<table
After enduring the sub-prime crisis, the poorly executed Troubled Assets Relief Program (TARP) in the US, huge capital losses suffered by many investors and, to top it off, Bernard Madoff’s alleged $50 billion Ponzi scheme; what is 2009 likely to hold?
From an economic and market perspective, we know Australia is relatively well placed.
Australia has both the willingness and the scope to provide a great deal more stimulus if required. Unlike the US, we don’t have a zero cash rate. We have already cut rates by 3 per cent, but could do a lot more if required. Equally, we have been running Budget surpluses for the past 10 years, so there is an ability to crank up Government spending by far more. These measures will underpin local earnings.
Equity valuations in Australia are looking extremely cheap historically based on various measures, including one year forward P/Es, equity yield/bond yield ratios, and so on. In other words, your pay-back period for an equity investment is shorter than the historical norm and you are getting paid a higher yield. On average, the market is trading on a forward P/E of under 10x and there are individual stocks trading as low as 3-4x.
The bears among you will no doubt say, ‘Ah yes, but have consensus earnings sufficiently captured the bleak economic outlook in 2009?’ Well, if history is any guide, almost certainly not. Consensus earnings for the equity market are what I would definitely put in the category of a ‘lagging indicator’, but even allowing for some further downward revision in earnings, Australian equities still look cheap.
Many companies have leveraged up in the good times and much of the concern reflected in today’s prices has to do with scepticism around the ability of these companies to refinance their debt when it falls due.
Again though, things are likely to look better on this front in 2009 as the global impact of central bank measures begin to gain traction. Even in these dark times, solid companies with real cash flows have been able to refinance debt (albeit at high interest rates). As the liquidity squeeze eases, so does this concern, and equity prices will be quick to reflect the reduction in risk.
Consequently, we think the market is close to, if not at, the bottom.
But February is a key date. Why? Because that is when reporting for the December half will be announced to the market. Once most of the bad earnings news is out, the analysts will roll their company models forward to include 2010, which by any measure is likely to be better than what we have just been through. We know financial markets anticipate outcomes, so this brighter outlook will get priced in during 2009.
What does the upside look like? The extent of any rally will be lopsided because the US is clearly in for a protracted recession and this will hit the Australian traded goods sector disproportionately. Nevertheless, a rally on the S&P ASX 200 to around the 4,800 level seems feasible.
Best value in our view include banks trading at 7.5 times earnings and forecast yields 8.5 per cent (once bad debts have been adequately provisioned for in February), and companies with good quality earnings, balance sheet strength and sound management, such as QBE and Ansell.
Matt Drennan is the director of investments, Zurich Financial Services Australia.
