A- A A+

Is the share market a good play?

Broker reports editor |  26 November 2013  |  Portfolio

“Bet”

Share ownership has sharply declined in Australia since 2007, despite the market showing some strength. In 2007, shares were about 40% of all super fund assets, now they are only about a quarter. More surprisingly, there has also been a decline since 2011, when shares were about a third of super assets. This probably reflects the rise of SMSF super. SMSF investors are more averse to shares than professional intermediaries. Outside super funds there has also been a decline in interest. In 2007, shares were about 10% of all household assets, now they are below 6%. It is a big drop.

Should shares be increased in portfolios? There are many ways for SMSF investors to assess the value of shares (equities). One way is to compare them with bonds. This is done by taking shares' earnings multiple (price earnings ratio, or PE, which is the share price divided by the earnings per share) and comparing them with interest rates. Deutsche Bank has looked at this and concluded that Australian shares are relatively cheap compared with bonds, but not with other stock markets.

The problem with this analysis is that fixed interest markets, due to the GFC, are extremely distorted -- more so than any time since the Great Depression of the 1930s or the Second World War. Still, it is worth seeing how Deutsche goes about doing its comparisons:

"Australia looks expensive vs other markets, but should stay supported. While the Australian PE ratio is quite high vs global markets (both in absolute terms and relative to history), we see it remaining supported for two reasons. (1) The cyclical parts of the market have arguably been under-earning (reflected in their share of market cap around a decade low of 37%, vs the average of 44%), and investors might look forward to normalization. (2) Fund flows are likely to stay supportive. Both super funds & households are underweight equities, and super funds are receiving robust inflows ($120bn annually, 50% of which is discretionary) which need a home.

Traditional PE ratios are quite high, but alternate measures are a little cheap The PE on 1-year forward and trailing earnings is above long-run averages (by 7% & 18%, respectively). But the ‘cyclically-adjusted’ PE (using 10-year trailing earnings) is 5% below the 50-year average. The other PE we consider uses the next year of earnings that are actually delivered, and has averaged 15.3x. If forecast earnings are broadly achievable, (which is our view, given improved EPS revision momentum) the current 12m forward PE of 14½x is a touch cheap."

Deutsche's key message from looking at four types of price earnings ratios is that the market is 4% more expensive than it should be. That is assessing it in terms of historical averages or international equities. But when you look at fixed interest, shares start to look good value:

"Equities look good value vs bonds even if bond yield track higher As is well known, equity yields are cheap vs bond yields. However the gap is less pronounced when we use real, rather than nominal, bond yields, which has a stronger theoretical backing. All up, equities look ~18% cheap vs bond yields, and 4% expensive on PE ratios. Taking the average suggests the market should be 7% higher, which corresponds to our target valuation of ~15½x on 12m forward earnings. Applying that multiple to future earnings that we expect to be a little below forecasts gives us our ASX200 targets."

Deutsche likes cycical stocks rather than defensive stocks, which it thinks are undervalued. A big reason for thatdefensives are liked by DIY super investors, who prefer low risk corporates, with their high dividend yields. But Deutsche is advising to look a little further:

"Australian cyclicals are less expensive, and the fund flow backdrop looks supportive Even so, we see scope for the market to remain supported relative to offshore, for two key reasons. Firstly, cyclical stocks are arguably under-earning, as suggested by their low share of market cap. Resources & cyclical industrials together account for 37% of the market, compared to the 10-year average of 44%. A normalization of earnings in time should lift this ratio, and investors may be willing to look ahead and pay a higher near-term multiple than normal."

The belief that funds will flow into cyclical stocks is questionable given how low risk SMSF investors tend to be. But it is worth a look.

 




Similar articles from Portfolio

Warning: Super is coming under pressure

PSI | 11/24/2013

 PressureThe signs are growing that as government finances come under pressure, super will be targeted. A Grattan Institute report has called for big tax changes. DIY super investors have to plan accordingly.


Look overseas, but with care

PSI | 11/18/2013

Economies Investors who invested overseas have done well over the last year -- and that is with the $A still at historically high levels. The reasons to look offshore remain, but great caution is needed. The economies of the developed world remain under long term pressure and big companies are still reluctant to invest.


Developing world worth a look

PSI | 11/17/2013

Developing The $A is high and SMSF investors should be looking offshore for some diversification. The developing world offers some high revenue-generating stocks, but there is also a higher level of risk in what are immature capital markets.


Is the party over for banks?

Broker reports editor | 11/14/2013

Party OverBank shares have almost trebled in value as a proportion of the share market over the last four years, a  reflection of the high dividend yields, which are tax advantaged. But is the party over? Some brokers are suggesting it is.


Banks run equal race

PSI | 11/5/2013

 RaceA rule of thumb in investment is that big companies which enjoy large market shares rarely outperform each other in the longer term. This has been the case in Australia's concentrated banking sector, which increasingly dominates the ASX.


 

Subscribe

Subscribe to the Personal Super Investor weekly email to keep abreast of developments in SMSF law and investment markets. SMSF investors looking to improve investment returns from shares, property, cash or other specialised investments, will find the PSI weekly newsletter an invaluable resource.

Subscribe now »

Disclaimer

The contents of this website are of a general nature only and have not been prepared to take into account any particular investor's objectives, financial situation or particular needs. Our content is not intended to be advice and must not be relied upon as such. You should seek independent advice tailored to your specific circumstances prior to making any decisions. Personal Super Investor does not provide financial product advice or recommend any financial products: Where this website or it derived newsletter/electronic publication refers to a particular financial product, whether it be within our editorial or a 3rd party advertising, advertising promotion or advertorial, then you should obtain a Product Disclosure Statement (PDS) relating to that product and consider the PDS before making any decision about whether to acquire the product. We also recommend that you should seek professional advice from a financial adviser before making any decision to purchase any financial product referred to on this website. We do not make any representation or warranty that any material on the Personal Super Investor website will be reliable, accurate or complete, nor do we accept any responsibility arising in any way from errors or omissions of our content or any content provided by any advertiser appearing the Personal Super Investor website. We will not be liable for loss resulting from any action or decision by you in reliance on the Material (whether editorial or advertising) on the Personal Super Investor website, nor any interruption, delay in operation or transmission, virus, communications failure, Internet access difficulties, or malfunction in your equipment or software. By using the site you acknowledge that we are not responsible for, and accept no liability in relation to any content contained on the site that you may use, including any other users’ use of the Personal Super Investor website in any circumstance. You use the Personal Super Investor website at your sole risk.