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Where Are The Opportunities In A Low Rate Environment?

Australia | May 25 2015

This story features STOCKLAND, and other companies. For more info SHARE ANALYSIS: SGP

-Opposing Oz, US official rate biases
-Oz 10-year yields unlikely to ease more
-Stocks picks based on growth & yield
-Key picks in housing, domestic cyclicals

 

By Eva Brocklehurst

Global growth is disappointing and Citi marginally downgrades the US outlook. Overall, the broker is still expecting global GDP growth of around 2.7% this year. Citi is modestly constructive on the euro area outlook and regards first quarter weakness in the US as temporary, although US growth prospects are considered modest, not spectacular. The broker also suspects most advanced economies will face persistent low inflation for the next couple of years. Against this backdrop, further monetary easing is expected from the likes of Sweden, Norway, Japan and Australia.

Citi expects the first official rate hike from the US Federal Reserve in the December quarter this year and the first from the UK in the March quarter of 2016. Both central banks could delay tightening if the growth disappointments were to continue, or disinflationary forces intensify. For Australia, the Reserve Bank restated its position in its latest Statement on Monetary Policy which, in Citi's view, signals the option to cut rates again remains live.

The broker believes another cut to the RBA's cash rate would offer the best chance to secure a return to trend growth in the face of an elevated exchange rate, and August remains the preferred likely date. The unemployment rate has stopped rising for now and the kick start to small-medium enterprise investment spending from the federal budget should provide some respite for the RBA, in Citi's opinion.

In terms of the connection between official rate moves and Australian yield stocks, Deutsche Bank believes Australian 10-year bond yields matter most. This is particularly the case with the banks. They have very little correlation to US yields. On the other hand, A-REITs and utilities have a reasonable correlation with US yields. This is reflected in the greater involvement of foreign investors in the latter group compared with the banks. Deutsche Bank notes local bond yields follow US yields, with the spread explained by market pricing of future actions by the RBA versus the US Fed. At present, Australian yields appear a little low on this basis.

As the two central banks have opposing biases some of the outlook is priced in already. Deutsche Bank suspects US yields will edge up, which will pull the local yields higher so Australian bond yields are unlikely to test fresh lows. What would it take to push Aussie bond yields lower? Deutsche Bank suspects this would be a delaying of US rate hikes, emanating from quantitative easing pressure in Europe and Japan. What would push Aussie bond yields higher? A lack of liquidity could cause US yields to jump – and likewise the locals – as the Fed hiking cycle approaches.

Now, Deutsche Bank does not believe traditional yield stocks are the best place to invest in growth in the current low rate environment as these stocks have already outperformed and Australian yields do not appear to be going much lower. Other stocks offer comparable yields but have improving momentum. In this bag the broker includes some with exposure to housing, such as Stockland ((SGP)), Fletcher Building ((FBU)), James Hardie ((JHX)) and Harvey Norman ((HVN)), financial markets, such as Perpetual ((PPT)), AMP ((AMP)) and Iress ((IRE)),  and defensive growth such as QBE Insurance ((QBE)) and Sonic Healthcare ((SHL)).

Morgan Stanley is removing QBE Insurance from its Asia Best Ideas list following the stock's recent strong performance and lack of catalysts. On a 12-month basis, the stock is a preferred pick amongst Australian financials as its remediation is now over. The business maintains a strong balance sheet and progressive dividend as well as leverage to rising US yields and falling Australian dollar. Best Ideas list is a collection of stocks that appear most promising on fresh analysis, long-term fundamentals and short-term potential catalysts. The list is not an investment portfolio and has no mandated sector allocation or number of stocks.

UBS expects bond yields will finish the year modestly higher than current levels, and move higher again in 2016. The Australian dollar is expected to fall but its near-term fortunes are dependent on the Fed beginning its rate tightening cycle in September. The broker also expects the iron ore price will continue to come under supply-induced pressure. UBS is overweight on those stocks with US dollar earnings and beneficiaries of housing construction and neutral on the banks.

UBS is Underweight mining, A-REITs, telcos, consumer staples and general insurance. The broker suspects the market has seen its highs for the year with the key sectors such as banks and mining seemingly constrained and valuations elsewhere not particularly compelling. The broker adds Echo Entertainment ((EGP))) to its model portfolio and removes Sims Metal Management ((SGM)).

Macquarie also maintains a broad view that the the global economy will continue with its slow recovery. Moreover, economies which have traditionally been closely aligned are now diverging. The broker remains predisposed to stocks which offer sustainable, above average earnings growth. Equally, as interest rates remain relatively lower for longer a combination of modest growth plus yield is also attractive. Australian equity market valuations have risen of the last two or so years and are now just above long-term averages. The broker does not expect any further broad base re-rating in the near term.

An Overweight exposure is maintained for offshore growth in the model portfolio but active positions in Computershare ((CPU)) and Brambles ((BXB)) are removed, given near-term earnings headwinds. Macquarie increases exposure to some domestic cyclicals after the federal budget, adding Tatts Group ((TTS)), as well as Carsales.com ((CAR)) which replaces REA Group ((REA)). Positions are increased in Seek ((SEK)), JB Hi-Fi ((JBH)), Lend Lease ((LLC)) and Flight Centre ((FLT)). Macquarie remains underweight in banks and mining and reduces energy exposure to modestly Underweight.
 

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CHARTS

AMP BXB CAR CPU FBU FLT HVN IRE JBH JHX LLC PPT QBE REA SEK SGM SGP SHL

For more info SHARE ANALYSIS: AMP - AMP LIMITED

For more info SHARE ANALYSIS: BXB - BRAMBLES LIMITED

For more info SHARE ANALYSIS: CAR - CAR GROUP LIMITED

For more info SHARE ANALYSIS: CPU - COMPUTERSHARE LIMITED

For more info SHARE ANALYSIS: FBU - FLETCHER BUILDING LIMITED

For more info SHARE ANALYSIS: FLT - FLIGHT CENTRE TRAVEL GROUP LIMITED

For more info SHARE ANALYSIS: HVN - HARVEY NORMAN HOLDINGS LIMITED

For more info SHARE ANALYSIS: IRE - IRESS LIMITED

For more info SHARE ANALYSIS: JBH - JB HI-FI LIMITED

For more info SHARE ANALYSIS: JHX - JAMES HARDIE INDUSTRIES PLC

For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP

For more info SHARE ANALYSIS: PPT - PERPETUAL LIMITED

For more info SHARE ANALYSIS: QBE - QBE INSURANCE GROUP LIMITED

For more info SHARE ANALYSIS: REA - REA GROUP LIMITED

For more info SHARE ANALYSIS: SEK - SEEK LIMITED

For more info SHARE ANALYSIS: SGM - SIMS LIMITED

For more info SHARE ANALYSIS: SGP - STOCKLAND

For more info SHARE ANALYSIS: SHL - SONIC HEALTHCARE LIMITED