plague, he used The Australian Financial Review newspaper to deliver a message which is summed up this way: “The downturn will come from a decline in returns of 5 per cent a year over the next three years, or a correction of 15 per cent immediately”.

The good news is that if we get whacked with the 15 per cent fall now “the market will revert to its normal return of 10 per cent a year”.

Adding weight to Mr Fiani’s prediction is the fact that he’s in charge of a $10 billion portfolio of “other people’s money” and he knows that priority number one is to protect the capital, and then chase the higher returns.

Much of his argument revolves around Briefcase’s favoured stock valuation tool, the humble price-to-earnings ratio; a simple measure of the price of a stock (in cents) divided by its earnings (in cents). The UBS estimate of the PE ratio for Australia’s top 100 companies is currently 15.6. Mr Fiani wants to see that cut by between 10 and 20 per cent.

Outside the top 100, the PE average is 19.7, a number which will tumble when Mr Fiani’s correction arrives because second-tier companies always suffer most.

Mr Fiani didn’t single out the resources sector, spreading his views across the overall market and using this telling description: “The volatility in the market is a sign that everyone knows it’s expensive. It reminds me of the tech bubble, when the markets were getting very volatile, because there wasn’t a lot of underlying support.”

Briefcase reckons that if Mr Fiani had focused on the resources sector where prices are being squeezed and hot, hedge fund, money is starting to be withdrawn, he would have had a field day.

Now, to theory number two; the financial engineering sector. For anyone not familiar, this incorporates specialist funds created by those clever people at Macquarie Bank, Babcock and Brown, and even Perth’s home town favourite, Alinta.

To support its belief that a correction is in the air for these vehicles, which make their money by peeling (and peeling, and peeling) fees off a captive asset, Briefcase turns to another group of clever people – the team at Goldman Sachs JBWere.

Last September, Goldman issued a warning about what happens to financially engineered products when interest rates rise, the deal flow slows, and the fees squeeze the lifeblood out of an asset. It was a report that rang a loud warning bell. Last week, Goldman did it again with a fresh analysis which challenges the financial engineering ‘model’ and, in the humble opinion of Briefcase, dramatically illustrates why this entire sector is heading for a crash.

Quite simply, the fees are too high, the model relies on non-stop deal flow, and there’s a constant issuing of more shares – all of which dilute the performance of the underlying asset until sanity returns, and asset values contract to a realistic level.

Don’t say you haven’t been warned.


On the question of deals wandering off course, it’s getting close to the time when the directors of WA Newspapers apologise to shareholders for the dreadful Hoyts deal they did in late 2004.

Back then, the purchase of a 50 per cent stake in the 377-cinema chain was hailed as having “the capacity to provide good longer term returns to WAN and an uplift in earnings per share”.

For that quote, Briefcase thanks WAN chairman Warwick Kent, who went on to say of Hoyts: “The business has consistent cash flows that will fit well with the profile of WAN and the expectations of our shareholders”.

Sit those soothing words alongside WAN’s confession in the report for the half year to December 31 that the profit earned by Hoyts of $4.9 million was “disappointing with admission levels … down 7.7 per cent”. Worse still, “total box office revenue were also affected by discounting and a resultant shift in attendances to days with lower admission prices”.

What makes the Hoyts problem look even worse, not that a WAN shareholder can see it because it’s not mentioned, is the insidious impact of the Internet (which can now deliver movies directly to a subscriber), and the rise-and-rise of pay television, which is also helping keep people at home.

As if all this isn’t bad enough, consider the plight of WAN shareholders who waited 10 years for their company to take a bold step into a new business – only to find that the step taken now looks like it was into an old and decaying business.

Perhaps someone at WAN should read the thoughts of Rupert Murdoch on the future of the media, the role of the Internet, and the critical importance of content.

Theatre ownership in the modern media world sounds a bit like the way the French defended themselves against Germany in 1939 by building the ‘impregnable’ Maginot line, which the Germans simple drove around and/or flew over.


“One can always be kind to people about whom one cares nothing.” Oscar Wilde


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