A colleague believes the Australian sharemarket will later this year enter the third phase of a bull market, where “irrational exuberance” takes over and prices rally.
According to Dow Theory, the bull market’s first stage is the “accumulation phase”. Here, the smart money starts accumulating stocks, usually at the end of a downtrend and before the next uptrend starts. Investor fear makes this a hard phase to spot.
The second phase, “public participation” is characterised by a decline in negative sentiment as earnings growth and economic data improve. As investors return to the market, a new uptrend begins, often longer and more rewarding than that of other phases.
Enter phase three: “excess”. By now, the smart money is scaling back positions and selling shares to latecomers to the rally. Naïve investors believe the hype and buy near the market top. As folklore goes, “taxi drivers start giving share tips”.
My friend, a combiner of fundamental and technical analysis, is a good judge of markets and has made plenty of money over many decades. He’s an avid follower of equity cycles, so I respect his views, even though I’m not entirely convinced the bull market’s third phase is about to start.
There are signs. Several leading fund managers this year have warned that the Australian sharemarket is overpriced and that they are scaling back positions. Many speculative mining stocks have rallied and the Initial Public Offering (IPO) market is rapidly recovering.
The iron-ore price has broken through US$90 a tonne, a rally that has lasted longer than commentators expected. The interim profit so far has been a touch better than expected and economic data, principally business sentiment, is improving.
The rally in US equity prices (surely that market is in the excess phase) and expectation of a Trump-inspired lift in global growth are other positives for Australian shares.
But the excess or euphoria that characterises the bull market’s third stage is still hard to find in Australia. The market is in an unforgiving mood, punishing companies that miss earnings guidance. The S&P/ASX 200 is still well off its record high.
Beware extrapolating models based on the past to the present. The effect of the 2008-09 Global Financial Crisis, and the international monetary policy experiments that followed, is unprecedented. Hoping that sharemarkets follow a similar pattern, and that cycles play out as they have in the past, is dangerous in uncertain times.
Nevertheless, I am bullish on Australian shares and expect a few good years – provided Trump does not permanently wound global trade or start a war. A jump in business confidence, reflected in NAB’s latest monthly conditions index, is encouraging.
If the market has a run at its high – (6,828 points for the S&P/ASX 200 index in November 2007) in the next 18 months, it is worth thinking about stocks leveraged to the rally.
Many active investors and traders will focus on smaller, speculative companies in strong price uptrends, knowing they need tight stop-losses (a pre-determined point to sell) if the music stops. Portfolio investors might prefer larger companies that benefit from rising markets.
Listed wealth managers are an example. Rising markets typically increase their assets under management, from higher fund inflows and as portfolio values expand. More funds mean more fees, profits and ultimately higher share prices.
The wealth managers’ leverage to equity market conditions, of course, works both ways. They can be terrible stocks when assets under management are contracting, although the best managers often diversify across markets and asset classes.
I have nominated several wealth-management stocks for The Bull in the past two years, principally because of an expectation of better equity market conditions. Magellan Financial Group, Platinum Asset Management and BT Investment Management were preferred ideas.
Magellan and BT Investment Management have performed solidly over that period; Platinum has disappointed and issued a weak trading update this year.
Platinum looks marginally undervalued after recent price falls. The well-run BT Investment Management has plenty of long-term upside, but its exposure to the United Kingdom, through J O Hambro Capital, could weigh on funds flow, post Brexit.
Magellan looks interesting, down from a 52-week high of $26.05 to $23.70. The company’s interim FY17 result, released earlier this month, met market expectation. First-half growth of about $3 billion in funds was solid and the cost-to-income ratio eased slightly.
Chart 1: Magellan Financial GroupSource: The Bull
Underperformance of the Magellan Global Fund and Magellan Infrastructure Fund, over three months and one year, was the main concern. Still, it’s far too soon to say Magellan, among the market’s top global equity investors, is coming back to the pack.
Earnings growth will be helped by Magellan’s launch of three low-carbon funds, two of which have already been seeded by institutional investors. The company’s ASX-listed funds, while small in its overall funds management, are another growth source.
New products and rising global equity market should underpin continued growth in assets under management, as Magellan’s record of investment outperformance reasserts itself.
A median price target of $26.80 for Magellan, based on the consensus of 11 brokers, suggests the stock is undervalued. I am not as bullish, but expect a solid double-digit total return (including dividends) over one year from one of the market’s best wealth managers.
The risks are on the upside with Magellan. If global equities are entering the third phase of a bull market, funds under management could grow faster than the market expects. But if the market rally loses steam and volatility spikes, owning shares in high-quality wealth managers that perform in up and down market provides comfort.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at February 22, 2017.