Research Watch

Citi’s stocks warning, euphoria hits a high, CBA stretched, and more.

Summary: This edition of Research Watch includes Citi’s stocks warning, euphoria hits a high, CBA stretched, the gold-silver ratio, the new Berlin Wall, and Dimon gets a spanking.
Key take-out: A research note by Citi says that after a strong performance, the Australian market is likely to level off and higher dividend payouts are limited. It has downgraded Australia to underweight in its regional allocation.
Key beneficiaries: General investors. Category: Portfolio management.

Australian equities have had a good run this year, but it could soon come to an end. As local stocks whiz past Citigroup’s year-end targets, testing yield limits in the process, the investment bank has downgraded our market to a sell. On the other hand, as global risk appetite approaches euphoric levels, Goldman Sachs is jacking up its forecasts for US stocks in the expectation that the rally will continue for years to come (there may still be time to put those valuable Australian dollars to use). Bank of America charts the “new Berlin Wall” being built in Europe, separating Germany’s financial markets from surrounding economies, while analysts take another look at beaten-down banks in the region. Meanwhile, UBS lists the global bubbles its most concerned about, Jamie Dimon gets a spanking, and, on video, Gerard Minack has some worrying parting advice.

Citi slaps a ‘sell’ on Australian stocks...

“Australian equities have started 2013 well and the local index has now hit our strategists’ year-end target. Tony Brennan, our Australian strategist notes that PE valuations in Australia have moved 10% higher than the two decade average, which was largely a period of low inflation and interest rates. The recent rerating of Australian equities has been concentrated in the more defensive stocks. … Australian equities have performed well as the global search for yield has intensified. At the start of 2012 the dividend yield for Australian equities was 5.1%, 220 basis points higher than the global average. Now it is 4.1%, 150 basis points higher. Tony notes the ability of non-commodity companies to sustain a much higher payout ratio from here is limited. They already distribute 60-70% of earnings in dividends. … An additional factor capping the near term increase in dividends is the moderate outlook for Australian company earnings. Expectations are for 4% EPS growth for the Banks over the next few years. Forecasts are for only a moderate recovery in ‘Industrial’ company EPS after five consecutive years of contraction. … We downgrade Australia to Underweight in our Global regional allocation.” (Citigroup, May 22)

But Goldman thinks the US rally still has legs...

“Goldman Sachs said the US stock-market rally may last at least another two-and-a-half years, sending the Standard & Poor’s 500 Index up 26% to 2,100. David Kostin, the bank’s New York-based chief US equity strategist, raised forecasts for the US equity benchmark, predicting it will finish 2013 at 1,750 and 2014 at 1,900 as stock valuations increase, according to a research report dated yesterday. The S&P 500 trades at 16.3 times reported operating profit, 16% below the average since 1998, data compiled by Bloomberg show. ‘Our positive 2013 outlook for S&P 500 has played out much faster than we expected,’ Kostin wrote. ‘Reasons for a higher multiple include increased confidence in the medium-term outlook for US economic growth, improving investor risk appetite and the wide gap between equity and bond yields that we now assume will be closed more by stocks than bonds.’” (Bloomberg, May 21)

The world is racing toward outright euphoria...

(Credit Suisse via Sober Look, May 21)

And where there’s euphoria, there are bubbles...

“We take a restrictive definition of bubble. The asset has: 1) to be valued beyond the reasonable bounds of fundamentals and 2) could correct rapidly. This leaves us with only five candidates:

  1. Risk free rates: Treasuries, bunds, gilts and JGBs.
  2. Credit, particularly in Europe.
  3. Real estate in Asia.
  4. EM stock markets: Specifically, Indonesia, the Philippines and Thailand. We would also add Mexico on the grounds that it is expensive, illiquid and of 28 stocks that UBS covers in the region only five have buy ratings.
  5. Australian banks.

(UBS via Pragmatic Capitalism, May 22)

CBA certainly looks stretched...

“What’s the world’s most expensive bank? Analysts at UBS think the answer is Commonwealth Bank of Australia, having crunched numbers like its price-earnings ratio or book value and compared them to global peers such as Citigroup or HSBC. CBA’s shares hit a record high of $74.18 on Monday and are up almost 50% over the past year. That means its stock is trading at 10.2 times its profits before accounting for provisions to cover bad debts, UBS says. CBA’s tangible book value of 3.6 times is also the highest in the world, according to UBS analyst Jonathan Mott. ‘This makes CBA the most expensive large bank in the world by nearly every measure,’ Mott, who is based in Sydney, said in a note to clients. He rates the bank a sell with a price target of $60.” (Wall Street Journal, May 20)

Equities, too, if you consider the gold-silver ratio...

"The gold-silver ratio has risen to its highest point in three years (August 2010) and in the past this served as a flash-point for a renewed risk-off trade. See the chart below and the divergence (S&P 500 surging and the gold-silver ratio sliding — historically this has a 71% correlation, likely because silver has far more industrial applications and as such this ratio is viewed as somewhat of a global economic barometer.) ... The bull market may well be in complacency.” (Dave Rosenberg of Gluskin Sheff, May 21)

A ‘new Berlin Wall’ is being erected in Europe...

(Michael Hartnett of Bank of America Merrill Lynch via Business Insider, May 20)

But banks there might be worth a look..

“Citigroup’s Jonathan Stubbs told CNBC that European equities have ‘rarely’ been so appealing to investors. The bank’s European equity strategist said the pace of downgrades to earnings forecasts is improving which, in the past, has been very positive for stock returns. ‘The last five times it has happened we’ve seen an average equity market return of 30% in the following 18 months – and that’s broadly where we are now,’ he said. … He said financials was his preferred sector and added that European banking stocks ‘will surprise many.’ ‘European banks are on this very positive journey from … capital deficit to a capital surplus. That’s one of the key themes we think that will sustain outperformance and performance from banks over the next couple of years.’” (CNBC, May 20)

Jamie Dimon gets a spanking...

“The real Jamie Dimon ended up faring pretty well for himself; the inflatable one, pictured above with an Occupy Wall Street dominatrix, who gathered outside 270 Park Avenue with other activists today to protest Dimon keeping his chairman title, can’t say the same thing.” (Deal Breaker, May 21)

Video of the Week: Gerard Minack’s parting words...

Morgan Stanley departing global equity strategist worries we could be on the verge of another global financial crisis as risks grow.

(Click here to view the video: ABC, May 17)

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