Another gloomy assessment of the share market

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The prospects facing the stock market are not looking especially bullish according to a Deutsche report which notes that whatever China does — initiates reflation or does little, resulting in further weakness in commodity prices — there is good reason for caution. Industrials are still in downgrade mode; all the good signs are coming from defensive stocks. Deutsche is still overweight banks for the yield, and sceptical of cyclicals:

“We are not confident of further near-term gains for equity markets. While an improvement in economic surprises and earnings revision ratios have typically been positive for equities, the charts below suggest equities have performed a little too strongly. This could make equities vulnerable to any disappointment, either from the data or policymakers. Equities have clearly been buoyed by central bank signaling, and there is the risk that they have already largely priced what policy makers may ultimately deliver.”

Deutsche is adding Sydney Airport, Ausdrill and removing Seek and NRW. A month ago it added IAG, Metcash, Woodside, Westpac, and removed AMP, UGL, Santos, Commonwealth. But Deutsche does not see much reason for optimism in the Australian market despite its weakness:

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“Turning to Australia, the market has been an underperformer for some time, but there seems limited capacity for this to be made up in the near term. One reason is continued poor momentum in earnings revisions. Australia has been stuck firmly in net downgrade territory for the past two years, while global equities have done considerably better. Following the recent reporting season (and the fall in commodity prices), there seems little reason to hope that this pace of downgrades improves much.

The second constraint is market valuation. At 12x, the market PE is not high, but it is comfortably above the lows of the past year or so. Further, forecast earnings (upon which the PE is based) are predicated on commodity prices considerably higher, and the AUD a little lower, than what currently prevails. If spot pricing persists, the market PE is actually ~14x, which would be the highest PE since the global recession, and a PE that is unlikely to be sustained.”

A fall in the $A might encourage more foreign investment, which is running at about two fifths of the market, but Deutsche does not see much chance of that:

“With commodity prices easing there is hope that the currency will also fall, providing support for earnings. But, along with our FX strategy and economics teams, we see limited downside for the AUD. Certainly the fall in commodity prices has been pronounced, but if we consider the long-run relationship between those prices and the AUD, the currency does not seem high. Instead it appears that the AUD largely looked through some of the strength in commodity prices over the past 5 years, and thus does not need to fall much as those prices ease.”

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All in all, a pretty gloomy assessment. Which may, of course, mean it’s time to invest.

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