Clouds part as appetite for risk returns
Is the bull market in defensive high-yielding stocks over? That is the question that Australian sharemarket investors need to decide in the coming weeks following some decisive developments during the first week of the profit reporting season. For most of this year defensive stocks that pay their shareholders generous incomes have been surging higher. In comparison, cyclical companies such as miners, non-bank financials and retailers have become friendless. Up until now investors have shown no ...
Is the bull market in defensive high-yielding stocks over? That is the question that Australian sharemarket investors need to decide in the coming weeks following some decisive developments during the first week of the profit reporting season. For most of this year defensive stocks that pay their shareholders generous incomes have been surging higher. In comparison, cyclical companies such as miners, non-bank financials and retailers have become friendless. Up until now investors have shown no compunction to jump on the cyclical train, preferring to hide in the likes of Telstra, CSL and Woolworths. Last week though, the switch to more risk was pronounced and some follow-through could see the emergence of a major trend.Last week's slightly disappointing earnings result by the defensive bellwether Telstra may prove the turning point. After years of underperformance Telstra's share price sprung to life late last year and has almost notched up gains of 20 per cent this year the broader All Ordinaries index has risen only 5 per cent. In the past week though Telstra's share price has fallen about 5 per cent despite the promise of a 14? fully franked dividend.Trading in other defensive stocks such as healthcare plays CSL and Ramsay Healthcare and gaming outfits Tatts Group and Tabcorp have also come off the boil despite the market trending higher. During the same period the big mining companies have perked up with Rio Tinto, BHP and Woodside leading the charge. Joining the charge have been cyclical industrials such as Lend Lease and Computershare.While it is too early to call this a sustainable trend, investors should keep a close eye on proceedings and be overjoyed if it continues. The genesis of any new bull market typically involves a surge in cyclical stocks that will benefit most from an improvement in the general economy. Investors will generally fund their move into cyclical companies by selling out of defensive stocks that have proven winners.Given the troubles in the world economy, what has been the catalyst for the events of last week? I think we should stick with three critical reasons. First, US bond yields have started to jump higher. The 10-year bond yield has firmed from 1.4 per cent a few weeks ago to 1.7 per cent. This primarily reflects investor willingness to take on more risk. The bears will argue that appetite for risk has a direct correlation with high expectations the US Federal Reserve will soon announce a third quantitative easing program in a bid to jump-start their economy. This may well be the case, but printing money normally has the effect of pushing yields down further and not up.A more plausible scenario is that investors are becoming more optimistic about the economic climate. The much-watched Citi expectations index of leading indicators has recently turned positive after falling for several months. This tells us the economic numbers being printed in the world's largest economy is now starting to match or even beat depressed expectations.The second reason is that defensive investments have become a crowded trade. In Australia, where the government and corporate bond market is thin, investors have piled into high-yielding stocks that pay fully franked dividends. Eventually a crowded trade results in expensive valuations and leaves few buyers to push these stocks higher.Finally, interest rates in Australia have gradually been coming down. Unlike Europe, the domestic economy would seem to be experiencing a more traditional cyclical economic slowdown. This fundamentally means that low interest rates should eventually start to stimulate economic activity in areas such as housing, transport, retail and financial services. Any meaningful rise though will not become apparent for some time, however professional sharemarket investors won't wait until it actually comes otherwise they miss the boat. As the world's greatest ice hockey player, Wayne Gretzky, said: "I skate to where the puck is going, not where it has been."The confirmation of a trend towards more cyclical stocks should either be confirmed or killed off in coming weeks. The biggest risk is that the US economy falls in a hole as investors, consumers and business people become increasingly concerned about the looming "fiscal cliff". This involves a reduction in government spending and a rise in a range of taxes that could cut economic growth by as much as 4 per cent in 2013. The fiscal cliff is due to come into force in January, and given the timing of the presidential election in November may not be addressed to the satisfaction of investors. If US investors do get twitchy about the economic outlook then you can expect a sharp reversal of last week's trend with bond yields falling and defensive stocks back in vogue. This would be a conclusive sign the secular bear market is not over and to remain cautious. It is a critical time in markets and compulsory viewing.Matthewjkidman@gmail.com
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