Thursday, 26 January 2012

A short-term dip to come before the bull?

ASX S&P200 XJO 4000 before 5000

I have been developing two fair value market indicators: one based on forecast earnings and the other based on economic indicators. They both are very useful for me in being able to be able to determine market conditions and likely trends. Both these indicators are in continuous development and one area that I had not previously explored was the short-term efficacy. Until now.

Contrary to my prior thoughts about a coming bull run in the markets, I'm not sure if the timing is right. The reason is that the indicators also appear useful in providing guidance over shorter periods. Whilst the longer term direction is certainly up, short-term is decisively down - or at least flat.

Is this a case of trying to peer too far around the corner? Perhaps. We shall see. However the indicators are accurate enough to give me caution for now (although I remain positive on gold and gold equities).

US Fed versus Greece
Markets rallied on the US Federal Reserve FOMC statement last night, with the announcement of continued low rates and the market's assumption that further monetary easing is on the way. In the near term we have Greece attempting settle with bond holders. We have rumblings from Portugal and Spain. Perhaps there is enough there to dislodge the current upswing for now.

The Scenario

*Note: these short-term indicators are newly developed so this is primarily a theoretical exercise at this stage.

A bounce down towards, or below, 4000 in the near term.

Whilst we could see markets run up a little further from here, the indicators are suggesting that it is unlikely.  

The short-term economic model is suggesting either a flat or down market starting very soon and potentially bouncing later in February.

The short-term fair value model is also suggesting a dip soon.

Whilst toying around with short-term indicators and forecasts, I noticed that the long term economic indicator is consistently too early. This is how it looks when the indicator is delayed by around 6 months.


And how it looks over the next six months...

Bringing us back to the first graph, illustrating the potential scenario...

Note that the delayed economic indicator model shown here is a long term directional tool, which does not accurately forecast absolute price levels, but it does appear to work well in picking up the trend.

Tuesday, 24 January 2012

ASX Stock Highlight: Medusa Mining (MML)

With a large correction since September from over $8 per share to recent lows of $4.50 per share, Medusa's share price has taken a big hit. Excellent value at current prices. Potential break out from down-trend.

Monday, 23 January 2012

Mt Gibson MGX: Trade Update 24 Jan 2012

Whilst I still see more upside in MGX, it has run up very quickly since an entry point of $1.18 on 10 Jan, and is up 21% in just two weeks. From a technical stand-point, it appears to be losing momentum, and as such I have exited at $1.43 with the view to buy in again at a lower level.

Entry price: $1.18
Exit price: $1.43
Gain: 21.2%

Remains on watch-list.

ASX Stock Highlight: St Barbara Ltd (SBM)

St Barbara released their quarterly today with gold production up 18% to a quarterly record 83,615 ounces, at consolidated group cash operating costs of $844 per ounce. The cash balance is up 47% to $110 million. 

  • Current mine line forecast at 10 years
  • Substantial additional exploration opportunities
  • Annualised production now at 334,000 ounces of gold
  • Operating cash margin of $744 per ounce
  • No debt
  • Stable gold price outlook

St Barbara now looks very stable, with ample cash and strong financials, it appears to offer great value for an Australian-based mid-tier gold producer. With substantial selling from Van Eyk over recent times, there is a good chance that buying pressure will return.

Entry price today: $2.13

Tuesday, 17 January 2012

Dow Jones Earnings Overview


Dow earnings margins are expected to improve. Revenue per share is up, earnings are up and dividends are up.

Forecast earnings have declined, however there remains substantial room for movement in estimates.

Earnings estimates have been consistently conservative by the time they are announced. On average they have been 5% less than actual earnings.

Economic indicators are bullish, indicating a continued growth in earnings per share at a rate greater than consensus forecast.

ASX Fair Value Update 18 Jan 2012

Markets are turning bullish - Indicators show a long way to go

Very strong moves up seen in the S&P 200 (XJO) over the past month, looking increasingly like a new bullish up-trend.

MacroValue Economic Indicator
Reminder: This is a directional indicator and the fair value target is an indication of strength, but not a hard target.

Very strong economic signals showing through.


 MacroValue Consensus Fair Value

Consensus earnings expectations continue to support a rally. Given the economic signals are in place, it is highly likely that, in aggregate, expectations are met. Whilst this is a moving target, the first half of 2012 is shaping up nicely for a rally.

Monday, 16 January 2012

ASX Value List Jan 2012

  • Company size > $100m
  • Currently earnings positive
  • Does not have problems with data metrics or forecasts (about 5 stocks removed)

The rating is based on a combination of value and quality. Quality is determined quantitatively based on factors such as:
  • Profitability
  • Outlook
  • Growth of company value
  • Liquidity
  • Debt levels
  • Share holder dilution
  • Free cash flow
This list does not take in to account individual company risks, qualitative factors, macro or company specific trends.

Right now, there are many companies which have a good combination of value and quality, whilst also paying a solid dividend yield. It is surprising how few are substantially over-priced. This fits within my theme that the markets should enjoy solid returns in 2012 - at least in the first half.

I may track 6 and 12 month performance figures to compare with this data series.

Stand-out companies:

  • Mt Gibson Iron
  • Silver Lake Resources
  • Troy Resources
  • Medusa Mining
  • Maca
  • Mastermyne Group
  • Decmil Group
  • Seek
  • Cash Converters
  • Computershare
  • K2 Asset Management
  • Seymour Whyte
  • Cabcharge Australia
  • Industrea
  • Sirtex Medical
  • Global Construction Services
  • McPherson's
  • Corporate Travel Management
  • Flight Centre
  • Reject Shop
  • Kathmandu Holdings
  • NRW Holdings
  • M2 Telecommunications Group
  • Automotive Holdings Group
  • Oakton
  • Mineral Resources
  • Rio Tinto
  • ASG Group
  • QBE Insurance Group
  • Slater & Gordon
  • Fantastic Holdings
  • TPG Telecom
  • Imdex
  • iiNET
  • BHP Billiton
  • Reece Australia
  • Woolworths
  • Breville Group
  • Iress Market Technology
  • DWS
  • Credit Corp Group
  • STW Communications Group
  • Gerard Lighting Group
  • GR Engineering Services
  • Sedgman
  • David Jones
  • Myer Holdings
  • Orica
  • Austin Engineering
  • Retail Food Group
  • Codan
  • GUD Holdings
  • SMS Management and Technology

Saturday, 14 January 2012

Price Inflation and the Impact on Equities

ASX S&P200 (XJO) versus price inflation gauge

Given that we are in a global environment where many countries have almost zero interest rates, it is the price inflation flows that have a substantial impact on equity market trends. This structure is likely to last for an extended period and therefore this is a very important indicator to watch.

It appears that we are entering in to a new positive environment for equities providing an upwards bias on prices.

Thursday, 12 January 2012

2012 Equity Market Outlook Summary

2012. Equity Outlook.

Wednesday, 11 January 2012

ASX S&P200 Investor Sentiment January 2012

Investor Sentiment Indicators
(US based data)

AAII Survey
The AAII sentiment survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six monts and measured weekly.

AAII Bear-Neutral-Bullish Split

NAAIM Survey
The NAAIM survey is based on active money managers representing their overall equity exposure on a weekly basis.

Chicago Board Options Exchange

US Equity Market Fund Flows

Source: Zero Hedge

Tuesday, 10 January 2012

ASX Stock Highlight: Mt Gibson Iron (MGX)

Mt Gibson Iron - Macro Value Analysis

Speculative Higher-Risk Value Momentum Strategy

I've been negative on iron ore prices and producers for some time. But one must move with the times and avoid being beholden to a single view. In line with the risk-on theme and the bullish potential for the markets in 2012 - at least in the first half of the year. What comes after this is something that will need to be watched closely, in particular oil prices. As seen below, my macro market indicator is confirming that it is time to be risk on. MGX is one of my positions to capture this move with an entry price of $1.18.

1 year share price

I realise that it is in a technical down-trend, however I'm calling a turn-around here.

The potential value already exists, however the macro trends have been against this stock. Given my view of a turn-around in the markets, I think that the price can now move towards value again. All the figures stack up for me:

  • Broad macro trend is in now in the right direction
  • Substantial value based on earnings expectations
  • Strong uplifts in earnings per share forecast
  • Stabilisation of recent EPS forecast declines
  • Trend up in iron ore prices
  • Consistently increasing forecast earnings per share matched by operating cash flow
  • Strong uplifts expected in revenue per share
  • Growing and solid margins
  • Solid cash liquidity and with growing cash generation likely to turn in to excess cash
  • Stable amount of total shares outstanding and no debt

And Iron Ore prices courtesy of Deus Forex Machina from

Monday, 9 January 2012

The Macro Value Economic Indicator - ASX 5000

Bull market ahead?

As mentioned in looking forward to 2012, I have developed an economic fair value indicator which appears very useful for medium to long term time-frames in predicting the movement of the ASX index - as measured by the XJO (S&P500). Whilst it is not yet useful for absolute price targets, it appears to be exceptionally useful in determining the nature of the markets.

I have performed a more recent update of the economic data inputs that feed through to the fair value indicator and it is becoming very bullish. For the first time since 2007, fair value has clearly surpassed price and is currently sitting at a target of 5000. Based on the historical performance of this indicator, one can clearly see that 9500 was too high in 2005 - however it still was correct in calling the bull market. So until the data flows break down, it looks like the Aussie market could be in for a solid run upwards in 2012.

Historical View

1 Year View

On a shorter-term basis, it is interesting to note how closely the change in the indicator matches market prices - even though no market data is incorporated in the indicator. This is something that I will look to analyse further, however one problem is that the data series lags market prices by up to one month - which is why the most recent figure on the indicator is flat, and is an area that will receive further attention and development.

Good luck to all in 2012.

Saturday, 7 January 2012

2011 Review - US markets and the lack of QE3

On 11 June 2011, I made a post about the lack of further stimulus via another round of quantitative easing (QE3). I came to this conclusion:

Credit market and sovereign debt issues aside, businesses are currently very profitable. Based on consensus forecasts there is a very decent margin of safety between prices and value. This provides substantial shelter in the event that earnings in the near future come in below expectations. I started out being concerned about market levels and whether or not QE3 would eventuate (I think it will), what shape it might take and the timing. I have now concluded that it doesn't matter too much for the market. I think that there are serious issues that the world faces, but the DOW companies are well positioned and are unlikely to fall substantially from current levels as some claim. 

On the next trading day after that post, the DOW was at 11,953. Where is it today? 12,360 or up 3.4%. 

In August/September, a correction did occur, however the type of analysis that I use is not based on short-term trading. The market can diverge from fair value in the sort-term, but the medium term trend can be determined. I am happy with the outcome of this prediction.

Wednesday, 4 January 2012

ASX Fair Value 2012

Australian Share Market Outlook in 2012

2011 turned out to be a very difficult environment in the markets for most people, which is a result of substantial ongoing volatility and broad market declines. We have seen ongoing difficulties in the sovereign bond markets, with a particular (and tiring) focus on Europe which seems never-ending. Overall the financial sector globally has been one of enduring stress with the wax and waning impacts of coordinated interventions followed by systemic de-leveraging and capitalisation issues. So we have had the ups and downs without any consistent direction. Neither have we had any solution to the problems, as there isn't any easy answer. The problem of too much debt in the system is being answered by financial repression: the artificial suppression of interest rates in conjunction with continued currency devaluation. The end result is that negative real interest rates and currency devaluation support share markets.

I have been focusing on the fair value of the markets. I believe that this provides an insight as to the fundamental under-pinnings behind them and gives me confidence in being able to see the big picture. To do this, I have been looking at important company statistics such as cash balances, cash flows, revenue, share issuance, changes to debt levels and so forth. However, whilst these factors highlight stresses or positives in the system, in the end the market is generally priced based on earnings. In particular - forward earnings. The market already knows what earnings have already occurred, and on a broad basis it is efficient based on past data, however the trick is to have an idea of what earnings will be in one or two years time - and hence my thesis is that current prices tend toward fair value based on these future earnings.

As shown above, this is the value trend that we get when using fair value based on past earnings, however it is based on forward earnings - not current earnings. Therefore it works very well as long as you know exactly what is going to happen in the future, which is not feasible. So what happens in reality is that the fair value is constantly being moved on the basis of earnings forecasts - and these forecasts change frequently. This isn't so bad as long as you are adaptable and can adjust as the climate changes. However it isn't ideal. During the lead up to 2007 this graph would have looked differently as analyst earnings forecasts would not have considered a huge drop over the following couple of years - it would have increased during 2006 and 2007. Nevertheless, it is a very useful gauge and can highlight substantial discrepancies between price and fair value.

The forecast earnings trend over the past few months has deteriorated consistently. Therefore fair value as obtained based on earnings expectations 90 days ago would have been higher compared to current earnings forecasts. This is a process of constant reassessment. It is for this reason that I have created a second fair value indicator - one based not on actual (or forecast) earnings, but based on solely on economic indicators - meaning that earnings are completely disregarded! This may sound strange but if one accepts that future earnings are unknown today, but that fair value now is determined based on the expectation of those future earnings, then it is more useful using the economic drivers than the earnings themselves. This applies to the market broadly, but not so much for individual companies (unless their earnings are highly correlated to market earnings). One thing that I have not previously done is to chart out the past performance of the economic fair value indicator. I have now done so and in my view the results are powerful.

The economic indicator is based on actual known information at any given point. Unlike consensus earnings forecasts, it does not rely on constant revisions. For this reason it is much more powerful. It is also very clear that it provided a strong indication of a strong upwards move in the markets during 2003 to 2007. It provided a early and stark warning in 2007 - with the trend crossover in around April of that year. It provided ongoing warnings of a decline in fair value through to 2009. It showed recovery in 2009, however it has not been as optimistic as the market - and it appears for good reason. The ASX S&P200 / XJO index is now roughly where it was in July 2009! The good news is that this indicator is now showing the market slightly below fair value - for the first time since late 2006.

What is the economic indicator that I use? It is a non-equally weighted modified index of important US based economic indicators that include: capacity utilisation, business inventories, PMI manufacturing index, new orders, M2 money supply, treasury rate, corporate bond yields and financial stress index.

I did not create the index to provide a post hoc curve-fitting exercise, but solely to create an indicator that approximated forward earnings. It makes sense that often earnings will be not always be representative of real economic gains, due to accounting adjustments, so the economic indicator is useful to provide a comparison point. As shown to the left, earnings per share are frequently different to the earnings indicator, however fair value as derived by the earnings indicator can change substantially more than the percentage change to the earnings figures - as demonstrated in 2007.

2012 Outlook

Whilst there is a lot to worry about (understatement) throughout global economics - government debt problems throughout the world, banking debt problems, a China slow-down and so-on, the potential impact on real economic earnings is unknown. Sometimes things can change unexpectedly. Therefore it is best to invest on tangible information as opposed to greed and fear.

Economics changes frequently, but often works within a trend. Right now, and since 2009, the trend is up. More importantly for the first time since late 2006/early 2007 fair value based on my economic indicator exceeds the market price. Whilst market price will frequently diverge to measures of fair value, it will move towards it. In addition fair value based on consensus earnings forecasts means that the market is cheap. Whilst I don't expect any major upswings, fair value is headed upwards. Should this trend continue, we could see 5000 again in 2012.

With this in mind, and unless economic indicators fall apart, any short-term price correction should be considered as an opportunity - 2012 is the year of continued volatility, a likely surprise move upwards and continues to be a market where individual stock selection is exceptionally important. My preference is for defensive sectors (e.g TLS WOW CCL), I continue to be adverse to iron ore companies and banks and remain positive on precious metal producers.