Is This The Melt Up?

Rudi Filapek-Vandyck

The difference in internal market dynamics in Australia and the USA was almost perfectly illustrated by market updates from Amazon overseas and from ANZ Bank ((ANZ)) in the local market.

Whereas the internet shopping leviathan significantly outperformed market expectations, leaving analysts scrambling for estimates upgrades and even higher price targets, ANZ Bank's FY17 report provided more evidence the majors are currently enjoying an operational sweet spot, but it couldn't quite match what analysts were expecting.

Amazon shares jumped by double digit percentage, ANZ Bank shares fell.

Not helping matters is ANZ Bank's consensus price target has now fallen to $30.50 from $30.75 prior to the release. This doesn't seem like a big deal, but the share price already is trading above $30 and prior to this year, every release of financial numbers would be followed by at least a mild increase in stockbroker's price targets.

Not this time, thus.

It didn't happen in May either, at the half-year mark, and back then ANZ Bank shares, trading above target at around $33, fell whole the way to $27 after the event, including payout of 80c in interim dividend. Investors will be hoping history won't repeat in the coming weeks as weaker banks will almost certainly scupper any ambition for the ASX200 to finally crack the 6000 level either side of Christmas.

Fingers crossed National Australia Bank (NAB), Westpac (WBC) and CommBank (CBA) will deliver a Macquarie rather than an ANZ in the coming ten days?

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Either way, it should be obvious market dynamics in the USA are very different from those in Australia. In the US leading companies are beating market expectations with a smile, creating more upside potential, even though share prices already have been running very hard for a long while. Funds managers are very much fully invested. Valuations are high. Volatility seems low. Market breadth is narrowing. Momentum looks to be running out of puff, sometimes, but somehow there's always a new trigger to push markets higher.

In Australia, the contrasts are sharp and pronounced. Here the index has finally jumped higher in October, after five months of general inertia on low volumes. Funds managers are still cashed up. They would love blue chip stocks like ANZ Bank to provide them with plenty of reasons to push the share price back to levels last seen in May, but it simply ain't happening.

Instead, money is flowing into the second and third tier where stocks including a2 Milk, Blackmores and Altium can do no wrong. Their share prices simply look spectacular on price charts this year. But how long can this go on? Look carefully at recent price action for the likes of Afterpay Touch, WiseTech Global and Mineral Resources and it might be interpreted as share price rallies hitting a ceiling?

Market strategists at Citi think there's enough around to stay positive. They observe analysts' earnings estimates are slowly increasing, predominantly for resources stocks, but also for banks and industrials. A weakening Aussie dollar should further contribute to this. (FNArena's daily monitoring is still registering more downgrades than upgrades).

In addition, if US companies see their corporate tax rate cut, part of corporate Australia will benefit too. CSL (CSL), ResMed (RMD), Cochlear (COH), Aristocrat Leisure (ALL), Computershare (CPU), Amcor (AMC), Boral (BLD), Orora (ORA), BlueScope Steel (BSL), James Hardie (JHX), Brambles (BXB), Westfield (WFD),... they all have substantial operations in the country.

Citi maintains the ASX200 is poised to successfully break through the 6000 barrier, and reach 6250 by mid next year. Thereafter, things are expected to get more hairy, also because by then markets might be zooming in on rate hikes, again.

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Market strategists at Credit Suisse are more bullish than their peers at Citi. Credit Suisse believes as long as the RBA remains on the sideline and keeps its finger far away from the interest rate hike button valuations are set to remain higher for longer. Hence why CS's target for the ASX200 is 6500 by year-end 2018.

Credit Suisse sees a new upswing in global corporate earnings growth opening up, and corporate Australia is set to command its share too. In a dumbed down version of the CS formula for the year ahead, delayed central bank action feeds into higher corporate profits, which translates into higher share prices.

Simple.

Against this background, UBS strategists recently expressed their concern with the market's affection for proven high growth, high Price-Earnings (PE) stocks such as Cochlear, CSL, REA Group (REA), Seek (SEK), ResMed, and others. All of these stocks are currently trading on above average multiples against their own history, warns UBS. Exercising at least a degree of caution would seem but the prudent approach.

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I remain of the view that mid-tier companies and laggards will increasingly land on investor radars, deterred by valuation limits in the top end of the market (see ANZ Bank, others), for as long as US indices retain their positive momentum.

Which is why the view of Vincent Deluard, President, Global Macro Strategy at INTL FCStone has attracted my attention. Deluard believes US equities are in "melt up" mode. This is the opposite of melt down. Melt up is an oft used description among US commentators this year and Deluard suggests this usage is probably correct.

On his own definition, melt ups occur when markets record new all-time highs in combination with year-on-year gains of at least 20%. They end when indices sink below the six month moving average. Bounces from corrections do not qualify. Others might add this is when investors throw all caution overboard and join the bandwagon, because they can no longer resist and fear missing out on ever accumulating gains. This is when share prices move higher because they are moving higher, and more money keeps on flowing in.

Melt ups have a bad name because they have preceded some of the ugliest bear markets in history, including 1930, 1987 and 2000. Some might include 2007 as well.

Deluard has a different view. On his analysis, since 1900 US equities have experienced no less than 77 melt-ups, representing 16 years in total duration, or about 14% of total time since. The average such melt-up lasts 45 days and delivers a gain of 5%, but the current version is already running longer than 315 days for gains of 15%. The current version is approaching the 329 days between April 1954 and March 1955. If it continues, it soon will be the longest recorded in history (at least since 1900).

Based on these numbers, concludes Deluard, it's probably safe to say the best days of the present melt-up are behind us. Again, this need not be a disastrous outcome for investors. Out of the 77 melt-ups recorded, only a small number transformed into an ugly bear market (or meltdown). On average, the year following the 76 prior melt-ups has generated a return of 6.8%, which is below the US market's long term average of 8.1%, but nevertheless a far cry from a potential meltdown.

In addition, notes Deluard, market volatility has been extraordinarily low. Combine this with the double digit gains recorded thus far, and the current share market rally sits in the 0.3 percentile of the best times in history. Put otherwise: conditions in the US stock market are now better than 99.7% of all times since 1900.

He thinks there's still a chance some of the funds currently invested in bonds might switch into equities. This would prolong the current rally.

All in all, Deluard is cautious but not yet straight up negative on US equities, arguing he'd rather be a bond bear than a stock market bull.

This is probably as good as any other time to remind investors: this too shall pass. You usually read this when times are tough, but it equally applies when times are exceptionally good.

By Rudi Filapek-Vandyck, Editor FNArena. Investors can check us out for two weeks at no cost and with no obligation: (VIEW LINK)


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richard dobosz

thank u great as always

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