Hard To Be Bearish Equities Short Term

It appears funds managers in Australia found themselves with too much cash on deposit, and with no weakness in September. The industry thus decided it's best to start moving some of that cash into the local share market.

Investors should also note that with an unexpectedly buoyant October, year-to-date total return for the ASX200 has now accumulated to circa 8% with banks and companies such as Aristocrat Leisure, Incitec Pivot and TechnologyOne yet to report and pay out final dividends.

This is far from bad for a year that had major indices boxed in a tight range throughout most of the five months preceding.

As far as I see it, this market has two obvious problems: having finally broken out of its sideways range to the upside, the ASX200 is now staring at the 6000 level, which might prove one mighty barrier to break through. The market broke through this level to the downside in the first quarter of 2008 and never felt confident enough to reach above it on the two upswings in 2015 and 2017 that pushed the index near it.

The second threat could be US equities running out of puff. I know what you're thinking: there's a whole army of worrywarts and bearish commentators who have been predicting a pullback for US equities for quite some time, and it never seems to happen. One day it will though, and that one day can just as easily be this week or next month; there is no rule that says the next correction has to occur past Christmas.

Valuation Constraints

Whereas resources stocks such as Rio Tinto, BHP and Oil Search are still trading well below consensus price targets, many others including Woodside Petroleum, Iluka, Western Areas and Independence Group are trading near or above target. Most importantly, two out of the Big Four Banks are now also above target, with ANZ Bank and Westpac respectively having only -0.7% and -1.1% left to fill.

In particular the fact that CommBank shares are now 1.3% above target, and National Australia Bank shares 3.7% above target indicates to me this market is already stretching itself near to full capacity. Not fully there yet, but close. NAB is about to pay out 3% to shareholders and analysts might well lift price targets a little bit post the upcoming FY17 release, but by how much exactly is realistic?

Last time the banks released financial results, in May (June for CBA), consensus targets hardly moved and they are lower today for all Four Major Banks.

The reason as to why investors should pay close attention to where bank share prices are vis-a-vis consensus targets is because history shows a close correlation between local risk appetite and banks surging beyond targets. Pre-2008 I used to warn FNArena subscribers on a regular basis about domestic shares overheating and every time this was on the basis of bank share prices moving too high. Every time, without exception, a pull back or correction for the share market in general followed next.

As the banks have wrestled with their own specific sector problems post GFC, this correlation has not always remained in place throughout the years past. But I have little doubt it has been reinstated in 2017.

Hence, the most important question to ask as we are about to close off on a very strong October, is: what makes this time different?

The answer might well be that ANZ, NAB, Macquarie Group and Westpac have as yet not reported and share prices are likely to remain supported until those fully franked final dividends are removed from share prices. Westpac closes off the season on November 6th, with CommBank providing a first quarter update two days later.

The usual seasonal pattern, if it can be relied upon this year, is for a share market dip in November, followed by a rally into the new calendar year.

Laggards And Shorts

Large cap stocks near full valuation is not what you want to hear if you are right now a fund manager with too much cash eager to be deployed. Already the past weeks have proved to be an absolute bonanza for many of the must have star stocks among the smaller and midcap names on the ASX.

Think a2 Milk. Mineral Resources. Afterpay Touch. WiseTech Global. Share price performance on recent charts looks vertical! Plus witness how quickly GUD Holdings shares surged from $10.50 to near $12; on one broker upgrade. Domino's Pizza shares rallied from below $40 to near $50 in a heart beat. The same goes for Blackmores (below $90 to $140), Platinum Asset Management (below $4.50 to above $7), and Santos (below $3 to $4.30).

But these opportunities cannot absorb all the cash that is looking to buy. Perennial dogs like QBE Insurance, AMP and Telstra have already moved off their lows.

It is not inconceivable investors' attention will increasingly focus on laggards outside the ASX Top50. It is here where a Bapcor, even after the recent rally, is still more than -15% below target. Similar for Webjet. APN Outdoor is more than -16% below target.

None of these stocks are without question marks, and they may not fill the gap in full in weeks to come, but at the very least there is a suggestion these share prices are not overly expensive, with plenty of room left to move to the upside.

In the absence of a full retreat in risk appetite, which would probably follow if and when US equities had a decent correction, it may well be there are still decent gains, and trading opportunities, to be had, even with the major index, and many a large cap stock, seemingly offering limited upside from here.

One obvious question to ask, in particular if investors own one or more stocks that carry a large contingent in short positions, is whether some of these shorters aren't feeling quietly uncomfortable in the face of more cash flowing into the share market? If they lose their nerve, sharp rallies can occur (see The Short Report on the FNArena website).

Another question would be that if a given stock looks cheap, and it simply cannot move higher, even in this context, then maybe it's not a bargain, but a potential value trap instead?

All in all, it is but logical to expect a pause in the October rally, also because bank share prices seem valuation constrained, but with funds managers looking to deploy more cash, and no obvious trigger on the horizon for a sell-off (best not forget the season either), it remains a tough ask to turn genuinely bearish on this share market in the medium term.

It is more likely, I suspect, fresh money will zoom in on laggards and further opportunities outside the top end of the market. I would not expect to see much weakness for the market in general, nor sustained, unless the overall context changes dramatically.

By Rudi Filapek-Vandyck, Editor FNArena - (VIEW LINK)

FNArena is a supplier of financial, business and economic news, analysis and data services.

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