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Opinion: Is there method in the market's madness

By Simon Louisson of NZPA

Friday 15th July 2005

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You'd think a drop in business confidence to levels last seen in the early 1990s and strong signs that economic growth is reversing in the form of falling retail sales would be clear enough signals to share investors.

Far from it. The sharemarket ploughed onward and upward this week, extending an eight week rally to a 15% gain.

Is this the madness it appears?

A number of analysts have noted the market's valuation is as close to "fully priced" as they have seen in years.

First NZ Capital broker Malcolm Davie called it "an increasing disconnect with the economy and reality".

"One would have to question the disconnect between the economy and earnings fundamentals and stock prices.

"Caution is definitely warranted."

Despite the fact that a slowing economy and the long-term effects of the high dollar will clearly affect corporate earnings, many analysts insist there is method in the madness of the market.

Also, Carmel Fisher, managing director of small and mid-stocks investor Fisher Funds, says it has not been a raging bull market.

The rally has been isolated to a number of stocks that have risen in response to corporate activity or for specific reasons. The index picture has been skewed by market heavyweights Telecom, Contact Energy and Carter Holt Harvey which have jumped for specific reasons.

Telecom has risen on the promise of a big one-off payout on August 5, Contact is up on energy prices and strong earnings and Carter Holt is up on news it might be broken up or taken over.

"It's not a market phenomenon because it's not right across the board," said Fisher.

"Some of the smaller and mid-cap stocks haven't rallied and those that have tend to be the better quality ones.

"It doesn't fell like a crazy bull market by any stretch."

Amanda Smith, senior equities investment manager at ING (NZ) assesses the market as "fairly, fully priced" but not over-extended.

Explaining the rally, she said there had been a "wall of cash" entering the market, much of it resulting from mergers and acquisitions such as the INL-Sky TV merger. The announcement of a takeover bid for BIL (formerly Brierley Investments) is just another example that will put cash in the hands of the remaining 50,000-odd New Zealand shareholders.

Smith says that while not all the money released finds its way back into the market, much of it does.

She said there had been a lack of IPOs this year and even the big upcoming Vector IPO will release cash through its simultaneous takeover of the remaining one third of NGC it doesn't already own.

"One thing we have always taken into account in our analysis is looking at the cash being generated by the market and the fact is that over the last month or two, and currently, it is pretty substantial, and you can't ignore it," said Smith.

"There are a number of offshore investors putting money here, particularly Australians - part of that is to do with the extraordinary amount of merger and acquisition activity we had in June."

She said once International Paper announced it was mulling its options over its 51% stake in Carter Holt offshore hedge funds piled in "like there's no tomorrow".

"They don't even necessarily know what Carter Holt does, but it has come up on their screens as subject to activity, so money flows in."

"You can look at the economic scenarios until you are blue in the face but if something happens with Carter Holt and Telecom, then it will shift the index," she said.

ING assesses the market on a dividend discount analysis and while that shows little upside outside dividend income over the next 12 months, it was not saying the market is outright expensive.

The fall of the New Zealand dollar will help the economy and, ultimately, company earnings.

Smith said that because the economic downturn has been so long in coming, there had been a reasonable degree of conservatism amongst analysts on the outlook for corporate earnings.

"People have been worried about how the slowdown would affect earnings so most broking analysts have reasonably conservative assumptions in place."

Some funds managers had anticipated the slowdown and gone short of New Zealand equities ahead of this rally. That meant they were being squeezed and were now reluctant to sell stocks.

Fisher said the slowdown has resulted in a flight to defensive stocks such as Waste Management (people will still need to get rid of their rubbish), and to quality.

She said this quarter's profit season will be more critical than usual.

"If you are going to get some negative surprises in the upcoming profit round, it's safer to be in better quality, proven companies." She said many companies said they had not seen a noticeable slowdown. The proof will be in their results and their indications on the outlook.

Those who issue profit warnings will be punished, as Feltex has discovered.

While Smith says there is some rationale for the market's rise, the higher the market goes the more risk there is.

"It may be that things have gone too far because of the flurry of merger and acquisition activity."

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