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 MARKET REPORTS |
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Analyst report - shares
2008 sector and stock outlook part 1 - global market overview
January 7, 2008
Simon Guzowski, Senior Equities Analyst, wise-owl.com
 After a 17-year dream run of economic growth here in Australia, the cries are getting louder that the good times may be nearing an abrupt halt. Out of nowhere a sub-prime saga has made its presence felt, US home prices have suffered record breaking declines and the ensuing credit squeeze has moved many an investor to the edge of ones seat. To add insult to injury, stock markets the world over have become more volatile, and interest rates in Australia have edged up to the highest levels we’ve seen in more than a decade.
Yet where some see clouds, others see a silver lining, and the environment unfolding in our markets will bring both winners and losers. In our 2008 outlook we will take you through the here and now of the global economy, and give you the inside word on the sectors poised to outperform in the year ahead.
Volatility to continue as sub-prime deteriorates
The volatility we’ve witnessed of late looks set to continue. Driving this will be problems faced by the world’s largest economy, the US. If you thought you’d read enough about sub-prime to last 2 lifetimes, you are in for an unpleasant surprise. Sub-prime is shaping up to be an even bigger story in 2008. The US Federal Reserve has estimated that we could end up seeing some $100-200b in sub-prime write downs.
To date US banks have confessed to $70b in sub-prime write downs, which is actually only a fraction of the estimated size of the problem. Suffice to say the majority of bad news on sub-prime is yet to be confessed to the market by US lenders. As more and more write downs occur, stock markets are likely to stay volatile, and credit markets could become even less liquid.
It is this freezing up of liquidity in credit markets that poses the greatest threat to global growth. Quite simply it means that businesses and people will start finding it harder to borrow money, which should flow into lower levels of spending and economic activity. All that easy money we’ve enjoyed for some time now is starting to dry up.
Australian credit spreads have spiked and are starting to place upward pressure on interest rates. In our view this will reduce the likelihood of the Reserve Bank of Australia lifting interest rates over the first half of 2008, or at least until the impact of this spike in credit markets becomes clear. Australian banks may also be forced to lift mortgages rates as it becomes more difficult for them to source money to lend.
Corporate bond spreads are rising and placing upward pressure on interest rates.
Not all is doom and gloom
There is hope that the booming Asian region will continue to grow at breakneck speed and in doing so offset any slowdown we see in the US. In addition to this, we expect the US Federal Reserve to continue cutting interest rates over 2008 which should boost confidence and help kick-start the US economy.
Global economy and valuations are reasonable
PE ratios are a great way to measure the value of a share market. Fortunately PE ratios both here in Australia, and in most overseas markets are at historically very normal levels. This means that both our markets and the majority of global markets are not in bubble territory. The Chinese and Hong Kong share markets are notable exceptions to this, and are looking expensive.
Generally speaking, global markets are valued fairly.
Painting a potentially bullish picture is the fact that many markets throughout the world are yet to break above previous highs that in many cases were set in the late 1990s. While our market has gone from strength to strength over recent years into record high territory, most markets are yet to break above highs set many years ago. Despite growing concerns over the global economy and a notably defensive stance taken by the European investment community, it has been interesting to see major European indices hold onto levels not too far from all time highs. We may yet see these markets break higher and set new records, which would be technically very bullish (from a charting perspective).
Many global share markets are yet to break the record highs set in the late 1990s including many European exchanges. A break above all time highs would be technically bullish.
Can oil de-rail the market?
Oil came within a whisker of the long awaited $100 mark in 2007, trading at an all time high of $99.29 (before pumching through $100 this week). A slowing economy in the US, which is the world’s largest oil consumer, could put a temporary cap on gains in the oil price. In the long term however, the fundamentals for oil remain bullish. Consumption of oil is rising quickly in a number of key geographies including China (the world’s second largest oil consumer) and the Middle East. We expect this consumption growth will continue to place upward pressure on oil prices.
OPEC seems increasingly supportive of high oil prices
2007 ushered in a period where OPEC has started to show a greater reluctance to lift oil production. In November 2006 OPEC announced intentions to cut oil supply by 1.2mbbl/d, followed by an announcement in February 2007 to cut oil supply by an additional 0.5mbbl/d. Needless to say, oil prices have been on the rise ever since.
OPEC has deflected criticism on its reluctance to lift oil production by increasingly pointing the finger at hedge funds, suggesting that their trading systems are pushing oil prices beyond what supply and demand would suggest is appropriate. The perceived complexity of the trading methods hedge funds use has meant that few have questioned this. Whether or not this is true, OPEC has still made a deliberate decision to stop lifting oil production.
If the world’s largest oil producers are reluctant to increase production even as oil approaches $100 a barrel, it appears the days of cheap oil are behind us. Will this derail the stock market? We suspect not. Oil prices are currently high on the back of booming levels of demand. In the past, high oil prices have caused economic problems when supply shocks have triggered the high prices. A classic example is the oil shock of the 1970’s when OPEC made substantial cuts to oil supply.
Futures markets are less bullish on oil and currently suggest a modest fall in oil prices to a long term price of $89.00.
Many global share markets are yet to break the record highs set in the late 1990s including many European exchanges. A break above all-time highs would be technically bullish.
2008 sector and stock outlook part 2 - sector and stock picks for 2008
Simon Guzowski is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
More articles from the latest edition of CompareShares:
Stock picks: Fund Manager Stock Picks - Siemens and Standard Chartered Bank
Stocks: 2008 sector & stock outlook part 1 - global markets overview
Stocks: 2008 sector & stock outlook part 2 - sector and stock picks
Investing: Gangbuster returns from Aussie microcaps
Superannuation: Borrowing in a SMSF
Commodities: Still bullish on global commodities story
SMSFs: Be wary of promoters - instalment warrants in SMSFs
Markets: Wall St skids amid recession fears
Rates: Major banks may follow NAB rate rise
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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