CBA and Rio: The market has one wrong
The market is pricing very different futures for Commonwealth Bank and for Rio Tinto and they both can't be right, says Gaurav Sodhi.
In marking up the share price of the Commonwealth Bank (CBA) to over $70 and slashing Rio Tinto's share price to $55, the market is making a judgement on both businesses: that CBA will thrive and Rio struggle.
It's an easy conclusion to draw. CBA operates a lucrative franchise in Australia with limited competition, sensible management and stable domestic conditions. Rio, meanwhile, is being whacked by falling iron ore prices, a disastrous acquisition and concerns about its largest customer, China. The market's verdict appears, at first glance, entirely sensible.
Yet much of CBA's own success depends on the success of the domestic economy which, in turn, depends on the success of China. Australia has been the fiscal oasis of the developed world not because it is inherently robust but because of its trade links with Asia. If China falls, so will the local economy. That will surely mean higher bad debts, falling house prices and less lending.
The fates of CBA and Rio Tinto are linked. Yet in pricing CBA and Rio as they are today, the market is suggesting otherwise. The future that is priced in for CBA cannot also be the future priced for Rio. Either CBA is too expensive or Rio too cheap. The market has one of them wrong.