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What to buy in a déjà vu market

There’s an amazing sense of déjà vu about this market, with the same playbook from 2008 likely to be the right one to use now and into early next year.

Think about it; all the headlines right now are about ‘financials’, ‘global growth’ and ‘China’. Financials and materials led the third quarter rout in global equities, with Bank of America falling 44% and Alcoa losing 40%, for example. Every guest on CNBC or Bloomberg TV is bearish, expects more volatility, and recommends investing in the defensive sectors. Well, that’s useful after-the-event advice.

The most surprising aspect of the last two weeks has been how everyone has become a ‘China bear’. Resource stocks globally are down 50%, luxury goods retailers have fallen 25%, with US-listed Chinese companies down more, US-listed Asian casino operators have dropped by 25% and industrial commodities are down 20%, on average.

Yet bulk commodity prices (which can’t be traded by hedge funds), such as iron ore, coking coal, manganese and thermal coal, have hardly dropped at all, suggesting to me the rout in all things ‘China’ is a hedge fund exodus just as it was in 2008, rather than a genuine slowdown in China. Even this week’s positive Chinese PMI (Purchasing Managers’ Index) was ignored by markets that continued to dump or sell short China.

Back in 2008 this proved to be the single best buying opportunity in markets. If you bought commodities, commodity equities and commodity currencies at the peak of a ‘financials crisis’, you made anything between 100% and 500% over the following two years. There is every chance this will happen again and that’s why our number one strategic recommendation remains to hold Australian resource stocks in Australian dollars.

Also note that almost every day that the hedge fund world ‘shorts China’, China Inc bids for another strategic resource stock globally. This week it’s Sundance’s (SDL) turn in Australia. This China Inc buying was also evident at the bottom in 2008.

I personally believe equity markets are now discounting a far more bearish global economic growth outcome than is likely to be delivered in 2012. Yes, there will be slow global growth, but there will still be growth! The equity market is discounting negative growth or in some cyclical cases much worse.

That is why I continue to believe it’s the time to become an investor, not a trader. It is not the time to trade, it’s the time to invest and set portfolios for the years ahead. The equity market is paying you an enormous equity risk premium over bonds to simply invest. The equity risk premium is a derivative of the extreme volatility we are seeing, but that volatility will ease and risk premiums will fall.

The entire world is waiting for a eurozone solution, which they will get this month in terms of a $2 trillion EuroTARP, associated eurozone bank recapitalisations, a partial Greek default, and coordinated liquidity pumping by the big five global central banks. The RBA may even wake up and realise they have Australian cash rates 100 basis points too high. This will all be occurring as the third quarter reporting season in the US comes in solidly.

So there you go. I am bullish, in fact VERY BULLISH. I believe we could see a V-shaped recovery over the next six months. Yes, V-shaped! The risk of further losses from here is minimal, with the risk/reward pendulum firmly pointing to reward. We were bearish on Australian equities at 4,900 in April, now we are VERY BULLISH at 3,850.

In today’s research pack, we start with BHP Billiton (BHP) after a site visit. BHP shares are currently trading $20 below our price target. If you believe anything I write above, the very first thing you should do is buy all four major Australian bulk resource stocks in the first hour today (BHP, FMG, RIO, WPL) in Australian Dollars.

BHP Billiton Ltd (ASX:BHP) – Buy

We continue to rate BHP as a ‘buy’. BHP remains cheap, trading at a fiscal 2012 price to earnings ratio of 7.8x and a fiscal 2012 price to net present value of 0.74x, which compares to its 15-year average of 1.14x. A strong platform of capital expenditure is expected to total some US$80 billion over the next five years and that will underpin organic growth for the next decade. BHP stands out as one of the best-managed companies in the Australian market, which is matched globally with a market capitalisation ranking it in the top 10 in the world. We have a price target of $56.05.

Sundance Energy (ASX:SEA) – Buy

We are initiating research coverage of Sundance with a ‘buy’ recommendation. The stock appeals to us as an established oil producer in the Bakken, one of the two premier shale regions of the US. The company’s growth targets look achievable, but our forecasts are more cautious. The share price is trading well below our conservative valuation of just the Bakken assets and the upside from the Niobrara could be higher than we have estimated. The company has already established good support from a number of institutional investors, and the new CEO, Eric McCrady has injected some new energy and financial discipline to the company. Our target share price is 86¢.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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