Research Watch

From complacency to panic signal? Why Australian property is perfectly priced. Introducing the ‘Geuro’. On video: Bill Gates’ 1979 Porsche.

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

It doesn't seem all that long ago that analysts were raising their market forecasts in a flurry of early-year optimism, but this week one of Citigroup's top equity strategists writes of growing panic – or, in his more colourful words, the “cataclysmic crescendo of capitulation”. That may sound rather gloomy, but according to the bank's contrarian 'fear and euphoria' gauge, which correctly predicted double-digit returns last October, now might be just the right time to buy. On the other hand, based on John Hussman's calculations, the speed and depth of the latest correction could signal that stocks are set to flatline near-term, then tumble. Closer to home, Credit Suisse brushes off fears of a collapse in Australian property prices – in fact, the bank reckons housing is just about perfectly priced. And after Macquarie unveiled its yield strategy last week, RBS Morgans has chimed in with its own recommendations ahead of distribution season next month. China has reportedly fostered an oddly close relationship with the US Federal Reserve, and analysts think they might be able to predict the Middle Kingdom's economic growth using a clever new indicator. Find out what Australia has in common with the PIIGS, and why a sweaty broker could be your best bet. And in a roundup of upcoming auction action, your chance to buy Bill Gates' Porsche and Ronald Reagan's...blood.

Cash in on fear...

“Sentiment has shifted rapidly from complacency in March to panic in the latest readings on our unique Panic/Euphoria Model. '¦ Admittedly, markets rarely get that 'cataclysmic crescendo of capitulation' to call for buying stocks, but proprietary measures such as the Panic/Euphoria Model now are intimating that upside opportunity has re-emerged. Meetings with institutional investors do not anecdotally demonstrate that people are 'freaked out,' but the sharp decline over the past six weeks has caused significant deterioration of sentiment (even amongst credit investors). Other metrics still are not providing the requisite buy inflection such that a more positive view for stocks is appropriate but that nuance does not imply a willingness to grow long bull horns yet. (Tobias Levkovich of Citigroup via Business Insider, May 22)

Overvalued and overbullish...

“The chart [above] captures a fairly simple filter of instances when the market lost 5% or more over a 2-week period, from a market peak in the prior 6 weeks (within 5% of the prior 52-week high) that was characterised by a Shiller P/E over 19, more than 50% advisory bulls, and fewer than 25% advisory bears. So the bars simply identify quick initial declines from overvalued, overbullish peaks. But the fact that they coincide with so many important cyclical bull market peaks says something about how those peaks are formed. '¦ Note that with few exceptions, even when the near-term outcomes have been benign, the outcomes within the following 12-18 months have typically been terrible.” (John Hussman of Hussman Funds, May 21)

Property is priced perfectly... “[Credit Suisse analysts Jarrod Martin, James Ellis and Omkar Joshi] cite numerous arguments as to why Australian house prices 'are (and presumably should be) relatively high by international standards': 1) Australia is a highly urban society by international standards with a cultural preference towards living close to central business districts / coastal cities (limiting desirable land area in an otherwise large land mass country) such that Australia’s capital city house prices to income ratio is comparable with coastal city metrics globally; 2) Australian housing stock is relatively of high quality in nature and both relatively large and land-intensive by international standards; 3) the supply of housing stock in Australia has been excessively constrained in long-term by land zoning and development restrictions (concurrently in some recent years by accelerating population growth); and 4) the Australian taxation system is unusually generous with respect to residential dwelling investment, reinforced by a cultural personal investment bias towards the residential real estate.” (Property Observer, May 23)

Welcome to dividend season...

“We continue to recommend investors maintain exposure to quality, high yielding stocks in a falling interest rate environment. June is distribution season with utility stocks and REITs paying yields above 6%. While most distributions are not franked, they are attractive and can provide regular and sustainable income flows for investors. Our key calls are Sydney Airports and APA Group in the utilities sector and BWP Trust and Cromwell Property Group in the property sector. The ex-dividend dates are before 30 June so now is the time to buy these names.” (RBS Morgans via Scribd, May 21)

China's special relationship with the Fed... “China can now bypass Wall Street when buying US government debt and go straight to the US Treasury, in what is the Treasury's first-ever direct relationship with a foreign government. '¦ [Documents] indicate that the US Treasury has given the PBOC a direct computer link to its auction system - which was first used in the 2Y auction of June 2011. Perhaps this helps explain the massive spikes in direct bidders July and August 10Y auctions (around the US downgrade). Interestingly, primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn't saving money by cutting out commission fees; instead, China is preserving the value of specific information about its bidding habits. By bidding directly, China prevents Wall Street banks from trying to exploit its huge presence in a given auction by driving up the price.” (Zero Hedge, May 21)

The Macau gaming indicator...

“Reuters is reporting that perhaps Macau’s gaming revenue growth could fall to 11% year-on-year in May. [Above] is a chart of Macau gross gaming revenue growth and China’s GDP growth (%yoy, real). This shows a pretty tight correlation between Macau gaming revenue and the Chinese economy...” (Also Sprach Analyst, May 22)

Introducing the 'Geuro'... “Greece’s best chance of survival may be to stay in the euro but opt for its own parallel currency or 'Geuro,' according to Deutsche Bank’s head of research, Thomas Mayer. In a research piece, Mayer said the Geuro would help Greece balance its primary budget without financial support from the 'Troika' of international lenders. This would allow the incoming Greek government to reject the strict austerity program on which aid is contingent. 'A plausible response of the Greek government to the shortage of euro cash, as a result of the end of financial transfers, would be to issue debtor notes to its creditors, promising payment as soon as fresh euro cash would be available. Mayer said. 'As creditors lacking euro cash would have to use the IOUs to settle their own bills, these instruments would assume the role of a parallel currency (let’s call it Geuro),” he said. Mayer said the Geuro would allow Greece to devalue its currency without formally exiting the euro and readopting the drachma. 'Initially we would expect a large depreciation, but the Greek authorities would have the power to stabilise or even strengthen the exchange rate of the Geuro against the euro, via prudent fiscal policy and structural reform, so as to keep the door open to a future return to the euro,' he said. Mayer added that the Troika did not need to 'give in' to Greece’s demands for unconditional financial aid out of fear of European or global economic chaos. 'Ensuring debt service payments and the survival of the banking sector would in our view be enough to avoid a catastrophe when financial assistance to a non-compliant Greek government is stopped,' he said.” (CNBC, May 23)

Rolling with PIIGS... Check out how Australia's austerity budget ranks globally:
(OECD, May 23)

Don't bet on Chinese stimulus... “A collapse in China’s real estate market is not needed for a fall in China’s industrial commodity demand. The prospect of rising unsold property inventories is much more concerning for companies exposed to the capex cycle (e.g. steel and mining) than it is for Chinese property developers. With a sound balance sheet a property developer can work through rising inventories; but their ability/desire to start new/complete existing construction projects if their unsold inventories are rising must come into question. In our view, for China’s steel demand to fall in 2012 a collapse in property construction is not needed, a scenario where property developers build slightly less than last year will suffice. '¦ While we believe Beijing is capable of providing sufficient stimulus to prevent a collapse in metal demand, we don’t think stimulus will be sufficient to create a material uplift in demand growth in y-y terms. '¦We believe announcements of fiscal stimulus (if any) may be met with unrealistic expectations about the ability of this stimulus to create incremental demand growth for industrial metals. We would advise readers to use this as an opportunity to sell down existing positions in steel/mining equities, or to engage in new short positions from higher levels as we expect the actual impact of stimulus.” (Nomura, May 23)

Profiting from a Facebook flop... “Morgan Stanley... sold 484 million shares of Facebook at $38 each. At the same time, they bought 421 million shares of Facebook from the company and its investors... That’s the greenshoe. When you sell more shares than you buy, you’re short that stock, so when a bank exercises its greenshoe option, as Morgan Stanley did in this case, it is going short the stock in question. Why would a company like Facebook want its banks to be short its own stock? Partly because when there’s a big short in the market, that provides upward pressure on the share price. Shorts need to cover their short position '” which means they need to buy stock. But more generally, the greenshoe is a way to provide the market with a nice extra slug of shares, which everybody wants if the stock trades substantially higher than its IPO price. The greenshoe does, however, raise certain existential questions... Do those extra 63 million shares exist? In one possible world the shares trade happily on the open market, in which case Morgan Stanley will exercise its option, and force Facebook and its investors to cough up the last 63 million shares; at that point, they certainly do exist. In another possible world [that is most likely given where Facebook is trading right now], Morgan Stanley ends up buying back those 63 million shares on the open market, thereby reducing the number of shares actually trading to the original 421 million. '¦ Which in turn means that over the course of the first two or three trading sessions, Morgan Stanley will have ended up buying 63 million shares of Facebook on the open market. It sold those shares at $38, remember. '¦ [If] it ends up buying a slug of shares below $38, then it’ll end up making a profit.” (Felix Salmon via Reuters, May 21)

A sweaty broker is a good broker... “If you want to know how ethical your broker is, give them a moral dilemma and see how much they sweat before deciding what to do. It's quite a jump from the laboratory to real-world decisions about asset management but British researchers have found that gut feeling can override rational thought when people are faced with financial offers that look unfair. Even when we could benefit, a physical response like sweating can make people reject a financial proposition they consider to be unjust. Researchers... gave 51 people a series of offers based on dividing 10 pounds ($16) between two people. They found that although an offer to split the money 50:50 was mostly accepted, an offer of less than a 'fair share' was often rejected, even though rejecting it left them with nothing. The game... showed gut reactions, especially made under time pressure with incomplete information, can lead to decisions that are irrational from a purely economic perspective. The researchers measured how much participants sweated through their fingertips and how much their heart rate changed. ... Participants were also tested on how accurately they could monitor their physical responses by counting their own heartbeats. Those who were most accurate were more prone to having their bodies dictate their decisions in the game.” (Reuters, May 22)

Baying for blood... “Ronald Reagan's foundation expressed outrage at a British company's auction of what it says is a vial of the late US president's blood taken at the hospital where he was treated after a 1981 assassination attempt. PFC Auctions, a company based in Guernsey in the United Kingdom, announced on Sunday that it would sell the vial of blood in an online auction... The latest bid for the vial stood at 6,270 British pounds ($9,910).” (CNBC, May 22)

Video of the Week: Buy Bill Gates' Porsche... A Porsche 911 once belonging to Bill Gates will go under the hammer in Vienna next week. The 1979 turquoise Turbo model bought brand new just four years after he set up his software business in 1975 is expected to sell for up to $63,000.

(Bloomberg, May 17)

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