It’s hard for the Australian stock market to fire when one of its largest sectors has come under intensified pressure due to concerns over the global economic growth outlook. While this sector now looks compellingly cheap, the news flows have so far remained unsupportive of a price turnaround.
That turnaround could come, however, with a little help from China and Europe.
Of course, I’m talking about the materials sector, which contains our bulk commodity exporters such as BHP-Billiton and Rio Tinto, and accounts for around 22% of the S&P/ASX200 index. A more narrowly defined sector grouping within materials is resources, which itself comprises the two sub-sectors of energy and metal, and mining stocks.
Broad exposure
If you like the mining sector but are unsure which stocks to buy, there is now a wide range of mining related exchange-traded funds (ETFs) available on the Australian market that provide broad exposure to the sector. The largest and cheapest at present is that provided by Betashares (ASX:QRE).
[1]¹Management Expense Ratio. ²Funds Under Management in Australia. ³Average % between best bid and offer price. ⁴ Average dollar value of five best bids and offers. Source: ASX ETF Monthly Report.
A major drag
While once the darlings of the share market before the global financial crisis, mining stocks have been a drag of market performance over the past year. Since its post-GFC peak in early April 2011, the S&P/ASX300 metals and mining sector has declined by 40%. Prices are down 46% from their overall peak in May 2008.
By contrast, the S&P/ASX200 index is down around 20% from its April peak of last year.
A decline in export commodity prices (albeit from very high levels) and fears over a slowdown in the Chinese economy have been largely responsible for the sector’s plight.
Analysts’ earnings expectations have been revised down sharply over the past year, and the market’s valuation of those earnings has also been cut.
Historically cheap
But from negativity often arises value, and mining stocks now appear quite cheap by historical standards.
The metal and mining sector’s price to forward earnings ratio, for example, has dropped to below 10 – a valuation rarely evident over the past few decades.
[2]Similarly, the sector’s price to book value is just over two, or close to previous lows since at least 1995.
As far as earnings are concerned, a small decline in profits is now expected this financial year according to analysts surveyed by Thomson Reuters, but – at this stage at least – earnings are expected to rebound by 10% in 2012-13, and a further 16% in 2013-14. If these earnings expectations hold up, and the price-to-earnings ratio returns to a more reasonable level (say around 12), the sector stands ready to provide very good gains on a one-to-three year view.
China and Europe
Of course much depends on developments in China and Europe. The slowdown in the Chinese economy over the past year has hurt demand for steel and led to price declines for both coal and iron ore. But China has no interest in slowing its economy too far, and is already trying to re-orientate its economy from speculative housing developments in major capital cities to infrastructure projects in more regional areas. Indeed, Chinese authorities are already starting to ease back in tight credit conditions, and a bottoming out in the economy could be close at hand.
All up, key mining export prices should hold up at still reasonably high levels, while the mining sector’s current investment in new capacity will result in a lift in export volumes.
It would naturally help if Europe also got its act together. Europe remains a major destination for Chinese exports, and the region’s self-inflicted recession has hurt Chinese exports with knock-on effects to local mining companies. That said, there’s even some light at the end of this tunnel, as following recent European elections, political leaders now seem more accepting to promote economic growth and not just fiscal austerity.
To that end, this week’s European leaders summit could unveil the first moves in the direction of a growth promoting regional package.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek advice.
Also in the Switzer Super Report
- Peter Switzer: I’ve got a case of euro-anxiety again [3]
- Bell Potter: Two stock ideas for your SMSF [4]
- Andrew Bloore: Offsetting the ‘death tax’ for SMSF beneficiaries [5]
- Ron Lesh: How to set up a paperless DIY super fund [6]