Any investor crawling out of their cave and surveying the wreckage of 2008 would be immediately conscious of one thing – the sharemarket is very cheap. In fact, it is as cheap as it has been for three decades, at about 8.8 times earnings, compared to an historical average price/earnings (P/E) ratio of between 14 and 15 times earnings. That’s what a 50% fall – the Australian market’s equal-worst loss – will do for share prices.
But very few investors have the confidence to invest. Not only are most still reeling from the effects of a savage 14-month bear market, they are scared stiff of what the near-term future could hold.
It was bad enough watching as what began as a US-centred credit crunch widened into a near-collapse of the global financial system – now investors have to contend with the fallout in the real economy, namely the biggest global economic slowdown since World War II.
Already, the US, Britain, the eurozone (led by Germany, France and Italy) Japan, Singapore and Hong Kong have slipped into recession, with Korea and Taiwan on the verge. China’s economic growth rate has slowed to 6.8%, down from 11% two years ago.
With China’s growth rate tumbling, just last week the International Monetary Fund (IMF) cut its 2009 growth forecast for the Australian economy from 1.8% virtually to zero. In effect, the IMF is saying Australia is already in recession, regardless of what the December 2008 quarterly national accounts will tell us.
And with the global – and Australian – economy going over a cliff, company profits will follow
For most of the decade, corporate profits and P/E expansion drove the sharemarket higher. The Australian market (that is, S&P/ASX 300 stocks) saw average earnings growth run at 20%-plus between 2003-04 and 2005-06, largely powered by 50%-plus profit rises from resources stocks.
But in 2006-07, average profit growth slowed to 12%, and in 2007-08 it came in at an anaemic 4.5%.
Not surprisingly, this year the market is expecting an earnings recession, with consensus estimates at this stage expecting a 5% to 10% fall in average profits across the market in 2008-09, led by a 20% slump in resources companies’ earnings. Such expectations are a far cry from the 25% earnings growth, which was projected as recently as October 2008.
But strange as it may seem, the outlook for sharemarket investors is reasonably optimistic, for the simple reason that the sharemarket is a forward-looking beast.
Simply put, it has factored in a very gloomy view of economic activity and company profits, and at some stage it will begin to factor in economic recovery – helped by the unprecedented synchronised policy response by governments all around the world.
Governments and central banks have pumped incredible sums of money into economies. For example, even before the $US825 billion stimulus plan proposed by President Obama goes to Congress, Bloomberg News says the US Government has committed since September 2008 a staggering $US8.5 trillion to financial rescue initiatives – a sum equal to 60% of the nation’s gross domestic product (GDP).
Much of that money has been aimed at unlocking the frozen credit markets, to get the lifeblood of global economic activity – bank capital – moving through the arteries of the financial system once again.
There is no shortage of cash on the sidelines; the Superannuation Guarantee (SG) alone raises $3 billion a week, $1 billion of which usually goes into the sharemarket – but over the bear market, fund managers have diverted much of that to cash.
This cash build-up is even more pronounced in the US. According to Goldman Sachs JBWere, US investors have squirrelled away $US8.8 trillion in cash, bank deposits and money market funds, an amount equal to 74% of the sharemarket’s capitalisation, and the highest ratio since 1990. “One surety is that this cash will eventually find its way back into the market in one form or another,” notes GSJBW’s trading team.
“Over 2009 we expect shell-shocked investors to gradually drift back to the sharemarket,” says Craig James, senior equities economist at CommSec. CommSec expects the S&P/ASX 200 Index to rebound to 4700 by end 2009 (from 3390 at present). But while James believes that fundamentals support a recovery like that seen in 1975 and 1983, he also acknowledges the threat from the “fickleness of investor sentiment”.
James says the best defensive areas of the sharemarket are pharmaceuticals, healthcare and telecoms, but believes that major banks, infrastructure-dependent companies and housing-dependent sectors will become attractive propositions as the year progresses, as investors begin to re-focus on capital growth in a recovering market.
According to Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, from the year 1900 to December 2008, Australian shares have delivered a total return (capital growth plus dividends) of 11.9% a year on average, with more than half of that return – 6.2 percentage points – coming from dividend income. In real terms, the return is 7.8% a year.
“Putting short term uncertainties aside, shares remain excellent value from a long-term perspective,” says Oliver. “Shares should benefit over the year ahead from the anticipation of better economic and financial conditions from later this year and through 2010, and they offer very attractive dividend and earnings yields relative to collapsing bond and cash yields.”
Despite an attempted rally in cyclical stocks towards the end of December 2008 and early this month, says the Goldman Sachs JBWere strategy team, investors have been gravitating over January to the more defensive healthcare, consumer staples and utility sectors.
But at some stage over the second half of 2009, GSJBW expects investors to leave the defensives and move back into the cyclical sectors that are leveraged to the expected improvement in the macro environment – with the obvious risks revolving around both the timing and sustainability of this recovery.
The investment bank believes the key sectors to participate in this “reflation trade” will be the following (along with its preferred stocks within these sectors, which it describes as “large-capitalisation stocks with strong balance sheets and sustainable, attractive positions within their industries”):
Another big potential attraction is dividend yield. According to The Australian Financial Review, there are 398 companies listed on the Australian Securities Exchange that pay a grossed-up dividend yield greater than 4.25% – well above the official cash interest rate.
For yield-oriented investors, GSJBW says nominal yields of 11% or better (that is, yielding 8.4% or better in the hands of a 46.5% taxpayer) are potentially available from selected large-cap industrial stocks across the next two dividends.
Among these are Asciano Group (40.2%), Boart Longyear (19.6%), Bluescope Steel (14.7%), Tabcorp Holdings (14.2%), West Australian Newspapers (12.5%), Suncorp-Metway (12.4%), OneSteel (11.9%), National Australia Bank (11.5%), ANZ Bank (11.3%), Incitec Pivot (11%) and David Jones (11.0%).
The caveat with all of these projected yields, of course, is that the companies’ expected dividend payouts are not downgraded.
Smart Company is the leading online publication in Australia for free news, information and resources catering to Australia’s entrepreneurs, small and medium business owners and business managers.
