It’s human nature to worry. It’s programmed into us, after all if our ancestors didn’t worry about enough things they were in danger of being something’s dinner. So when good things come along it can be tricky to refocus – we’re wary those lovely autumn leaves might turn into a sabre tooth tiger.
There are only two things to focus on when it comes to share markets: valuations and earnings. If earnings are being delivered and valuations are cheap, there’s a whole lot less to worry about. Headlines announced with dread during February that global shares entered a bear market, which undoubtedly sounds worrying but means valuations have necessarily become cheaper. At the same time we also got the earnings results from both our local and U.S. companies, both of which were pretty good.
Here in Australia our interim reporting season saw just over half the companies deliver results that were above forecasts and more than half saw earnings upgrades for the next 12 months, which is significantly more than we usually see. If you were to exclude the resources companies those numbers get even better.
In the U.S., fourth quarter earnings didn’t look quite as happy with an overall drop of 3% year on year, but once again if you take out those troublesome energy companies the numbers went up. And U.S. companies overall seem to be in rudely good health, with free cash flow per share at a 20 year high, net debt to earnings at a 20 year low and capex (an indicator of future growth) running above the long term trend.
So prices have gone down and earnings are up. Sounds like a bargain?
With the ongoing focus on oil it’s interesting to note that the price bounced some 25% from its February low – see the chart below.
The oil market is all about supply right now. In the last two years demand went up by 3.1 million barrels a day, which is a fair amount and around the longer term average. But over the same period supply went up by 5 million barrels a day, largely because of those pesky shale oil drillers in the U.S., which between them added 4 million barrels a day in just four years – see the chart below. That excess of supply has been going in to storage, but they’re running out of places to stash it.
World oil supply outpacing demand
During the month the Saudis and the Russians agreed to freeze production at January levels, but that was close to record highs. Someone’s going to blink and there will be casualties.
We’ve written a few times about the unforeseen consequences of running the greatest monetary policy experiment in history, and they’re still finding their way to the light of day, like bubbles seeping up through a volcano. The excess oil supply is one of those consequences: there are a lot of shale oil companies that would never have been able to raise the money to do all that drilling if credit markets weren’t so dysfunctional.
Another is emerging market debt, where private credit as a proportion of GDP has increased from 75% in 2009 to 125% now. Over that same period emerging market debt that is denominated in U.S.$ has increased from U.S.$1.6tn to U.S.$3.3tn and a fair chunk of that was to energy companies. So there are a few things to worry about still.
Apparently when people worry they tend to run out and buy gold, thus its title as a ‘safe haven asset’. Gold’s had a great rally, enjoying its best start to the year since 1980 – see the chart below.
But gold seems to be a bit picky about its crises: it hit a 12 month low only six weeks after Lehman Brothers failed in 2008 but then rallied during the European sovereign bond crisis only to collapse again just when Cyprus looked like it was going to sink the EU. The other reason investors apparently buy gold is as a hedge against inflation, but there’s still no sign of that around anywhere. Go figure.
If you look closely enough there will always be things to worry about. After all, since 1960 only three years have avoided a correction of more than five per cent and we’ve seen a 10% correction on average every second year. But if you take a step back, you’ll see that over time markets have a happy tendency to keep trending up – see the chart below.