Introduction
In an economics point of view, excessive stock market speculation is an inefficient way to allocate resources since the market is not resolving capital requirement and savings destination according to equilibrium purposes. On the other hand, lack of it would typically result to higher transaction cost of stock market participants due to monitoring of firms actions and service fees to brokers. Due to this, a macro- and micro- difficulty is present in the system. As a reply to this bottleneck, this paper aims to address the micro-problems investor would face in investing in stock market with trading/ investment destination being St. George Bank. The bank is the fifth largest bank in Australia and belonged to elite publicly-traded firms in the Australian Stock Exchange. This paper includes a profitable trading/ investment strategy based on assessment done in political, economic, market and firm figures which is located at the second part of presentation. The data included here and framework used is gathered in relevant websites, books and journals.
Profitable Trading Strategy
The Trading Itself
The shares of St. George can be considered as fairly accurate measure of economic trend and financial market decisions. It is within the top 15 publicly listed companies in Australia (2006) that places its shares reasonably among high ranked common stocks in the country’s stock exchange. In addition, the economy is found to be on the early stages of economic cycle (see attach 1) which suggest that stock prices are also climbing. With findings showing that there is no indication of too much speculation rather the market is in chorus towards emphasizing economic indicators, it is highly suggested that St. George shares should be bought in order to exploit the non-speculative market and supportive political/ economic gauges.
For the initial purchase suggested above, active asset allocation ( 2000 p. 62) will be resorted to be able to rationally decide where the financial markets are in economic/ stock price cycle. Stage I and II, which is said to be the current placing of the markets, implies gradually rising stock prices from the initial low levels due to recession or fiscal and monetary adjustments of the state. If the purchase strategy is applied today, there is a better chance for the investor to gain from selling the shares when stage III occurs. This is, however, should be coupled with guidance from a broker or the investor’s own perceptions of the cycle emergence. The strategy is somewhat speculation-based intended for short-term gains which cannot exploit tax incentives of a 365-day fund investment ( 2006).
In a different approach, there is a bright long-term gain from St. George stocks as its financial position and future outlook is supported by a growing economy and stable-to-rising interest rates. The potential of the firm will not be easily distorted/ disregarded by the market since speculation is not yet there. In effect, both short- and long-term gains in buying its shares are attributable to possible investors. This place premium on their investment decisions since the threat of interest rate increase of consumer due to increased purchasing power and spending coupled by bullish economy can be easily mitigated by selling the shares and get a mark-up from such sale. In contrast, the continuous (at least one year prior to purchase strategy) bullish economy would be beneficial for the firm and it will be able to issue dividends as well as business expansion which entitled the investor also to medium-term gains and increased expected future earnings.
Coupled with Investment Decisions
Due to the importance of sustainable wealth creation for the shareholder, the earlier identified as active asset allocation is replaced by passive asset allocation (2000 p. 63) after the initial purchase. This act of redefining the strategy is attributed to favorable conditions of the firm, markets and the economy. In addition, the strategy would be at risky and unpractical position if the investor will continually concentrate and place his resources and risk in one firm. As a result, there is a need to diversify investments that makes passive strategy crucial. At this point, active allocation is deemed expensive especially when the investor maximizes its wealth by a diversified portfolio due to broker’s fee.
On the other hand, focusing on the shares purchased from St. George, the strategy should take into account the emergence of stage III wherein the market starts to anticipate economic recession/ contraction. As a result, the price of both stocks and bonds will drop at low levels. This time is the most critical to the purchase strategy done earlier. At this point, even if the firm continues to grow in profits and liquidity, the market will likely speculate that such positive momentum will eventually fall due to lack of money in the economy. In effect, it is time to either sell purchased shares for a mark-up or rely in the diversified portfolio equalization. The former gives the investor enough liquidity to face the challenging down trend/ relaxation of the economy while the latter is ambiguous of such gains as he will wait for another stage I and II cycle to harvest results o compensate for speculation in the long-term success of the firms.
At this stage, the share is sold for investment on money markets. At this point, money markets are the most attractive investment alternative since bonds and stocks are in their low-level of yields. Everybody in the economy, except of course for the government, lacks liquidity and is willing to place premium on hard cash. After this short money market investment, eventually, stage IV will ensue which suggest the start of economic recession as the political and economic actors try to reconcile interest rate, inflation and economic activity. As a result, the investment in money markets are gradually relaxing premium earlier applied in stage III since the government is now willing to issue another pool of money in the economy to start the economic cycle again. In effect, premiums are given to buyers of government bonds. The strategy, then, will anticipate this situation in order for the investor to have strong liquidity at the on-set of stage I and II.
This developed strategy is highly based on the ideal economic activity/ cycle the government, financial markets and firms are currently emphasizing in their decisions. As a result, it becomes a combination of active and passive-diversified strategy depending on the reaction of the market and government to the current dealing. However, as suggested by the following evidences, these actors are almost in uniform direction. In effect, St. George shares are highly attractive in both short, medium and long run decisions.
Proofs and Evidences
Background
For the stock price, an increase in expected dollar earnings of a firm with unchanged risk will increase its value while an increase in expected dollar earnings with lower risks will significantly increase its value (2000 p. 4-10). Due to this scenario, higher-ranked common stocks are more preferred than lower-ranked stocks and the latter tends to be sold in favor of the former. The former is defined as those stocks with highest expected rate of return for the risk or the lowest risk for an expected rate of return. As earnings per share (EPS) indicates the dollar return for every stock an investor purchased, it is one of the most items in the firm’s financial information that receives highest interests. For its part, the firm should solidify its claim of having high-ranked stocks to be able to compete for the limited available capital in the economy. As debt financing is more risky than equity financing (since the firm is obligated to pay debts even minimal or no profits is obtained), this task of the firm should be convincing.
Although corporate earnings have positive relationship with stock price (2000 p. 4-10) (that is, the greater earnings are, the higher stock price will be), external forces both political and economic in nature would barred the firm from optimal realization of such relationship. In effect, being inclined or parallel with economic indicators is as crucial as internally generated earnings. One indication of this is that expected earnings should exceed interest rate of government bond to be able to be competitive. Another is that it should flow consistently with changes in interest rate, inflation and economic activity. This will make the firm’s investors to avoid unguided speculation when making investment decisions. It is a well-known dogma that no participant in a stock exchange can control the entire trend of stocks and so the consensus counts. And where will a rational firm/ investor/ government base their decisions? Of course, on what is really happening to the economy with small number of them speculating for short-term gains, that is, a mere buy and sell strategy.
Too much inflation (hyperinflation) has negative effect on stock price which can either be stimulated by pull and/or push consumer/ producer effects. To dispute this, common stocks are viewed as inflation hedgers ( 2000 p. 56) as they can easily maneuver the cost of firm’s goods to follow inflation in the cost of production. Generally, the adverse inflationary effects on stock price is rather of short-term basis while the long-run inflationary functions of common stocks can be derived by an investor who is willing to place his investment longer in the hands of the firm.
There are at least three types of traders/ investors in the stock market ( 1964). This will serve as a guide for every trading/ investment strategy. For portfolio managers, one profitable trading strategy especially for portfolio managers is top-down stock strategy wherein the economic and market environments are analyzed before making a decision. Bottom-up approach emphasizes financial analysis of a firm’s data including comparison of stock performance against its competitors. For technical traders, there is also a technique to forecasts stock price movements by using previous charts to identify trends and there signals of actually happening including their impact. Hedging and arbitraging strategies are also used to aid in analysis. For sales traders, another is the strategy that aims to determine the best price by having knowledge of trading partners and relative prices to identify who is liquid in the market and exploit such identification.
The Benchmark of Interest Rates: Government Bond
Government bonds are sometimes referred as risk-free investments because the debt is back-up by the state funds. On the other hand, corporate bonds and shares should outperform these risk-free instruments by offering higher expected earnings with higher risks. For its part, the Reserve Bank of Australia has the primary goal to control inflation through monetary policy that provides a general signal to the market when making its decisions. In effect, the economic cycle (see attach 1) can be a ready tool for the market in determining the direction of the economy particularly direction of a government bond. This will guide the market towards more accurate peak of the economy for long-term growth and prevention from disruptive bubbles/ speculations.
The Australian Government Bond is an attractive bond than the United States (see attach 2) because it exceeds the percentage yields of the latter for a 10-Year bond in both daily and monthly basis. This means that local and possibly foreign investors are relatively in a more profitable position if their investments go to the Australian bond. As government bond serve as the benchmark of the attractiveness of financial markets, this advantage trickle-down to private firms in search of capital and liquidity. However, the monthly 10-year government bond yield movement of Australia shows that the economy seemingly is in the initial or last stages of economic cycle (see attach 2). Money is out in the private hands to stimulate economic activities.
The comparison of government and corporate bond yields (see attach 2) shows that firms still have the upper hand of the investor’s attention than the government. It could also mean that the market is closely monitoring the movement of the economy and actions of the government which solidifies the absence of economic bubble. In effect, economic indicators are taken more seriously by the market instead of speculations. Further, investors preferred relatively riskier bond issuers in favor of relatively higher returns as illustrated by relative preference of BBB shares than AAA shares (see attach 2). This contributes to the future prospects and performance of firms in the market because investors are out of their safety zones and ready to go with the direction of the management. In short, they trust the business sector and capability of firms to meet their targets.
Inflation Rates
Inflation rate can provide indication for the market to view the direction of the economy and where is it currently in the economic cycle. High inflation implies active economy which will eventually cause rising pressure to interest rate if other economic indicators like wages will not offset high consumer prices. In a comparative illustration (see attach 3), the first half of the 10-year moving average of consumer price index and wages showed that inflation growth was faster than wage increase. However, the second half of the decade had rebound the favor to the wage-earners especially due to more consistency of government’s move to adjust wage in the current condition of the economy. In fact, wages posted higher percentage movement particularly 2004 onwards.
This brings into the picture the reliability of demand to equalize demand in order for firms to obtain their profit and return targets. This is supported by favorable control on exchange rate of the Australian currency which settles the issue of dumping that can hurt local producers (see attach 3). The currency moves along with import prices to avoid unhealthy competition in the economy. As a result, the ambiguity of globalization factors is fairly controlled by the government which strengthens the belief of the market to the stability of political and economic factors. Thus, the benefits are transferred not only on the producers’ sector but also to consumers (for internal control of quality and prices) and financial markets (both firms and investors).
Financial and Market Background for St. George
The fundamental and technical indicators of Australian market show a favorable environment for investment and there is not yet potential economic bubble (1997 pp 309-310) facing the stock market. Fundamental approach on this analysis has explained that price and earning ratio is stable and therefore no indication that the strong market is the result of significant speculation (2006). However, there are economic areas that posted risks like resource sector particularly mining that shared the large bulk of market gains despite downsizing regimes. This may suggest that the market might overestimate cost-cutting actions of such firms towards efficiency and underestimation of loosing opportunities. In addition, the surging oil prices are always standing-by to attack strategies of firms not only the manufacturing sector but also consumer goods since freight for the finished products could pressure price increases.
In a technical perspective, the market is in a bullish channel (see attach 5) that suggested another cycle unfolding after reaching the maximum range. This is solidified by the chart’s performance above the critical point of 4,500 ( 2006). However, in similar footing with fundamental indicator, technical estimates show that the market is volatile due to abrupt surge of trading despite its ambiguity of future direction. In effect, there is a need to put considerable effort for portfolio investors on financial data of their firms while classifying them as resource industry- or oil industry-related firm. There is also a need to determine the future chart performance of the market to guide data of economic conditions and market’s updated investment decisions.
In its Interim Report 2006 ( 2006), St. George posted 11.5% increase in profits before significant items and in accordance to accounting standards while after significant items resulted to 0.3% increase to this percentage. Dividend also rose to 10.4%, earnings per share (EPS) increased by 9% (excluding hedging and derivatives), return on equity up to 23% from 21.8% and expense to income down to 44.1% from 46.8%. By this data, it can be said that the firm has strong earnings potential and continues to be going-concern to its business reflected by its cost-effectiveness in cutting down expenses or in a different approach providing superior products/ services at low costs. Further, shareholder funds continue to gain as shown by EPS which means that investments in the firm have its way of increasing its value in the future. This increase is also advantageous to investors because the movement of EPS is consistent to the movement of dividend payout (see attach 6).
Return on Equity (ROE) is also dubbed by the firm as superior ( 2006) although their announcement of strong expected performance in the future might pull this dubbing if the management does not meet its goal. As an illustration, the aggressive volume taking of the firm had provided a year-on-year earnings and revenue stimulation in all its three key business areas in lending, retail deposits and managed funds. The firm, despite this aggressiveness, had continued to perform well in its operations as shown by its interim result in March 2006 at 2M compared to 3M in September 2005 (see attach 6).
In the same time frame, the firm posted strong results in non-interest income primarily due to hedging and derivatives (a M gain) which was not the nature of bank’s operations. This served as offset to drop in lending spreads due to competition. The situation suggested that investors must give trust to the ability of the firm to recoup its modest losses in its primary operations by diverting some of its liquidity in speculative re-investments like hedging and derivatives. The 70-year experience of the firm in financial operations should back-up the trust given by its investors ( 2006).
However, the firm should emphasize the importance of holding an asset for at least 365 days to be able for investors to maximize their capital gains ( 2006). The fund tax rate within that time frame is 10% compared to 15% if the firm let go on the assets prior to such number of days. As a result, the annual return of investors is understated by 5% which could be a big amount of money for someone who has substantial investments. The fees being deducted by the firm has relative small impact that is adversely applied to investor’s financials compared on their loss of fast turn-over of the firm’s asset management.
The firm is also unattached to risky industry areas mentioned. This means that fluctuations in these firms stock price due to external events will not directly affect the share of firm. But, an exemption should be applied when excessive speculation (which was explained as not yet in the offing) emerges since the positive performance of St George would not be clear rather bias from speculators point-of-view. Of course, the market will react to such speculations resulting to unrealized gains of St. George stocks. Due to this, investors should be cautious on forecasts and future movements of the markets to anticipate the emergence of too much speculation. This idea will also support the needed information from markets and economy.
Another consideration that makes St. George shares a strategic investment is that it is consistent to the Standard and Poor’s/ Australian Stock Exchange 200 index. As show by the graph (see attach 7), the moving average, or more appropriately, movement of share prices of both are almost in the same direction which means that St. George shares fairly reflect the general market sentiments of investors. The fact that only 1,800 companies out of 1.4 million (2006) are registered in Australia, this firm performance can be a good starting point to base investment decisions.
Profit Position of St. George
As segmental profit contribution of retail banking is almost 50% for St. George (see attach 6: May 2006), the expansion of this share has bright prospect due to increasing monthly values of retail sales in the country (see attach 4). In the contrary, the market could not capitalize in extending capital gain options to households especially those in the upper income bracket since consumption is limited in disposable income (see attach 4). The explanation of this could be the negative relationship of assets and savings in the household level (see attach 4). This could be a signal that the population feels that the current economy is undervalued by asset prices and may invoking their speculative decisions through asset acquisition in replace of declining savings.
The debt of household is also in increasing trend (see attach 4) adding support to their asset undervalue speculation. Money is in demand (on the hands of people) and out of banks reserves. Interest rate increase may ensue as to control inflationary effects of shortage of money in circulation. This poses challenge on the financial market since scarcity of capital is aggravating coupled by consumer spending. As a result, fixed asset requirements intended for long-term strategies may not be optimal to firms while only those within highly-ranked common stocks receives special attention. In effect, St. George (as one of the top-ranked firm in the country) will possibly survive tight capital reserves.
Conclusion
The shares of St. George can be regarded as high-ranked which is guaranteed by its market position, financial standing and future prospects or growth. The economic well-being of Australia suggests that the market is in the early phases of stage I which makes the purchase of stocks both profitable and strategic. The theories imply that under growing economy with stable interest rates and increasing corporate earnings will result to long-term rise in stock prices. As a result, the investment in St. George will gain from short-term dividends as well as long-term multiplicity of investments due to firm growth. However, when stage II is off, selling or holding through diversified portfolio can save the economic impacts to share price. In whatever situation, the investment will gain by simply following the economic indicators which serve as the popular basis of the market in its investment decisions.
Bibliography
Attachments
Attachment 1: Economic/ Stock Price Cycle ( 2000 p. 33)
Attachment 2: Australia VS USA Bonds ()
Attachment 3: Inflation and Wages ()
Attachment 4: Household Data and Retail Sales ()
Attachment 5: Stock Market Performance from 2004-2006
Attachment 6: Dividends to Earnings per Share Comparison ()
Attachment 7: St. George Share Performance and S&P/ ASX 200 Index ()
Credit:ivythesis.typepad.com
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