Looking through the global trading damage of last week, there really was nowhere to hide other than US dollars and US treasuries. The rest of the investment world saw highly correlated losses, with commodities, commodity currencies, global developed and emerging market equities all falling in tandem in what can only be described as a race for the exit.
Most of what happened last week was classic ‘risk off’ trading, particularly in the carry trade. (The carry trade involves borrowing low-cost funds and putting them in higher yielding investments, often in foreign denominated assets. Because of the risk involved, these investments are often cashed in – or ‘unwound’ – in volatile conditions.)
This carry trade unwind has occurred at least three times in the last five years, every time being more spectacular in its speed and scale. Yet by the time gold is caught in the unwind downdraft, it has always signalled the peak of forced selling. When you see gold lose US$200 an ounce in a crisis, you know this is more about a giant global hedge fund making a collateral call than anything else. That is why I’m trying to trawl through the indiscriminate damage and position our portfolios for a better end to the year.
There are a couple of other developments that also give me hope this downward market is bottoming.
- Goldman Sachs are now forecast to make a loss for the quarter. If the ‘vampire squid’ can’t make money, it must be the bottom.
- UBS lost its CEO; always seems to happen at the bottom.
- The VIX is above 40 points. At the market peak in April it was 14. We have gotten to the fear of fear itself stage.
- Rumourtrage is rampant again, with everyone having some scare story on something. Rampant rumourtrage and market bottoms do occur simultaneously.
- Downside scenario analysis is rampant, wonderfully useful AFTER a 20% correction.
- Retail money is flowing out of equities at very low valuations and high yields into fixed interest at record low yields.
- The RBA is backing off a way too bullish view on global growth (déjà vu all over again from 2008’s monetary policy errors).
- Investment banks and brokers are cutting staff in huge numbers, globally and locally. History shows there is no better contrarian market indicator than the hiring/firing cycles of the investment banks and brokers.
All the indicators that I look for as a sign of a market bottom are in place. Sentiment is shot to pieces, momentum is very negative, and all investors have given up on central banks and governments being able to do anything to avoid an extended global recession. To me, watching the correlated collapse in all cyclical assets last week, that view is now consensus.
That opens up the chance of a HUGE rally in cyclical risk assets when that consensus view – which has already been priced into the market – is proved to be too pessimistic over the next three to six months.
There is so much value apparent now that investors are spoiled for choice. The market is paying you an enormous equity risk premium over bonds to simply take a risk.
I remain of the view that the first place to put cash to work is in Australian resource stocks in Australian dollars. That is where the 50-100% upside trade lies just as it did back in 2008 when all the headlines were the same as they are today.
The first place I would start is Fortescue Metals Group (ASX:FMG) at under $5. It’s simply way oversold. Fortescue is more profitable today than it was a week ago when the stock was above $6. The Australian dollar and diesel price are down sharply, yet spot iron ore remains firm despite all the spook stories. All that has happened to Fortescue’s shares is that someone has sold, perhaps force sold, 50 million shares into a weak market, triggering a disproportionate price fall. Fortescue should be the first stock you buy in large cap resources if you believe like me that markets are trying to bottom.
Anyhow, you know where I stand on this. It’s time to be an investor, it’s time to add risk, and it’s time to be braver.
Here’s some more stocks for those of you out bottom fishing:
Iluka Resources Ltd (ASX:ILU) – Buy
The Iluka sell-off is overdone. Iluka has fallen by about 14% from $15.20 a share to about $13 a share since 19 September. We continue to rate Iluka as a buy and we expect to continue to see tightness in the zircon market driven by strong demand from China, India, Middle East, Asia and South America. We expect to see Iluka’s share price resume its upward trend as attention is focused on short to medium-term earnings and the pending release of its corporate and production plan, which could result in a further increase in production. Our price target is $21.32.
Suncorp Group (ASX:SUN) – Buy
We believe the market continues to ignore Suncorp’s defensive characteristics. Suncorp remains a significant medium-term value proposition, underpinned by: (1) being the only large cap financial with a credit rating upgrade and positive outlook since the GFC; (2) increased payout expectations to 50-70% and capital return prospects of up to 110 convertible preference shares; (3) merger and acquisition appeal; (4) non-core Bank immunised from rising wholesale funding requirements and costs, and with stable asset quality and run-off still ahead of schedule; (5) likely recovery of provisions in both banks; (6) SOTP (sum of the parts) value of around $10 per share ensures an investor today will notionally get the value of the banks for free; and (7) being better placed than IAG (UK drag, India diversion, weaker capital) and QBE (facing US hurricane season, poor investment returns). Our target price is $9.70.
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Also in today’s Switzer Super Report