It’s not really the resource companies driving the profits of the ASX/200. Though we couldn’t break out S&P earnings by sector here in Australia, we did find that financial companies make up fully 44.5% of the market capitalisation of the ASX/200. Materials companies are barely half that at 23%.
Later, over a bowl of pasta on Fitzroy Street, we read how profits from the financial sector all around the globe have made up a large portion of total market earnings. Our friend Dr. Marc Faber reports that, “The financial sector’s earnings rose 14-fold since 1990 to an annualised US$251 billion, whereas the rest of corporate earnings experiences only a fourfold increase to US$636 billion.”
Faber sees the numbers and forecasts doom ahead (it is The Gloom, Boom, Doom report, after all). “If asset markets failed to appreciate further, financial earnings would begin to decline and likely pressure S&P 500 earnings.” Thus the feedback loop of higher financial earnings driving demand for financial assets (stocks and bonds) would be broken. And stocks would fall. A lot, according to Faber.
Faber quotes ABN-Amro analyst Gerard Minack, “arguably there’s been a marvelous self-perpetuating mechanism at work here: the bull market in asset markets has helped drive the financial sector’s performance, and the resultant earnings growth has maintained the boom in equities. That feedback mechanism is stronger in Anglo-markets than elsewhere. While it’s well-known that the UK and US market are over-weight financials, it’s also worth noting that the best total-return developed-world equity market since 19900—Australia—is now 44.5% financials.”
Well there’s an irony and an opportunity for you. It’s not China-risk the local market should be worried about but financial risk. Falling local indices don’t mean you should sell BHP, get out of base metals, and retreat to bank stocks. Quite the opposite actually. S&P ASX/200 earnings could fall dramatically as financial stocks correct. But the resource and material stocks may keep charging ahead, despite the overall decline in the index. Nothing will be as it seems.
For now, the financial deal-flow is still robust, meaning earnings for financial firms are robust too. Australian private equity firms are doing over $1 billion worth of buyouts a day, according to Nicolette Davey at Financial News. That’s news that makes the front pages. And for awhile, it should keep the crash at bay.
We really have no idea what’s ahead. But we think the Melt Up is more likely. Then comes the melt down. But it reminds us to ask, if you have a black-box trading system with all the answers, one that produces perfect buy and sell signals, drop us a line at firstname.lastname@example.org. Until Monday…
Markets and Money