17 December 2009
Investors are hunting growth assets, in particular emerging markets and commodities, for the first time in three years.
Since March, there's been a rally in equities, oil, energy and commodities with gold standing out.
Given the relatively cheap money around, investors are targeting riskier assets, boosting share market gains on both sides of the Atlantic, Asia and Australia. But they still have a way to go to reach the peaks of 2007.
Blackrock equities strategist James Holt says an average rally in the US market since 1900 from trough to peak is around 100 per cent over three years.
"The starting point for this rally was preceded by a historically large decline in equity prices," he says, "exceeding even the mega-bear market of the early 1970s".
"So while the recovery in US markets has been strong, it's not out of kilter with past experience, with markets remaining well off their 2007 highs", Holt says.
The Australian market has recovered considerable ground - especially the big banks - but remain well off all-time highs.
"Historically, it takes about three to five years for the market to regain all-time highs after a major bear market. We're almost a year into that process," he said.
UBS equities strategist Mark Rider is optimistic about the market, and feels it is undervalued.
Earlier in the year, the market fell to a PE of 10, compared to a market average of 17, he said.
"Following two distinct phases of the rally, the market is still below fair value, and has gone a fair way back to pricing-in normal economic conditions."
Matthew Sherwood, Head of Investments Markets and Research at Perpetual Investments, says equity markets have been helped by solid corporate earnings results in the August reporting season, and with solid dividend yields of around 4 per cent.
"The All Ords could have between 10 to 15 per cent growth next year reaching 5,500 - 6,000 if all goes to plan."
Much of Australia's growth path is on the back of emerging markets in Asia, particularly China.
Holt says global equities continue to be attractive to investors, and sees growth opportunities in emerging markets, such as China.
Emerging markets soared in popularity as investors sought high-yielding assets with few links to the weaker western economies.
Dr Shane Oliver at AMP Capital Investors points out investors need to move away from the concept of traditional international equity funds, and allocate to stronger growth Asian economies, and other emerging countries.
He says that traditional international equity funds are benchmarked against indices that have 80 to 90 per cent exposure to slow-growth advanced economies, such as the US.
Investors appear to be split into two camps - those that worry central banks are blowing asset bubbles, and those riding the emerging markets bandwagon.
And China is the growing dominant player in this story.
China bubble territory?
China is now leading the world economy in industrial production, closely followed by India.
The initial massive stimulus package undertaken by the Beijing Government focused on infrastructure. And Chinese banks opened their wallets to fund a growth spurt.
James Holt says this stop-gap measure needs to give way to more sustained growth over coming years, and the best option available to China is growth via internal consumer demand.
"Chinese consumers - fearful of a future with no welfare safety net - save around 30 per cent of their income: an enormous percentage even by Asian standards. This has constrained consumer demand'.
"The Chinese consumer could help maintain China's growth and re-balance its economy," he added.
With GDP growth at 9 per cent, and the official purchasing managers index PMI showing steady increases over eight months, the view from China analysts CSLA is that the two key asset classes - residential property and A-Shares - are still bubble-free.
Shanghai is the best performing stock market in 2009, but it's only half of its October 2007 peak of 6,092.
Chris Peng, an investment analyst in Shanghai, told The Financial Times that the PE ratio is still lower at 30 than the 15-year average of 42.
So if China manages to avoid asset bubbles, what about other countries?
Hot money
It's clear central banks are focusing one eye on the economy, and the other on the potential formation of asset bubbles.
World Bank President Robert Zoellick believes the combination of loose money, volatile commodity markets and poor harvests means asset bubbles could be the next big risk as the world recovers.
However, The Reserve Bank of Australia (RBA) is not so shy, and leads the global pack in raising cash rates to 3.75 per cent from the emergency rates it set in 2008.
UBS equities strategist Mark Rider argues the RBA wants to avoid inflationary pressures in house prices and more broadly, consumer goods and services - both sources of volatility.
As interest rates go up it creates conditions of uncertainty, but maintaining lower rates for too long will also lead to higher volatility and in-balances in the economy, he says.
Perpetual Investments' Matthew Sherwood argues the RBA's rate settings are to the upside, with official interest rates expected to reach around 5 per cent by mid-2010.
And while the RBA assumes a more aggressive stance, eyes will be on the US Federal reserve and what it will do next year.
Raising rates in the US will make Asian exports more expensive, hurting the Asian recovery.
But a do-nothing policy may also have unintended consequences, says Dr Doom, Nouriel Roubini.
Roubini spells out the problem: investors are shorting the US dollar on a highly-leveraged basis to buy higher-yielding assets and other global assets, but they're borrowing at negative interest rates.
He calls it the "mother of all highly leveraged global asset bubbles."
Opportunities for 2010
Certainly in the short term, James Holt says Australia will continue to enjoy the benefits of the Asian growth story via a continued resources boom for many years to come.
"The challenge will be to manage that boom without over-stimulating other parts of the economy."
Holt says high quality companies with very attractive dividend yields have been left behind in the global rally, especially in the Telecommunications, Consumer Staples and Healthcare sectors where low valuations and dividend yields of up to 6-7 per cent can be obtained in some cases.
UBS's Mark Rider says there are opportunities in cyclical sectors, particularly consumer discretionary stocks such as David Jones, Billabong, Aristocrat Leisure and News Corp.
And Matthew Sherwood says there appears to be better opportunities in some defensive companies, such as Telstra where regulatory risk has been over-priced with good dividends, healthcare and consumer discretionary, which have lagged the market recovery.
AMP's Dr Shane Oliver argues that Australia's strong exposure to high-growth Asia and commodities, and its rapid population growth provides a positive backdrop for Australian shares, which suggests investors should have a bias towards Australian shares.
Oliver says there is always a cycle and bubbles; however, each one is a bit different and this time around the rise in the relative fortune of emerging countries versus developing countries is different enough to have significant implications for investors.
But investors would be wise to heed the warnings of Dr Nouriel Roubini who accurately picked the bust of the recent housing and credit bubble in the US.
He says the Federal Reserve seem unaware of the monster bubble being created. The longer regulators remain blind to it, the harder markets will fall. A sudden appreciation of the US dollar will start the decline.
"A stampede will occur as closing long leveraged risky asset positions across asset classes funded by dollar-shorts triggers a co-ordinated collapse of all those risky assets - equities, commodities, emerging market asset classes and credit instruments".
The scary part is he was spot-on with his last warning; maybe it's a case of preparing to buckle up for the next ride! Or it's much ado about nothing.
