After a sustained fall to about 5000 on the index the Australian share market now presents as reasonable value, and it is time to deploy cash into quality equities.
The intrinsic valuation buy signal is flashing after a few years of exuberant pricing. The All Ordinaries has fallen to 5014 points (update). That’s below our intrinsic current value range of 5380 points as at June 2015 and it is also below our forward 12-month valuation forecast of 5675 points.
Basically, the market has pulled back to a 10 to 12 per cent discount to future value. With dividend income included, that suggests a potential 15 per cent return over the next 12 to 15 months.
We have been cautious over the past 12 months and have held elevated cash levels. Now is a good time to start deploying some of that cash.
Banks become attractive
There are rarely flashing signs to buy the equity market but in the last month a value-based assessment of the market based on a 10 per cent required return over 12 months gave the first strong buy signal for the market in nearly 18 months.
Today the market index is the same level as nearly two years ago and yet the economy has grown, interest rates are lower and importantly the $A has devalued by over 20%.
Simply stated, some of the key inputs for assessing the market value have improved since 2013 and yet the market index has not. The recent fall in market prices is indeed good news for value investors. Further, the projected return has been enhanced by the higher projected yields.
In particular the banks are yielding 6 per cent and retailers 5 per cent, both franked. They are clearly in value and well supported by their yields. Discounted capital raisings by the major banks are attractive.
Is it time to start buying resources?
Not yet. Our confidence in resources will not lift until the $A falls into the mid US60 cent range.
Commodity price falls have not been offset yet by currency declines, and the $A has to fall much further before we get interested in resource stocks.
Patience, however, is still warranted and market volatility isn’t going to end.
The critical issue driving the market is the significant fall in Australia’s terms of trade on the back of the commodity-price slump. This is caused by both a slowing in China’s growth rate and a massive expansion in the supply of major commodities.
Indeed we are most concerned about the fall in the oil price and the translation into lower LNG prices. Australia’s long term export future (and the strength of the $A) will be increasingly linked to selling liquid natural gas (LNG), particularly into the burgeoning Chinese and Asian markets.
We suspect that the declining outlook for LNG export prices is becoming understood by foreign investors, but not so much by Australian investors. Foreigners are clearly perceiving the $A to be high risk and the currency has devalued by over 5 per cent since 30 June.
We believe that given the declines in oil, ore and coal prices, the $A will fall further to the mid US60 cent range. That will also support a valuation of the market at 10 per cent above current levels and it will likely bring resource stocks into value.
Let cash move into equities
As you no doubt would have noticed, we have taken a cautious approach, particularly in the past 12 months.
But with the Australian market now trading below intrinsic value, it is time to let some cash move into the equity market.
Around 200 companies are currently in value in StocksInValue. But which are quality investments?