Now that the battle haze has lifted from Iraq and world health authorities are saying the SARS virus has peaked in most of Asia, market watchers are taking soundings of global equity markets and declaring that, yes, they may have touched rock bottom.
Veteran market watcher and ING director Don Stammer says it looks increasingly likely that the low point for the US market was last October, when the Dow Jones touched 7200. By the end of April it was close to 18 per cent higher at 8470.
The Australian market appears to have reached a turning point in mid March, when the S&P/ASX 200 hit a low of 2693 as it became clear that war with Iraq was imminent. By the end of last month it had bounced almost 12 per cent, to 3007.
Not everyone is convinced that recovery is assured, though. Macquarie Equities strategist Tim Rocks suggests we are not quite out of the woods yet. "We've seen a burst of optimism over the last few months and I'm not convinced it can be sustained," he says.
Craig James, a senior strategist at CommSec, believes the markets have started to turn, but, with the postwar rally constrained by SARS and confrontation with North Korea, there is no clear air for markets to rally in. "Uncertainty is the real killer of markets," says James.
But uncertainty also creates opportunities for investors with the ticker for the long haul (see box). HSBC chief strategist John Banos reflects: "You get the best value when uncertainty is high."
Many analysts believe that investors are not as averse to risk as they have been in the recent past, and that low-risk assets, such as cash, fixed interest and listed property, are beginning to look expensive relative to shares. If interest rates begin to rise in the next nine to 12 months there could be selling pressure in the listed property sector.
"There's so much good news still in the property market [that] it's alarming, and there's so much bad news in sharemarkets here and in the US [that] it's comforting," says Stammer, whose experience tells him that the market cycle is turning in favour of shares.
Cavil Singh, the head of broking investment services at Godfrey Pembroke, says equity markets have rerated equity risk premiums now that war with Iraq is over and the focus can shift back to fundamental economic and stock issues.
If the economy performs well, earnings will follow and so will share prices, but few analysts believe that earnings will increase sufficiently in the medium term to justify the start of a new bull market.
The big issue for all equity markets is the state of the US economy, where growth has stalled due to high consumer debt, excess capacity, a growing budget deficit and overstated corporate earnings.
Singh is concerned that, with George Bush hell-bent on being returned as president next year, the budget deficit could blow out to 6 per cent of gross domestic product and this, in turn, could be the catalyst for a weaker US dollar.
European economies are expected to grow at an even slower rate than the US - 1.4 per cent this year - with Germany close to its second recession in two years.
Japan's economy, meanwhile, is still on the critical list, with shares and property at 20-year lows.
In economic and political terms, James says, Australia is perceived as "an island of stability in a turbulent world". As such it is drawing interest from global fund managers, who are increasing their weighting of Australian equities at the expense of our Asian neighbours.
Australia's non-farm economy is still growing at a healthy 4 per cent, which is important for corporate profitability. James believes the Australian market is relatively sound and while the overall market is not cheap, it is no longer expensive. He has a target of 3150 for the All Ordinaries by the end of the year, compared with the current levels of just below 3000.
In mid-March the All Ords price-earnings (PE) ratio of 14.1 was the lowest in 11 years. Since then the market rallied 7 per cent in March and 4 per cent in April, which has lifted the market PE back to around 15.5 - still below the long-term average of 16.
Banos has a 12-month target of 3500 on the All Ords, which translates into an 18 per cent capital gain, but points out that with dividends thrown in, long-term investors should do even better.
Stammer believes shares still look "a bit cheap" relative to bonds - 10-year bonds currently yield around 5.3 per cent, while the cash rate is 4.75 per cent - and Banos agrees.
"Investors are being given a big buffer in the form of a risk premium above the cash rate for investing in shares," says Banos, who points out that bank stocks have a dividend yield of more than 5 per cent fully franked. In fact, equity risk premiums are at their highest level in 25 years.
While there is a consensus of sorts that equities have turned the corner, there is wide disagreement over the magnitude of the recovery and hence the strategy investors should follow.
Banos is bullish about the outlook for Australian equities because he thinks the fundamentals favour this market. Earnings have improved and should continue to grow in the year ahead, valuations are at their most attractive in recent years and interest rates are at historic lows.
"In my view the Australian dollar will appreciate against a weakening US dollar and this favours companies with assets in Australia," he says.
Rather than identifying investment themes in the current market, Banos says investors are better off remaining defensive and looking at companies with physical assets on their balance sheets.
This is in marked contrast to the late 1990s, when it was fashionable to buy companies with few assets but strong brands or intellectual capital. Investors discovered that when earnings dropped, companies with few physical assets fell a long way.
Stammer believes the Australian equity market will continue its modest but uneven recovery, led by the banks, Westfield Holdings and the like, and later spreading out to the broader market.
In fact, there are already signs of life in the small companies sector, where bigger fish traditionally hunt for growth opportunities when the economy is expanding.
Matt Riordan, the head of smaller companies for BT Financial Group, says a rash of takeovers of smaller companies is an indication that larger companies see value in the small cap sector. Recently we've seen bids for OPSM, Neverfail, Jupiters and Bristile, and analysts believe the trend is set to continue.
However, there has been a spate of earnings downgrades among small caps in recent weeks, and Riordan says the prospect of further downgrades is a key issue in the short term.
Rocks expects significant bad news will emerge from the upcoming season of annual general meetings. In fact, he hazards a guess that the market levels achieved in the past month could be as good as it gets for the next 12 months. Even if the economy picks up in the second half of the year he can only envisage the market returning to recent levels, not surpassing them.
When volatility is the order of the day, diversification across asset classes and sharemarket sectors is especially important for investors.
According to James, the diversification argument has grown in strength over the past year because of corporate difficulties at companies that seemed to have good fundamentals. "You can't be prepared for all events, such as potential fraud," he warns, adding that investors should look for well-managed companies with a good record of solid earnings.
The point most analysts do agree on is that investors should expect total sharemarket returns in the high single digits instead of the 10-12 per cent returns they were enjoying five years ago. But when you look at the returns available elsewhere, 8-9 per cent begins to look good.
"If I had a rich uncle who died tonight and left me a million dollars, I'd put it all in shares," says Stammer.
Getting a fair share: predictions and picks from market analysts
As recently as a fortnight ago at least one analyst was quoted as tipping Pan Pharmaceuticals, which has gone from flavour of the month to dog of year in the time it takes to say "product recall". This highlights the problems of stock-picking, especially in a market that is shell-shocked and uncertain about the future. Equally, some of the best profits are to be made at times of the greatest uncertainty.
All the analysts we spoke to urged caution and attention to fundamental principles, such as a track record of solid earnings, a secure dividend and good management.
ING director Don Stammer believes the sharemarket recovery will be led by market leaders such as the banks and Westfield Holdings, then later broaden out into small and mid cap stocks.
Bank stocks - the largest sector of the market - have lots of friends ahead of the release of interim profit results and should continue to benefit from an overall market recovery, as should the insurance sector.
HSBC'S chief strategist, John Banos, still favours the banks. "I don't expect shining performance - house lending and wealth management businesses are slowing - but yields are attractive and they should provide single-digit growth over the next two years," he says.
QBE Insurance remains the pick of the insurance sector for most analysts, despite a 40 per cent gain in the past year. In the short term, well-managed insurers such as QBE should benefit from rising premiums and market consolidation.
One bright spot favoured by many analysts is the non-residential building sector. An infrastructure spending boom on projects as diverse as the North West Shelf to the Chatswood-Epping railway and Sydney's east-west tunnel are good news for building and engineering companies such as Leighton Holdings and OneSteel, which have already enjoyed solid gains. Activity in this sector is expected to remain strong until 2006-7.
Macquarie Equities strategist Tim Rocks likes the infrastructure sector. Even so, he urges investors to be cautious and stick to companies with secure returns and dividend yields, such as banks, listed property trusts (LPTs) and utilities.
Other analysts warn, however, that LPTs, banks and utilities could be left behind once there are clear signs of a global economic upturn.
In any event, Cavil Singh, the head of broking investment services at Godfrey Pembroke, says the double-digit returns achieved by LPTs over the past three years - when total returns for the sector were 56 per cent - won't be repeated. He expects distributions of 7.5-8 per cent from LPTs in the coming year, with small capital gains of about 1 per cent.
Singh recommends investors keep an eye on well-managed industrial growth stocks such as Brambles and Wesfarmers that have been sold down to the point that they are now value stocks. He says stocks like these and those of media groups, including the Seven and Ten networks, are getting to the point where their grossed-up dividends are better than those on offer from the banks.
In the medium term, Singh says investors should remain defensive and be opportunistic about sold-off growth stocks, entering the market on a dollar cost averaging basis.
"Buy on the dips for attractive dividends and reasonable PEs," he advises.
CommSec's Craig James says media stocks are poised for an advertising turnaround as economic activity picks up.
Banos believes the best value is probably in the small cap sector, but investors take bigger risks with small caps because they are under-researched. With hundreds of companies to choose from, though, there are always some standout successes.
Take Reece Australia. Matt Williams, co-manager of Perpetual Investments, says you may not have heard of it, but it is probably Australia's largest bathroom products group and a phenomenal success story. In the past three years its share price has almost trebled, from $2.20 to $6.40.
Williams looks for well-managed companies with solid earnings. Apart from Reece, he likes Fisher & Paykel Appliances for its attractive pricing, and the building products company Crane Group. All three are linked to the home building cycle; Williams says while they are priced for a slowdown in earnings growth, the alterations and renovations market is likely to remain strong.
Williams also mentions market software supplier IRESS and wagering group UNiTAB, which has enjoyed strong profit growth in recent years.
Matt Riordan, the head of small companies at BT Financial Group, likes some of the smaller companies benefiting from the boom in infrastructure and mining projects, singling out Coates Hire and engineering, construction and maintenance company United Group.
The health sector is another bright spot for investors, buoyed by increased spending by an ageing population and a more positive regulatory environment, including changes to Medicare. Riordan recommends Primary Healthcare, which operates medical centres, and nursing home operator DCA Group.
