Stock Broking
Markets Unsteady – Again
More than US$2 Trillion has been wiped out of global stock markets values from the high reached in May. The US stock market has declined for the last 5 weeks as a result of economic news that manufacturing weakened and that unemployment rose.
What does all this mean?
Well according to Bloomberg the S&P 500 is trading at 12.2 times earnings. So what does this mean?
This means that for every dollar of profit you need to pay 12.2 times that amount to buy the business on the stock exchange based on current prices. The long term average is anywhere between 16 and 17 times for this index which means that we are acquiring the assets on historically cheap terms. That means that there is already consideration for some “bad” events in regards to the current prices. Naturally shares can always get cheaper but if you are a long term investor there is an opportunity to take a longer term position and reap the rewards.
Commodities – Opportunity or Trap?
The Australian economy sailed through the GFC with not so much as a glitch. Many believe that our commodities industry who had revenues of $187 Billion last financial year is who to thank. Australia’s mining industry contributes 8% of our nation’s wealth as measured by GDP but a staggering 47% of our exports.
Having had a number of conversations at the pub recently with people on the exciting long term prospects of these companies as investments it is probably time to step back and assess.
With all sectors more capacity is coming on stream due to the high prices currently on offer. A perfect example of this in Australia is Fortescue Metals, iron ore producer, who was born in this commodity boom. As well as new players existing players are increasing their investment in other projects and increasing supply. In their last report the CEO of BHP spoke about the difficulty in finding projects at the right price.
In any case Australia is a low cost producer and its proximity to Asia will always mean that it is a competitive force to help sustain pricing. Regardless, it would be a brave call to say that prices will not be impacted downwards at some point and the thing that does vary among such bears is the magnitude of any decline.
To show the difficulty in such factors world renowned investment manager Jeremy Grantham, who correctly forecast the tech wreck and the subsequent decade of US equity declines as well as the large bankruptcy of global banks in GFC, says that long term Asia demand for energy, metals and crops will outpace supply. However he also goes onto say that there is a 25% chance of China slowing considerably due to bank losses and the unwinding of a property bubble which would have a large impact on commodity prices. Hedge Fund Manager, Jim Chanos, who correctly forecast the collapse of Enron said that the property bubble in China is “as big or bigger than we saw in the west” after considering the size of the economy.
The question becomes how do you balance these risks as we assess the world economy going forward? As investors we need to ask what are the opportunities and traps we need to be looking for?
If you have any queries please call me on 1300 132 214.
Energy Mix – The Final Word
As a roundup to my blog's series on our current mix of energy sources and the future problems this will bring there were some interesting releases over the last few weeks on this matter.
The International Energy Agency said that we were over reliant on coal and need to boost incentives for clean coal. Coal whilst being “dirty” produces about 47% of new worldwide electricity in the last decade. They propose energy efficiencies and subsidies to promote new development in renewable energy and concepts such as electric cars. They also addressed recent trouble in Japan with the nuclear reactor saying that nuclear power is still part of our energy mix and needs to increase output by about 30% before 2020.
The IMF this week released a report citing the impact on global growth if a timely alternative is not found to oil. The risk is obvious. As they note some savings will be found in efficiencies others will be found in the development of alternatives such as bio fuels and electric cars. Interestingly, they also talked of taxes on oil which the revenue could be used to research the answers for this conundrum. Interestingly, in Australia we already have a lot of taxes and levies on fuel I wonder what proportion of this revenue going to the government is being spent on the development of efficiencies or alternatives?
Our Addiction To Energy – First Step Acknowledge the Problem
Lifestyle and location is dependent on the amount of energy used per capita. In the US every person uses the equivalent amount of energy to continually burn 110 light bulbs. Europeans use 55, Asians 16 and Africans 8 however, as the world develops the demand for energy is rising rapidly.
As China and other countries such as India and African nations urbanise and become middle class they will demand and consume more energy.
Where does our energy come from?
Fossil fuels account for the most Oil 33%, Coal 25% and Natural Gas 20%. The remainder is made up of other sources such as nuclear 9%, Hydro electric, solar, wind and Geo thermal.
We are addicted to oil and it is getting harder to get which makes it more costly. 100 years ago it took 1 barrel of oil to get 20 Barrels of oil whilst currently in Saudi Arabia it takes 1 barrel of oil to get 20 Barrels of oil. Scarily , it takes 1 barrel to produce only 5 barrels of oil from the Canadian Tar Sands. Furthermore, many believe that we have pulled out more than half of the oil reserves we have. Given the dramatic increase in demand how long will the rest last? Other fossil fuels such as coal and gas are more plentiful but they release a lot of carbon dioxide into the atmosphere which most scientist agrees causes climate problems.
Importantly, there are ways we can as individuals decrease our demand for energy. Also, there is a way that we can produce the amount of energy that we require now and in the future but by implementing a portfolio of energy sources it is a challenge that needs to be and can be met.
A very good documentary in lay terms talking about these issues can be located below.
Episode 1/3
Episode 2/3
Episode 3/3
What Can You Do?
What is Currently Good Value?
Assessing the valuation means we look at the amount of profit they are making relative to what we have to pay to own a stake in that business. Valuation is a different concept to that of the financial strength or appeal of a business. For example you can have a pretty poorly run business but if it is really cheap it may be a great investment. Alternatively, you can buy the best run company in the world but if you pay too much for it you will be waiting a long time to get a suitable return on your investment.
Speaking of valuations our favourite asset class or investment, residential property, is displaying some worrying signs in regards to valuation.
The Demographia International Housing Affordability Survey for 2011 found Sydney was the second most expensive city in a survey which included countries such as US, China, Australia and Canada. When using the measurement of median property price divided by Median household income a multiple of 9.6 times is the result. It should be noted that the long term average for this measure is closer to 3 times. A similar survey conducted by HIA puts Australia’s ratio of house prices to household income at 4.1 times. When they started the survey in 1995 this measure was only 2.5.
For those looking to buy their first home or an investment property how does this fit into their thinking?
BHP Announces Record First Half Profit
BHP has just announced a record first half profit of US $10 Billion.
Interestingly, the CEO said that they were not looking at major acquisitions given that they were having to pay “top dollar” for assets. They also said they were going to pump Billions into developing the assets they already own as way of keeping the supply of their product flowing.
There is no doubt that the emerging economies are growing and as the Western World continues to recover from the GFC we will no doubt see further demand for oil, coal and other commodities. However, the question becomes how is the demand and supply equation balanced, especially in light of the very high prices these commodities are now trading at? Where is the potential risk? Is it to “surprising” the market with good news or indeed disappointing news?
I would argue the latter so, ceteris paribus (buyer beware) for investors that blindly following the commodities train. Remember, it is the amount of profit over the long term that will ultimately determine a company’s value, hence share price.
What is going to be in huge demand as the world’s population grows?
The impact of food costs are further exacerbated by natural disasters such as floods and droughts which also disrupt production and supply.
As investors there are a number of ways that we can look to benefit from owning assets in the “food chain” over the long period that this will play out.
Buying insuance companies after the QLD floods
This would obviously lead to those that are covered by an insurance policy and those who are not. Those with an insurance policy need to check whether their policy covers floods as the fine print in some policies excludes such damage.
With the large amount of expected claims to insurance companies the share prices of insurers like IAG and Suncorp have fallen dramatically since the start of the floods. It should be noted the Suncorp’s policy does specifically cover floods which means that their payouts will be considerable larger than an insurance company that can wriggle its way out of honouring the policy. However, local insurers only cover a certain amount of damage themselves and they then apply to reinsurers for any amount over that threshold. In Suncorp’s case the damage bill will be limited to around $90 million with large overseas reinsurers footing the rest. Given the cost for Suncorp is capped it may be a good opportunity to pick up these sold down insurance companies shares. Indeed, no doubt premiums will increase next year plus less people will go without insurance policies with such a disaster fresh in their minds meaning more premium income for the insurers.
Who Does and Who Wants To Own US Debt
The purchases from Japan show no slowdown in demand for America’s debt which will help keep funding costs down as the deficit swells.
Foreign holdings of US debt have increased US$374 billion this year to US$4.07 trillion as of July, according to Treasury data.
Demand from international investors for Treasuries is in contrast with the view of Warren Buffett the world’s greatest investor. He states unequivocally in a Fortune magazine article that investors buying bonds now “are making a mistake”.
“It’s quite clear that stocks are cheaper than bonds,” Buffett said. “I can’t imagine anyone having bonds in their portfolio when they can own equities.”
Stock dividends are paying more than government bonds. According to Bloomberg Ten year Treasuries yield 5.2 percentage points less than equities of companies in the Standard & Poor’s 500 Index.
Looks like of another case where investors are taking their eye off the ball in regards to weighing up the benefits and risks of investment choices.
Australian and Overseas Shares Cheap
As discussed it is pointless to try and guess the direction of share markets. We need to focus on the underlying principles of the performance of the assets that we own as reflected by “business performance” NOT their “share price performance”. Over the long term the share price should reflect the “value” attributable to the profit generating ability of these businesses.
Reporting season has just finished in Australia and according to Australian Bureau of Statistics, Australian company profits rose 18.9 percent in the second quarter from the previous three months. This is the biggest jump in company profits in nine years further showing the resilience of the Australian economy to the GFC whilst other countries including the US still struggle. If companies are making bigger profits they can invest more and pay higher dividends wouldn’t that make the businesses more valuable hence share price rise?
Profits at mining companies surged 62.7 percent in the second quarter with the “Big Australian” BHP reported a doubling in profit to US$6.59 billion for the six months ended June 30.
Banks and insurers climbed 28.9 percent with Australia’s four largest banks, Commonwealth Bank of Australia, Westpac Banking Corp., Australia & New Zealand Banking Group Ltd. and National Australia Bank Ltd., this month reported increased earnings after stemming losses from bad loans after the financial crisis.
Woolworths Ltd., Australia’s biggest retailer, forecast last week that earnings will rise as much as 11 percent and announced it would buy back $700 million of its shares.
According to Bloomberg, analysts say profits for companies in the MSCI World Index of 24 developed nations will gain 28 percent in the next year. The MSCI index trades at 11.5 times forecast earnings. Except for the six months starting October 2008, the index has never traded below 12.5 times reported earnings. This is an indication that shares are cheap as you can buy the underlying businesses for a smaller multiple of profitability. Bloomberg also states profits for companies in the S&P 500 are forecast to reach US$83.34 a share in 2010 and climb 22 percent in the next 12 months to a record US$92.15 a share. What will be the effect of this on the value of the underlying businesses and other things being equal their share price?
Recently, Federal Deposit Insurance Corp. said U.S. lenders posted their biggest quarterly profit in almost three years. According to the FDIC US Bank profits totalled US$21.6 billion in the second quarter, up from US$18 billion in the first quarter. This is very important sign given the nature of the GFC and the impact it had on financial institutions. One of our international investments has approximately 50% of the portfolio allocated to overseas banks.
Centre Capital Securities are stockbrokers and member participants of the National Stock Exchange, have over 50 years combined experience in stockbroking and are contactable on 1300 132 214.
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