American employment and economic data has improved, Chinese data remains firm, quantitative easing is in place in the UK and the EU, the Reserve Bank of Australia has opened up to the idea of a rate cut and most importantly of all, the eurozone, albeit slowly, is headed for a comprehensive solution to its sovereign debt problem by the end of the month.
My view remains that this fourth quarter rally in equities will continue into year-end, particularly as momentum now swings positive in a market where everyone has been defensively positioned or outright short, despite the best outright value in cyclical equities in living memory.
I read an amazing statistic recently that 85% of NYSE daily volume is accounted for by high frequency trades (HFT) and those following short-term algorithmic momentum strategies. On that basis, it’s no surprise that we are seeing unprecedented intraday volatility in US and global equities.
With ultra short-term strategies dominating short-term equity pricing, it’s also no surprise that when momentum changes it has an extremely large influence on prices.
As you know, I believe HFT increase ‘volume’ but not true ‘liquidity’. So when momentum changes and all the computer programs say ‘buy’, there really is a lack of genuine stock supply. That is why you now see ‘melt up’ events, like the ASX200 rallying sharply, with riskier stocks up as much as 40% last week from Tuesday’s lows. That sure beats being parked in cash at an interest rate of 4.75% per annum, unfranked.
There’s just no such thing as a flat market anymore, not in the new world in which we operate. Markets move with unprecedented speed. That is why when I’m writing my Australian trading and investment strategy, I have to be focused well ahead of the market. You simply can’t get yourself in the position of playing ‘performance catch up football’, or as I call it ‘chasing alpha’.
For the entire year, the Australian equity market has not controlled its own performance destiny. Australian pricing and sentiment has been entirely hostage to global market developments. We now operate in a fully correlated financial world where information travels at unprecedented speed.
In all my time in dealing in Australian equities, I can never remember a period when Australian investors have had less influence over the daily pricing of Australian equities. The new marginal pricers of Australian equities are global fast-money accounts, and global fast-money accounts are driven by global macro and sentiment events.
Yet, while the global fast money has a massive short-term influence, the simple fact is they hunt as a pack and take markets to extremes. They eventually crowd out their own positions and then when the unwinding starts, they realise they have been playing a game of pass the parcel with themselves. That was easily evidenced last week when just about all Australian stocks gapped higher with real money sellers almost impossible to find.
‘Short the rumour, short cover the fact’ has been a trend right across Asia, but probably no more so than in Australian banks.
Aussie banks have been an easy short as we warned you back in April. They are over-owned by pretty much every Australian investor, which means in a correction nobody really has the firepower to take on the short-sellers unless they want to buy more and go more overweight. You find that shorters find very little resistance in Australian banks, that is until the momentum changes.
My view is shorting the fundamentally strong is rarely a profitable medium-term strategy. Eventually, the fundamental strength supports the stock price, particularly when they are driven down to undeniable fundamental value.
That is why we continue to bang the drum hard on the cheapest and most leveraged banks ahead of the full year reporting and dividend season. And there is no cheaper and leveraged bank than National Australia Bank (NAB), which in my view is also the most shorted by global fast money accounts. This is confirmed by NAB leading the sector off the lows, a development we think will continue.
National Australia Bank (ASX:NAB) – Buy
NAB remains our highest conviction buy recommendation in Australian banks. NAB commands a major price-to-book discount due to UK exposure, but my view is they will sell some UK assets and release $5 billion in capital. Instead of issuing capital, NAB will be buying it back. On fiscal 2012 multiples, NAB is the cheapest bank when comparing price to earnings (P/E), yet it has greater earnings per share (EPS) growth than the rest of the Big Four banks combined. It also has the highest yield. NAB continues to gain profitable market share from all others in a zero credit growth environment. It is priced, for historic yet unjustified reasons, as the risk bank, and risk is on. I met with Cameron Clyne last month and I rate him above all others in the sector. He is absolutely excellent in my view. NAB’s P/E at 8.7x is lower than its 9% EPS, which is ridiculous! Our new technical share price target is $26.30.
ANZ Bank (ASX:ANZ) – Accumulate
ANZ’s momentum shows it has the right strategy in place and the right focus on the core markets for growth (Australia and APEA). The long-term benefits of its Super Regional strategy far outweigh short-term headwinds (such as, trading income and acquisition risks) and we maintain the $22.60 price target and Accumulate rating, with substantial value upside if the bank were to acquire Macquarie Group (MQG).
Challenger (ASX:CGF) – Buy
Challenger is in a unique position, as it is one of just a few financial companies that benefit from some market volatility. In terms of our earnings revisions for Challenger, we’ve upgraded our retail annuity sales outlook for fiscal 2012; increased our Cash Operating Earnings (COE) margin over the medium-term given the robust asset spreads available; reduced our mark-to-market funds under management in Wealth Management for the year; and lowered our transaction and performance fee expectations in Wealth Management for the 2012 financial year. Overall, our earnings revisions are net-neutral. Our Strong ‘buy’ recommendation is maintained along with our $6.20 price target.
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