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A bearish view of market prospects

This article appeared in the July 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

This analyst says chart patterns suggest further falls ahead for Australian shares.

Photo of Alan Hull By Alan Hull, author

If you watched my ASX Investment talk in early March you would know my outlook for global markets is bearish. In short, I think global markets are all due to turn further down in unison in the coming months - with the exception of China, which is already in a well-established bear market.At home, the All Ordinaries has been caught in a four-year consolidation pattern (sideways movement) that I think it is about to break out of. Sadly, I expect it will be to the downside, as I demonstrate in the chart below. It may jump around a bit beforehand but will eventually make its move and my money is on a breakout to the downside.

(Editor's note: Do not read the follow commentary as stock or strategy recommendations. Do further research of your own or talk to your financial adviser before acting on themes in this article. Remember that different views, bearish or bullish, make a market and that they do not take into account your individual circumstances or investment horizon).

All Ords ASX-Weekly chart - 2009 to 2013

All Ords ASX-Weekly chart - 2009 to 2013

Created with SuperCharts by Omega Research © 1997

My recommendations for local investors are:

  • Sell down your growth portfolio because most growth shares are shrinking, not growing.
  • Hold but don't buy income shares (ie with high dividends) right now as they are generally overpriced.

I will drill down deeper into our market and qualify these recommendations. Reviewing the leading resource stocks is fairly easy because the charts of BHP Billiton, Rio Tinto and Fortescue Metals Group all look the same and are headed the same way - down.

BHP Blt-Weekly chart - 2011 to 2013

BHP Blt-Weekly chart - 2011 to 2013

Created with SuperCharts by Omega Research © 1997

What's more, the chart of BHP bears a close resemblance to that of China's Shanghai Composite Index. It's in a bear market and has been for more than three years.

These are our best known and favoured growth shares of recent times but at present they are shrinking and have been for some time. Hence my recommendation to sell down your growth portfolio.

Income shares with good dividends

You should only buy income shares when markets are depressed, not when they are rallying near their highs. In August 2011 I suggested at an ASX lecture that ANZ was looking like an attractive proposition as an income share. Purchased around that time (just below $20) and based on the current dividend per share, your yield would actually be about 7.9 per cent now. That is a lot better than below 6 per cent if you had bought it around $30 in the past few months.

Thus, I suspect a key reason for all the recent interest in chasing yield is because our market has been in a sideways consolidation pattern for the past four years.

There has been very little prospect of achieving capital growth. Combine this with the poor performance of our resources sector (thanks to China), and low term deposit rates, and I guess chasing dividend yield is the next logical option. The following chart shows China's Shanghai Composite Index caught in a three-year bear market.

Shanghai Comp-Weekly chart - 2010 to 2012

Shanghai Comp-Weekly chart  - 2010 to 2012

Created with SuperCharts by Omega Research © 1997

Of course, there is also our record low interest rates and so on a comparative basis ANZ's current yield of around 5-6 per cent looks pretty good. But interestingly Warren Buffett does not analyse yield on a comparative basis. Based on his purchases during the GFC in 2008, Buffett would appear to have a minimum benchmark of 10 per cent. Hence he purchased $3 billion of General Electric (GE) preferred stock with an annual yield distribution of 10 per cent.

He also made several other large purchases with similar annual distributions, and when I recommended ANZ in 2011 the yield (when taking into account franking credits) was in the ballpark of 10 per cent.

Who does purchase yield on a comparative basis? Fund managers who are being benchmarked against fixed-interest investments do, and that is what sent high-yielding shares such as the big four banks and Telstra into the stratosphere recently.

Sadly, it looks as if a lot of retail investors jumped on this bandwagon in the mistaken belief that a high-yielding stock automatically makes a great income share. That is not necessarily the case.

Beware dividend traps

It is really important that a company you purchase for income does in fact have the ability to grow its income. Interest rates change over time but the yield you buy at is largely fixed and only changes with increases in actual dividend distribution.

A 6 per cent yield may look really great compared to fixed interest of 4 per cent, but not so great if returns on low-risk fixed-interest investments grow to 6 per cent-plus. That is possible if inflation starts rising and central banks start raising interest rates in response.

If there is no improvement in earnings/profits there is commonly no increase in annual distribution and therefore no increase in your yield. This is assuming yield is based on your purchase price, which is how I calculate it. Therefore, timing your entry when you buy income shares is important and aiming for an absolute (not comparative) benchmark such as 10 per cent is a good idea.

Telstra as an example

I use Telstra to prove my point. Earnings per share (EPS) have not significantly increased since 2004, nor has the annual dividend per share. EPS growth for the past 4 years has been negative, and dividends per share have been 28 cents per year since 2004 and are projected to stay at the rate for some time.

If you bought Telstra at $5 you should be happy with a yield of 5.6 per cent. But what if interest rates go up and you are stuck with a not-so-attractive yield? You could buy more Telstra shares when the price drops and average down your buy price and average up your yield. This is commonly referred to as dollar-cost averaging.

But there's a caveat: you have to believe Telstra has a long and prosperous future because this tactic assumes you intend to stay in Telstra shares for a long time. When I analyse its share price, the long term does not look too flash. Below is a monthly chart of Telstra, back to 1998:

Telstra-Monthly chart  - 1999 to 2012

Telstra-Monthly chart - 1999 to 2012

Created with SuperCharts by Omega Research © 1997

In the longer term, Telstra has repeatedly cycled up and down, while ultimately working its way lower. And at present it is on a cycle high and therefore the next anticipated move is down. Looking forward, I don't see any earnings growth or share price growth, so you would probably be stuck with the current yield if you bought Telstra - and the possibility of a falling share price if markets turn lower, as I expect.

There is a much better story for the banks as income stocks because they have actual earnings growth, even if they are somewhat overpriced.

In summary, I repeat my recommendation: hold but don't buy income shares right now as they are generally overpriced.

About the author

Alan is a second generation share trader, fund manager, businessman, writer, mathematician, I.T. expert and popular speaker on the seminar circuit. He is the best-selling author of 'Blue Chip Investing' and 'Active Investing', both by Wrightbooks. Alan has also managed millions of dollars of other people's retirement funds, his performance beating all the major ASX market averages.

From ASX

The ASX Charting Library has a wealth of information on technical analysis.

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