Citigroup’s [NYSE:C] assessment of the Aussie stock market is gloomy. They say it’s the worst time for investors to find real value in the market in a long time.
The average price to earnings ratio is the highest it’s been for two decades. In financial jargon, that just means that the market is flooded with expensive stocks — resulting in lower returns for investors.
That’s despite the stock market rising 7% in value year on year. But it’s still not enough for bearish investors who feel that stock prices will fall from these heights.
Why it’s not just commodities dragging the market down
You may be aware that resources have taken a battering. Commodities prices have dropped sharply since last year. Everything is down — iron ore, coal and oil have all taken a hit. But Citi aren’t blaming the lower than expected growth on the resource sector alone.
Once the resource sector is stripped out of the equation, the average price to book valuation of the rest of the market looks even higher. In other words, investors can’t find the kind of overlooked, low priced stocks that they could in the past.
But I want to go back to commodities for a moment. I’m not convinced we need to lump resources in the same basket. It’s true that iron ore may stay below AU$60 a tonne for years. HSBC just last week predicted that iron ore prices wouldn’t recover above US$50 until 2019 at the earliest. But it doesn’t sit well with me to include oil with the other commodities.
Oil price volatility is down to politics more than supply and demand economics. Saudi Arabia alone could send your petrol back above AU$1.60 a litre overnight, if they wanted to. All they’d need to do is make a passing comment about a cut to global oil supplies. Then just sit back and watch the markets scramble.
Why Citi is wrong to write off commodity exporters
Citi remain bearish on commodity exporters. They say the return on equity in the resource sector is likely to remain low. Return on equity measures how profitable a company is. It does this by showing how much profit a company makes with the money shareholders have invested.
But I’m going to borrow some advice from my colleague Bernd Struben. As managing editor of The Daily Reckoning, Bernd knows his stocks.
He might not agree with me that commodities aren’t as risky as Citi believe. But he does say that companies providing shareholders real value are worth investing in — even when stocks are down. Companies looking to grow their market share, to pay down debt, and to improve investor confidence (through buy back schemes for example) are worth their price in shares. Both Rio Tinto [ASX:RIO] and BHP Billiton [ASX:BHP] have been doing exactly that.
Instead of simply chasing stocks with high returns on equity, investors need to consider what else a company is doing to increase value for investors.
Citi’s five stocks tipped to rebound this year
Alongside their cautious outlook for the ASX, Citi have given investors some stock tips for this year. I should warn you that these aren’t high return on investment picks. They’re the so-called recovery stocks. These are companies with falling share prices that (Citi feel) may recover their losses this year. Without further ado:
- Woolworths [ASX:WOW]: Down by AU$5 dollars since February (trading at AU$29.20 as of May 1)
- Orica [ASX:ORI]: Down AU$2.19 since July 2014 (trading at AU$20.40 as of May 1)
- Fletcher Building [NZE:FBU]: Down AU$1.44 since April 2014 (trading at AU$8.26 as of May 1)
- Coca Cola Amatil [ASX:CCL]: Down 80 cents since early April (AU$10.22 as of May 1)
- QBE Insurance Group [ ASX:QBE]: Down 50c alone since Wednesday (trading at AU$13.56 a share as of May 1)
Investors will have the final say on whether these stocks rebound. If they’re right, buying in now could provide solid returns for investors. But remember that just chasing quick returns isn’t the way to successfully manage your portfolio. As Bernd would say, more risks equals…more risk. That’s why he’s written a free report, ‘Three Essential Rules to Boost Your Profits and Lower Your Risks’, to help you understand the golden rules for creating wealth in the stock market. To find out how to download his report, click here.
Contributor, The Daily Reckoning