How about that? Contrary to our gloomy disposition yesterday, the stock market has taken off like a rocket this morning. The material sector is up 2.9% today alone. It was the worst performing sector in Australia on the ASX in 2011, down 25% thanks to lower commodity prices.
Yet this morning copper is up 3%, gold is up 2.5%, and oil prices were up over 4%. We’ll get back to oil (and Iran) in a moment. Commodity prices, though, are reacting to the strongest US manufacturing activity in six months. That, plus a survey indicating an expansion in Chinese manufacturing, has investors throwing caution to the wind and buying with both barrels.
Are Aussie stocks cheap? We broached the subject yesterday but didn’t examine forward price/earnings ratios. So let’s do that! According to data from the Reserve Bank of Australia (RBA), Aussie stocks trade at a forward P/E ratio of just about 10. That looks cheap, historically. But is it?
You’ll note that stocks looked really cheap in 2009 on a forward P/E basis. But it wasn’t because the “E” was growing. The ratio was low because the “P”, stock prices, had fallen quite hard. You can see just how hard from the chart below.
Were stocks cheap in 2009? Well, they were certainly at lower prices than late 2008. But cheap probably isn’t the right word. Before the Federal Reserve began intervening in markets to boost stock and commodity prices, investors had priced stocks for the popping of the great global credit bubble.
The reflation of that bubble – or at least the attempt to make it deflate less quickly – is what drove commodity prices and Aussie stock prices back up. Since then, the market has made several attempts on the 5,000 level and failed. Has something happened in the last two days to make a big earnings recovery in 2012 worth buying now?
We’d say no. But then, we’re inclined to say no, aren’t we? This is a credit depression. Low P/Es are a value trap. The important variable in forward P/E ratios is the analyst’s forecast for 2012 earnings. If those forecasts are bullish (higher commodity prices and GDP growth) stocks are going to look cheap.
Those forecasts are probably way too bullish. Why? Well, there’s the little matter of nearly $7.6 trillion in government debt that has to be refinanced in 2012. This is dead weight. It’s money that’s already been spent. Yet more must be borrowed…and it won’t produce any real economic growth.
What’s more, over the next four years, the G-7 countries alone will have to refinance some $18 trillion in debt. That kind of over-supply of government bonds is massively deflationary. It will suck money out of the private markets. And if the private markets don’t pony up, the central banks will have to “monetise” this debt by creating new money to buy it.
You might be thinking that this is all very scary, but doesn’t really have anything to do with Australia. Yet Australia has to borrow its money from somewhere too. In 2011, banks raised more cash from depositors. But the refinancing needs of corporations and banks will have to be at least partly met by borrowing abroad. There are a lot of companies with their hand out at the moment.
Spare a thought for government debt, too. The current government has repeatedly trumpeted the fact that Australia’s government debt-to-GDP ratio is soooo much lower than everywhere else. That’s true. But it’s growing! Give this government time and they just may catch up!
Australia’s government debt tab went over $200 billion for the first time ever late last year. The Parliament quietly raised the debt ceiling to $250 billion. If lower iron ore and coal prices wipe out the expected revenue from the mining tax, the government could be faced with a bigger gap in its budget than expected.
You know what that means… More borrowing! These things always start out as temporary measures. And they almost always turn into a licence to live beyond your means until your credit rating gets ruined.
But maybe this is all much ado about nothing, right? After all, if things were really bad or getting worse, someone would tell you, wouldn’t they? Maybe not.
According to this report from the Sydney Morning Herald, some information about Australia’s financial system is simply too dangerous for the public to know. The report refers to 12 documents compiled by the Australian Prudential Regulation Authority (APRA) assessing the risks faced by Australia’s banks, insurers, and superannuation funds.
These risk registers were apparently compiled in 2008, after the onset of the financial crisis in 2008. They assessed key risks in Australia’s major financial industries, including a firm by firm assessment. So what did they reveal?
Well, we don’t know. “In my view,” said APRA’s general counsel Warren Scott, “the confidence in the economy may be undermined if the potential emerging risks and APRA’s discussions and thoughts were disclosed … this may have a systemic effect in the industry which may affect the stability of Australia’s economy.”
According to the SMH article, “Mr Scott said release of the registers could influence investing decisions by Australians and harm individual institutions – a reference to behaviour such as a run on a bank when funds are withdrawn all at once.”
Hmm. Of course not all potential risks become actual risks. If you model a scenario severe enough, it will destroy even a sound financial institution. APRA is just being prudent in conducting a candid assessment of Australia’s systemic risks. But shouldn’t that private candour be accompanied by public disclosure? Or is that information only available to people “in the know” and not to the little people (shareholders)?
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