Not so sanguine as blood begins to flow

That is a stark picture to paint about the future of the local equity market. It is not uncommon for analysts to dial down earnings forecasts but to do so for a decade would be crippling. We all live in hope that sometime in the next few years the economy will snap out of its funk and battle-weary analysts will begin to upgrade earnings. Current sentiment mocks anyone who attempts to articulate this scenario.

There is no sentiment indicator for the stock market in Australia. That is remarkable given sentiment is regularly pinpointed as a powerful contrarian indicator. Baron Rothschild coined the term, "buy when there's blood running in the streets", way back in 1871. We have to ask is there enough blood in the streets today for the Baron to get out the cheque book?

In Australia have we totally capitulated? Unfortunately we have to rely heavily on flimsy indicators such as trading volumes and anecdotal straw poles to measure sentiment. Trading volumes are down about 30 per cent since peaking back in 2007.

The straw pole, though, reveals a far darker story. Heads have been rolling in the stock broking industry for two years with Macquarie Group, Royal Bank of Scotland, Bank of America and Goldman Sachs all having a turn at culling. Those remaining feel like dead men walking, with hundreds more jobs predicted to be shed before the year is out.

Dealing rooms are deathly silent because the phones have stopped ringing. In the bear market of the early 1990s sedentary brokers sharpened their crossword skills. This time they are downloading the latest gaming application on their smart phones.

Strategists in the Australian market, after years of predicting a major rebound in equities, are starting to come back to reality. Still, most are forecasting the ASX 200 index to finish the year higher than today with most predicting a climb of 10 per cent. Only one thinks it can sink 10 per cent from here. Stock analysts are still forecasting high single-digit earnings growth while professional investors think it will be closer to zero.

Expert commentators have suggested that bonds yields will stay low for many years to come. In other words there is no bubble in bonds but simply the "new normal".

It is an easy task to construct a bear case at the moment. Europe is a basket case, China continues to slow, the US has a fiscal cliff to contend with and company earnings at home are being wound back at a rapid clip. Investors have either ploughed their funds into term deposits, despite declining yields, or hidden in highly defensive equities such as health care and utilities.

So is the "blood running in the street" and do we buy? We know the blood is starting to flow but we don't know if it is going to turn into a torrent. And there lies the angst of the situation.

The Australian market is trading on about 11 times forecast earnings, which is historically cheap but still above the normal cycle low for a bear market. If earnings have to be downgraded still then prices could easily fall another 20 per cent to hit the nadir.

One of the most accurate market forecasters, Craig Scheef, of Technical Investing, believes the bottom will take place late this year. Scheef has been deadly accurate predicting the market direction using a combination of technical and fundamental analysis.

Scheef believes the US market has again started a downtrend that will be punctuated by short rallies such as the one that has taken place during June. The most likely trigger for these short upward bursts by the market is to be policy announcements about global stimulus, a drug many investors have become addicted to.

Just where the bottom is he is not sure, but it will be a precursor to a rally that kicks off in earnest in early 2013. Obviously, he believes there is not enough blood flowing yet. A conclusion that many investors and stock brokers would disagree.

This, though, could be more hope than reality.

- In last week's column I wrote that in late 2008 NAB failed to raise funding in global wholesale debt markets with the government sovereign debt. NAB refutes this happening, saying it was able to raise funds along with Australia's other major banks.

matthewjkidman@gmail.com