Australia’s Outlook For 2016

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This article was first published for subscribers on December 16. It is now open for general readership.

By Greg Peel

Reasonable

2015 has been a messy year for investors, notes AMP Capital’s head of investment strategy and chief economist, Shane Oliver. We’ve worried about China. We’ve worried about emerging markets in general. Fed uncertainty has caused volatility and uneven returns across asset classes. Australian equities have continued to underperform.

In 2016 we are likely to see reasonable but uneven global growth, Oliver suggests, low inflation and easy money conditions. The Fed will raise rates gradually while other countries, including Australia, remain biased to further easing.

Most growth assets are likely to trend higher, including equities, resulting in reasonable returns. But the easy gains are well and truly behind us, Oliver warns, and volatility is likely to remain elevated.

The main factors to keep an eye on in 2016 are the Fed, China, and the ongoing rebalancing of the Australian economy.

Commodity prices may see a rebound from very oversold levels but given excess supply, many commodities are expected to remain in a long term downtrend. Australian shares are likely to improve as the drag from the slumping resource sector abates but Australian shares will continue to underperform global markets given commodity price headwinds will persist.

Oliver expects the ASX200 to rise to around 5700 by end-2016.

Commercial property and infrastructure should continue to benefit from investors’ search for yield. Capital city house price gains are expected to slow to 3-4% as the heat comes out of the Sydney and Melbourne markets. Bank deposits will continue to provide poor returns.

On ongoing commodity price weakness, Oliver expects the Aussie dollar to fall to US60c.

Monetary & Fiscal Policy

Whereas Macquarie previously assumed some recovery in commodity prices ahead, the broker has now conceded to lower prices and a spate of significant resource sector earnings downgrades has followed. Deutsche Bank and Credit Suisse have also joined Macquarie in substantially lowering commodity price forecasts and slashing resource sector target prices. Ongoing price weakness leads to a lowering of Macquarie’s 2017 GDP forecast.

Macquarie has nevertheless lifted its GDP forecasts for the December quarter of 2015 and the March quarter of 2016, following on from a stronger than expected September quarter GDP outcome. Yet the broker believes weak domestic demand and income growth and an acceleration of the downswing in mining capex will challenge the outlook through 2016. The rotation to non-mining growth from mining growth is moving slowly, Macquarie notes.

The broker forecasts RBA rate cuts of 25 basis points in both May and August. The decision will nevertheless be dependent on the Aussie dollar, and whether further currency weakness can offset the need for more aggressive policy. Whatever the new government comes up with in terms of fiscal policy may also play a balancing role.

Goldman Sachs expects Australia’s 2015 GDP growth to come in at 2.2% and is forecasting 2.0% for 2016. Falling capex will continue to provide a drag while housing investment will begin to recede. The Australian economy will remain reliant on commodities exports, Goldman assumes, thus leaving a “soft underbelly” of weak domestic demand.

The broker believes weak commodity prices and a peak in new housing investment are now priced into the market. But 2016 risks include a waning of foreign funds flows into Australian equities, declining house prices, drought, and an Aussie that won’t go down. Goldman sees the possibility of further easing being required from the RBA, but notes the central bank seems reluctant for now.

The fiscal side of the equation has now become important in broker perspectives given the change of leadership. Previous governments have implemented policy in direct contrast to the RBA’s attempts to revive the Australia economy, forcing additional rate cuts. But in 2016, it is possible that the government and the RBA end up on the same team. Goldman Sachs suggests the Turnbull government’s early hints at ambitious policy changes may well see the need for an immediate mandate, implying an election in the first half of the year.

Goldman Sachs forecasts the ASX200 to be at 5600 by the end of 2016.

Despite recent market capitulation, the broker remains Underweight resources and particularly energy. The broker expects domestic companies will outperform offshore earners (not all brokers agree with this forecast) and prefers stocks with a mix of income and growth over rate-sensitive yield plays. Despite expectations for a cooling in the housing market, Goldman believes the market has become too bearish on the outlook for housing-related stocks.

Earnings Growth

Deutsche Bank now expects the ASX200 to reach 5500 by end-2016, having previously forecast 6000. The broker expects 5800 by end-2017.

If dividends are included, Deutsche’s 2016 forecast represents a total shareholder return of 10%. The broker expects mid-single digit corporate earnings growth over the year, combined with an increase in market PE to 15.5x from a current 14.5x. The broker points out that the non-mining sector of the market is already delivering on such a growth target. It only remains for the mining sector to deliver flat earnings rather than falling earnings in the year.

To recap, AMP expects the ASX200 to be at 5700 by end-2016, Goldman Sachs expects 5600 and Deutsche Bank expects 5500. Going, going…

Australian investors are now pricing in expectations of a considerable decline in dividends. This is too bearish, in Credit Suisse’s view. Even if growth remains subdued, the broker expects dividends to expand modestly in 2016 and PEs to re-rate.

Credit Suisse is forecasting the ASX200 to be at 6000 by end-2016.

From here on in, the broker sees corporate earnings growth to be moderate, but positive. The direction of the index will demand on how corporates respond, and Credit Suisse expects more cost cutting, capex reductions and M&A activity to generate shareholder returns. Risks include a sharper contraction in China, an acceleration of global inflation and another big year of new equity issues (IPOs, capital raisings).

Like Goldman Sachs, Credit Suisse likes stocks that provide a reasonable dividend yield along with solid dividend growth potential. The broker also likes stocks that are in a position to conduct share buybacks, that are beneficiaries of M&A, or that are trading at valuations which do not yet reflect the growth outlook.

UBS expects Australian stocks to “edge higher” in 2016, driven by a moderate rise in global stocks, a lower Aussie, and a benign but constrained growth outlook for the domestic economy. The broker notes the beginning of a Fed tightening cycle has historically not been bearish for global or Australian stocks on a 6-12 month perspective. (Although it must be noted that in historical terms, the last Fed tightening cycle was a very long time ago.)

UBS notes FY15 saw earnings growth of negative 4% in Australia and forecasts zero growth for 2016. In 2017 the broker expects a return to low to mid-single digits. The broker notes that if we take out resources and banks, growth is tracking at a moderately above-trend rate of 7-8%, with a little help from the Aussie.

UBS remains Overweight companies earnings in US dollars, in contrast to Goldman Sachs. The broker remains Overweight banks and Underweight miners, and Overweight domestic cyclicals. UBS believes the market has become too bearish on the Australian economy.

Stock Picks

In terms of individual stocks, UBS’ key picks going into 2016 include Challenger ((CGF)), CSL ((CSL)), Incitec Pivot ((IPL)), Lend Lease ((LLC)), Harvey Norman ((HVN)), Qantas ((QAN)) and Star Entertainment Group ((SGR)).

Goldman Sachs notes there are ten stocks within the ASX200 that have now proven long term laggards, down 20% or more since 2010. They are Paladin Energy ((PDN)), Whitehaven Coal ((WHC)), Ten Network ((TEN)), WorleyParsons ((WOR)), Metcash ((MTS)), BHP Billiton ((BHP)), Rio Tinto ((RIO)), Orica ((ORI)), QBE Insurance ((QBE)) and SAI Global ((SAI)).

The broker covers eight of these ten and of that group, sees prospects improving for only QBE an SAI Global. A sixth straight year of weak performance is expected from Whitehaven, Worley and Rio.

On the flipside, there are fourteen ASX200 stocks are up 70% or more since 2010 and have not had a down-year in the interim. They are Domino’s Pizza ((DMP)), Corporate Travel Management ((CTD)), Technology One ((TNE)), REA Group ((REA)), Ramsay Health Care ((RHC)), Sydney Airport ((SYD)), James Hardie Industries ((JHX)), Carsales.com ((CAR)), DuluxGroup ((DLX)), ARB Corp ((ARB)), APA Group ((APA)), Transurban ((TCL)), Investa Office ((IOF)) and AusNet ((AST)).

Goldman Sachs covers only seven of the fourteen and of that group, and only has faith in James Hardie being able to extend its winning streak. It is the only stock trading at a discount to, rather than a significant premium to, its historical PE.

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