A murky forecast

Ever wondered why the gorilla, the astrologist and the dartboard vie for top spot in the annual stock tipping contest?

Or perhaps you’ve pondered the converse. How can the experts be so consistently wrong?

The simple explanation is that if economics is the dismal science, trying to predict markets is an exercise guaranteed to cause heartache and disappointment.

Take American hedge fund king John Paulson. He made squillions by betting the US housing market would collapse in 2007. But, ever since, his funds have languished, shedding 51% in 2011 and another 11% last year.

Little wonder then that our own bunch of investment banking analysts are a little gun shy right now. For three years, each Christmas, they have fired off hopelessly optimistic forecasts for the year ahead, all of which ended in tears.

A recent survey of market economists from 12 leading institutions by Fairfax Media highlighted the cautious tone pervading our investment banks this year.

The most bullish prediction for the ASX 200 for 2013 came from HSBC’s Paul Bloxham, who estimated 5,200 by the year end. Macquarie Group’s Richard Gibbs was the most bearish with a target of 4,600 for New Year’s Eve. That’s significantly below the market’s current level.

It’s worth noting that four of the 12 weren’t prepared to even have a stab at what the market may hold.

Not surprisingly, a month ago, as analysts trotted out their first tentative forecasts for 2013, an overwhelming sense of negativity pervaded the predictions.

2013 would be tough for the economy and possibly even worse for markets. The negativity was dominated by three main themes. The mining boom had run out of puff, the Australian dollar was suffocating the non-mining sector, and the furious round of rate cuts had failed to fire up consumer sentiment. That, they deduced, was environment conducive to another year of poor corporate earnings.

On top of that, the global economy was slowing with the US stuck in neutral, with Europe continuing to battle its debt crisis, Japan displaying further weakness and China yet to land from its self-induced slowdown.

I noted back then (The equities aerial view for 2013) that the pessimism was overdone, that neither financial crises nor resources booms last forever.

Much to everyone’s surprise, a great deal has changed in the past three weeks, giving an indication of just how perilous the art of prediction can be and just how fluid the situation in the global economy is right now.

Anyone predicting an 85% rebound in iron prices from their September lows just weeks ago would have been declared insane. But it has happened. A fortnight ago, the soaring price was declared a short-term inventory restocking exercise. But last week’s sudden surge in China’s exports and imports hinted at something far more substantial.

There has been tentative evidence of a Chinese recovery for several months now, and with the new leadership likely to be installed in the weeks ahead, a new round of optimism is firing up the engine room in our biggest trading partner. The mining boom, delivered to the mortuary just a few months ago, has been resurrected.

Then there is America. Unemployment has been creeping lower. More importantly, the US housing market – where the virus that infected global finance first took hold – is now showing definite signs of having bottomed.

Last week Macquarie Private Wealth analysts noted that 2012 would be the year that marked the turnaround in the American property market, with 2013 likely to see a resurgence on Wall Street that already has threatened to head to a new peak.

While they were more circumspect on the prospects for Australian stocks, an improving or at least stabilising global economy, following four horrid years, certainly seems possible. Ultimately, that could only benefit Australia.

The main doubts about our market revolve around the recent rally from mid-2012. Now trading on a price earnings multiple of 13.3, most brokers late last year maintained that it had overshot and that the earnings growth required to justify such a ratio simply will not occur.

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Source: ASX

Citi analysts last week softened their attitude. They pointed to the lower domestic interest rate environment, arguing this would decrease pressure on earnings downgrades following a disappointing year for corporate earnings in 2012.

JP Morgan highlighted that earnings growth had been a depressing story for the past three years, with momentum now at its lowest level since the GFC write-downs.

Among those maintaining their bearish stance are Merrill Lynch Bank of America. Where Citi and others see the positives in a market trading on a PE at a slight discount to its long-run average, Merrill Lynch reckons it should be nowhere near that long-term average in the first place.

“Aside from short-term upgrades from moves in iron ore prices, our work suggests it unlikely the Aussie market will soon enter a sustained earnings upgrade cycle. Our model suggests mid-single digit earnings growth over the coming year.”

Merrill analysts are wary of cyclical domestic stocks and urge investors to look at companies with US exposure.

Credit Suisse is similarly cautious. Global growth rates may have bottomed but there is unlikely to be a strong recovery, they argue. Like Merrill Lynch, they are looking at domestic defensives and US exposed corporations.

Argue the toss how you will, there is no doubt the global storm clouds are lifting. Almost everyone is in agreement on that point. And a low Australian interest rate environment, with the prospect of more cuts before mid-year, will only serve to drive cash out of bonds and into equities.

In such an environment, prices can be expected to rise well in anticipation of earnings.

Most of the analysts are correct to note the poor transmission of recent Reserve Bank cuts to increased spending.

That’s because consumers, corporations and, more recently, government have for three years been focussed on cutting costs and reducing debt. When executed en-masse that can have a debilitating effect on an economy, which is what we have been experiencing since 2008.

Longer term, however, that is a positive for the domestic economy. The combination of healthier balance sheets and a low interest rate environment can be a potent force, and when equilibrium is reached a turnaround in consumer spending, corporate activity and a subsequent rebound in earnings is sure to follow.

The Australian stockmarket is still 30% below its 2007 peak. It is clear that it now has bounced off its lows and, while this year may not be spectacular, it is likely to be the year when the foundations are laid for a return to steady growth.