The Bull Still Has A Long Way To Run
The Age
Saturday March 10, 2007
The global bounce is about excess cash, not genuine bargains.
ONE of the ideas swirling around this week was that the market's 175-point bounce was fuelled by the Treasurer's approval of the Qantas takeover, since it would mean $11 million would flood into the sharemarket (minus fees, of course, which would flood into the real estate and motor vehicle markets).Right timing, wrong conclusion. For one thing, surely no one thought the Government would actually knock the bid back; to do so would have been a national joke. Also there are still a couple of important and very stubborn hold-outs against the offer that could still bring it undone.And secondly, markets have bounced everywhere, not just here, and as chunky as the Qantas takeover offer is, it isn't moving Tokyo and New York.Then again, the global bounce is all about excess cash, rather than genuine bargains, and while the cat might not be quite dead, as in dead-cat bounce, it is unwell.The February correction in global equity values reached just 6 per cent before the pent-up cash tickets waiting to be clipped persuaded fund managers that it had gone far enough. Since markets are not mathematics, but a branch of psychology, or perhaps anthropology, whether it really had gone far enough is beside the point.My view is that the correction lows will be re-tested, and probably broken, but that in any case, this is merely a reversal within a bull market that has a long way to go. The length of it will be a function of the durability of the two super-cycles that have created and underpinned it.The two pillars of this global bull market in equities, which is now four years old (following the 2000 to 2003 bear market) are:? The low-inflation, commodity super-cycle produced by the rebirth of global trade and the entry into the system of China, India, Russia and Brazil (in order of importance); and? A super-cycle in financial intermediation banking, investment banking and wealth management. Especially banking. The first of these will be with us for a long time; the second is temporary.The elongated economic growth cycle and decline in unemployment since the last recession in 1991-92 has been turbocharged by the low inflation that has been exported from China and India.That, in turn, has produced a long decline in interest rates for both bonds and cash.Low interest rates have encouraged a massive increase in debt leverage in the developed economies: first household debt, which has fuelled property booms everywhere, and now corporate debt through the boom in leveraged buy-outs (recently renamed private equity to improve its image).The new LBO cycle is an explosive mixture of the booms in superannuation and banking, and it has a long way to go.In essence, this bull market in equities has been built on banks and investment banks: their asset growth has produced the liquidity that is supporting valuation multiples, and their earnings growth has meant that the financials have dominated the sharemarket.In Australia, the financials represent 44 per cent of the market, including property trusts. Excluding them, it is still well over a third, despite the recent boom in resource stocks.In the US, the financials represent 23 per cent of the market, up from 8 per cent in 1991. Citibank, JPMorgan, Bank of America and AIG now earn as much profits as the bottom 250 companies in the S&P 500 Index put together.As Gerard Minack, of Morgan Stanley, noted this week, there's been a self-perpetuating mechanism at work: the bull market in asset markets has helped drive the financial sectors performance, and the resultant earnings growth has maintained the boom in equities. That feedback mechanism is stronger in Anglo-markets than elsewhere.In fact, I'd go further - the liquidity from bank lending has actually helped create the bull market in asset prices that is being dominated by the earnings of the banks, created, in turn, by the lending.In the first phase of the bull market this came via households gearing up and dis-saving (reducing the equity in their homes), and at the same time building superannuation assets. These things are linked. Enforced saving via super, along with low interest rates, allowed households to give themselves permission to borrow more.This was most pronounced in Australia because of the mandatory super system and, as it happens, the Australian sharemarket has produced the best total return in the developed world since 1990.Now corporate borrowing is taking over from families. The superannuation assets are now being diverted into alternative assets - what Warren Buffett called the 2 and 20 brigade in this week's annual letter to his shareholders - as competitive pressures force the funds to look for better returns than the index.Most of this flow of cash is being leveraged four to one by bank debt, so every $1 that's diverted from the long-only, ungeared fund managers, into private equity, hedge funds and infrastructure, turns into an investible amount of $4.In personal and home mortgage lending, there is a direct relationship between unemployment and loan delinquencies. Low and falling unemployment over the past decade has allowed banks to run the lowest bad-debt provisions for a generation, which has underpinned their profits.But within the boom in home mortgage, there has been an ever greater sub-boom in subprime and low-doc which, as noted on Wednesday, is coming home to roost in the US (not here).LBOs are a similar subset of corporate borrowing and, led by Qantas, are now moving into low-doc (the Qantas bidders call it covenant-lite, which means the lenders have less power to declare the loans in default).That, in turn, means defaults will be late, will sneak up on the banks, and will be totally unredeemable. But for the time being it's party time.Alan Kohler publishes Eureka Report, an investment newsletter financial backed by Carnegie Wylie & Company, an adviser to Qantas. The views expressed here are Kohler's alone, not Carnegie Wylie's.-- ak@eurekareport.com.au
© 2007 The Age
