Our market's still in value territory

Data shows Aussie stocks are in value … prepare for the long-awaited earnings rebound.

Summary: The volume of mining projects still underway shows that, far from coming to an end, Australia’s minerals boom still has a long way to run. And now building and construction also is picking up, with data showing non-mining investment gaining momentum. It all adds up to growth, and shows why our market has further to run.
Key take-out: The latest quarter’s data shows mining investment was up 5%, while non-mining investment rebounded 6% over the last six months.
Key beneficiaries: General investors. Category: Economics and strategy.

There been a lot of press lately about whether our market is expensive. Price earnings ratios are high, and some of our builders are leading the charge in the expensive stakes, according to several of the larger broking research houses.

It’s not just the Aussie market though. Similar concerns are being expressed for the major global indices; it’s a global thing and fairly natural after a strong run.

Focussing solely on the domestic market for now, I actually think we got further confirmation this week as to why our market still retains significant value. In fact, from a macro perspective, it was the single-most important week for some time. Why? Well think about ‘The Great Tragedy’ for the Australian market – the whole economy actually. This inexplicable pessimism that’s weighed like a millstone around our necks. It’s dominated the public discourse for about five years, led by the Reserve Bank and the major global investment banks . That’s despite our great country largely being unaffected by the global financial crisis. More importantly, that’s despite our very strong metrics. On paper we should be in the middle of a growth spurt.

The end of the mining boom call is a case in point. That went out over a year ago, and this week we found out that 15 months on we’re still not seeing the end of the boom. For those who haven’t seen the numbers, the latest quarter’s data shows mining investment up 5% after a 2% rise in the June quarter (according to the Australian Bureau of Statistics). As chart 1 shows, mining investment, far from collapsing, is at a new record – more than 12 months on from the supposed end of the boom.

It’s not just the ABS statistics either – these are figures that are backed up by the Bureau of Resources and Energy Economics (BREE) as well. I realise that some of the press surrounding those figures loudly proclaimed the end of the boom again – and BREE itself may have said this. Yet this isn’t what the BREE’s data actually shows. BREE’s data shows, just like the ABS data, that mining investment surged to a new record in October—see chart 2 from BREE. So instead of trumpeting the end of the mining boom again, it would have been more accurate for headlines to note the “Investment boom continues”.

Now, to reiterate, I don’t doubt that the mining boom will end. It will. The call made last year by the RBA and others was, however, extremely premature, as I argued at the time. Subsequent data has borne that out, and policy makers simply panicked it seems.

Yet I do believe this was the single-most important piece of news that we’ve seen. Don’t let anyone underplay it like some of our sour puss business commentators and economists who, having got the boom call wrong, are now questioning whether you can believe the data. But it was critical, because in this ‘Great Australian Tragedy’, policy makers have been operating under the assumption that the mining boom had ended. It’s part of the reason why the cash rate is at 2.5%, and a key reason why confidence is struggling in this country. We’re all worried by the employment outlook, growing debt, the rising budget deficit. Some commentators loudly proclaim that we will have to take a major hit to our living standards!

That the mining boom hasn't ended, pulls the foundations out from under these people and this will reinvigorate interest in the Australian growth story. That's good for confidence and good for earnings.

In fact, not only has the mining investment boom gone on for longer and proved to be stronger than expected – but any unwinding of the boom, when that does finally occur, will at the bare minimum be an orderly process. We know this because government data shows two things:

1. Firstly, even during the height of the end of boom hysteria, there was no sharp unwinding of investment intentions – look at the last four columns on the chart.

2. Secondly, data released by the BREE shows there is something like $250 billion in projects that are still awaiting to be completed. That’s about 10 times what was just competed this quarter or, based on completions over the last year, 2½ years’ worth of investment. More to the point, there is a further $318 billion to $360 billion in projects at a less advanced stage – that’s a further four years’ worth in the wings. And people go on about the end of the mining boom!

By the way, the chart below that that gets bandied around to show the mining boom has ended is a little misleading.

What the chart shows is BREE’s estimates of projects that may be committed to – not completed mind you. Note that it doesn’t show committed projects coming off until 2015 (maybe), and no doubt under some fairly pessimistic assumptions given everyone thought that commodity prices would slump and the boom was over.

This is quite positive in itself, because we have passed the worst in terms of pessimism for the country – no iron ore collapse, no US fiscal cliff, no Euro zone implosion, no Chinese hard landing. And so business investment intentions will only rise from here, and there’s a good chance so will projects that get committed.

With that as our backdrop, I’m heartened by another signal we saw this week. Construction elsewhere is turning up. Check out chart 5.

Following six consecutive quarters of falls from late 2011, non-mining investment has rebounded over the last six months, rising about 6%. This is the strongest gain in about two years and brings non-mining investment back to where it was a year ago. This is a positive thing by the way, because there’s a lot of catch-up to go here. There has been a massive underspend in the non-mining space for many years – so there is a long way to go here.

Data defying the economic bears

The bottom line is that I love Australian equities, and it’s very clear to me that our market still retains a lot of value. The premise that it’s expensive rests on the erroneous view that the mining boom has ended and that the economy will slow sharply next year. As a result of that downturn, it’s argued that earnings couldn’t possibly justify some of the price gains we’ve seen. Yet that’s not what the economy is telling us, that’s not what the market is telling us, and the fact is this view is just plain wrong.

Not only has the mining boom not ended, but construction elsewhere is turning. This is great for our miners – the production boom has only just started. It’s great for mining services. It’s great for our building and construction stocks, which is great for the rest of the economy. The way the planets are aligning – Australia’s construction boom has probably only just begun!

The downturn hasn’t come, and you shouldn’t take seriously anyone who continues to go on about it.

The way I see it, we have a choice. We can get dazzled by the glitz and glitter of bauble wearing investment bank analysts and the PhD wearing economists trumpeting bad news. Or we can look at facts and evidence. I strongly recommend that investors look at the latter – that’s where successful investing lies and where the money is.

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