Evacuate risky shares before bondcano blows - The Australian 18 October 2016
Will stronger economic growth mitigate the “bondcano”? Credit Suisse Australia strategist Hasan Tevfik thinks stronger global economic growth will lift Australia’s S&P/ASX 200 share index to 6000 points by mid-2017, but he’s wary of a short-term pullback in shares as the “bondcano” starts to erupt.
The man who coined that term to describe the potentially damaging effects of a substantial rise in bond yields told clients last month to rotate from expensive bond proxies in the property, infrastructure, utilities, healthcare facilities and casino sectors to less-crowded and cheaper companies in the materials, financials, healthcare supplies and consumer discretionary sectors.
At the time, he warned that the overall market was vulnerable to high PE ratios and rising bond yields, particularly since “real” or inflation-adjusted bond yields were rising from extremely low levels.
While the sharemarket was surprisingly resilient in recent weeks, the S&P/ASX 200 index suffered its biggest one-day fall in five weeks yesterday, diving 0.8 per cent to hit a three-week low of 5388.7 points. The worsening sell-off came as Australia’s benchmark 10-year bond yield hit a four-month high of 2.31 per cent after bouncing off a record low yield of 1.81 per cent in August.
“Often the initial stages of bond yields rising is bad for equities but when we get clearer signs of earnings coming through and maybe the earnings recovery broadening out — not just in the resources sector — the overall market should start to do better,” Mr Tevfik told The Australian yesterday.
In his view, stocks with high PE ratios, high dividend payout ratios and high financial leverage — those at the top of the bondcano — are most sensitive to higher bond yields, while lowly-valued companies should benefit as the premium associated with growth stocks diminishes.
With central banks already near the limits of effective policy stimulus, the worst case for shares would be a rise in inflation that pushes up interest rates without any improvement in economic growth. But thankfully inflation is dormant and the current sell-off in bond proxies may be outweighed by recovering value stocks if investors sense that the global economy is improving.
Accelerating global economic growth may be supported by stronger US capital expenditure, a resilient European economy and stable-to-improving activity in China, where greater fiscal expansion is on the cards, according to Credit Suisse.
Global GDP growth will slow to a seven-year low of 2.9 per cent this year before accelerating to 3.2 per cent near year and 3.3 per cent in 2018, according to Bloomberg’s consensus estimates. And there are some early signs that an improving global economy is helping earnings per share.
“Last week was a bullish week for US profits as the US investment banks were surprisingly solid,” Mr Tevfik said. “It’s been a combination of increasing market share and business activity.”
Indeed, Bloomberg’s estimate of consensus earnings per share for the S&P/ASX 200 in the year ahead has risen about 25 per cent in the past six months after hitting a six-year low at the end of March, although the earnings recovery in Australia so far has mainly been in resources.
The combination of improving EPS expectations and falling share prices has seen the one-year forward price-to-earnings ratio of the S&P/ASX 200 fall from a 10-year high in late August to a four-week low of about 15.9 times yesterday.
But while there are some signs that a rough patch in shares will give way to a profits recovery, Mr Tevfik doesn’t expect a “grand stonking profits recovery”.
Indeed, since the recent “profits recession” in Australia was mild, the ensuing recovery is unlikely to be strong. Earnings per share fell 13 per cent over 24 months, whereas the average profits recession has seen EPS fall 30 per cent over 30 months.
WOW Price at posting:
$24.25 Sentiment: Buy Disclosure: Held
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