Australia | Jun 23 2014
By Mathan Somasundaram, Baillieu Holst Quant Strategy
Summary: Aussie market opened positive on China data hope and extended it before giving up post lunch gains. Aussie market was up 0.62% while turnover was just below $4.4b. China flash PMI was finally above 50 while Iron Ore is holding above $92. We remain positive with the big miners (i.e. BHP/RIO) and prefer to add resource exposure through them till China risk subsides. AUDUSD bounced back above 94 cents with better China data, but we continue to expect it to stay in the 90-94 range in the short term on safe haven basis and track down to mid 80’s longer term. We remain cautious on the market in the short term due to risk outweighing return till the end of June. We are beginning to see more strategist and economist coming to our view that unemployment will hit 6.5%, consumer sentiment recovery will be delayed and any chance of rate rise is now in the second half of 2015.
Top 10 reasons why you should take profit and wait for July (from Friday 13th morning)
o Expect Iraq risk to remain for an extended period and drive up energy costs and create risk to global growth
o Good US growth outlook, Improving Japan and Euro stimulus already in the price
o Volatility measures are at relatively low levels and expect it to rise
o China risk and Iron Ore dropping to $91.50 will drive more risk to Resource and Mining Services sector
o Falling consumer sentiment hitting all cyclical consumer sectors and property prices
o Tax loss selling of big underperformers and big winners by June 30 expected
o Institutional Investors taking School Holidays off will reduce market exposure by Jun 30
o Government risk to consumer sentiment with more budget marketing and new welfare plans coming
o Currency and market valuation stretched with market expecting more downgrades
o It’s Friday the 13th and we have not heard anything from Putin for a while!!!
FIFA WORLD CUP WINNER: Due to the temperature and humidity, history shows that when it’s played in Europe it favours European countries while anywhere outside it favours South American countries. Since it’s a multi-layer group knock out competition and not a straight out horse race, any factor based ranking very rarely works. Brazil, Germany, Argentina and Dutch should make it to the last 4. Despite the great game against Spain, Dutch have a history of delivering bad games in knock out stage while the Spanish are slow starters in most competition. Australia has had a great tournament and now has nothing to lose against a Spanish team with no motivation. It could be a shocker…worth a look. My pick still remains with Brazil to beat Argentina in a South American Classico Final.
Iraq war – the next generation: Unless you were hiding under a rock, Iraq was a basket case waiting to blow up after the war of last generation. Trying to measure non-western countries and cultures based on western standards are fraught with danger. Taking spin aside, Iraq will remain a mess for a number of years, if not decades, till it reaches a new equilibrium between all the domestic non-western parties. The best case scenario for equity markets is for US and its allies to talk tough, move on and let nature take its course. Despite the social and human loss, equity markets have a way of looking past these issues as short term (i.e. like Ukraine and Syria). Any argument that Iraq is different will reinforce the argument that it is all linked to energy and not humanitarian. No matter what happens, this chapter of Iraq war (i.e. the next generation) will end in another mass loss of life and create another generation of hatred aimed at the West. We have been in this situation before and we are very likely to make the same mistake again. Recent updates do not build me with any confidence.
M&A Cycle: Businesses with strong cashflow and solid balance sheet in a falling consumer sentiment and low interest rate environment prefer to chase growth through cost cutting, share buy backs and M&A. Cost cutting cycle is coming to an end with further improvements requiring wage reduction or M&A. Wage cuts will take time to work through structurally and also will have political implications for the government. This leaves corporates either buying back shares or consolidating industries to drive better earnings per share growth. Private equity is sitting on the side lines with substantial war chest built up by floating number of stocks over the past 6-12 months. M&A candidates in media sector are TEN, SXL, PRT and APN likely prey while NWS, NEC and SWM are potential hunters. M&A candidates in retail sector are DJS, MYR and PBG are likely prey while Private Equity, PMV and global retailers are potential hunters.
Consumer Confidence: Tidal waves of unemployment coming in the next few years, rising cost of living pressures, falling real wages and budget worries have slammed consumer confidence down to multi year low. Recent Job Ads and Employment data further strengthens our argument that unemployment is going to get worse in the next 12-18mths. We continue to be negative on local cyclicals with slowing economy. Continued bickering, party politics, lack of long term planning and real policy reform will keep sentiment low. We expect the unions, pensioners and students to continue to keep the media fuelled for months to come. We expect the government to release the new welfare streamlining plans and I am sure that will get media attention and likely to be a further risk to consumer sentiment.
Property Prices: We continue to expect areas where substantial unemployment and middle to low income earners live (i.e. Canberra) to see property price decline in the next 1-2 year time frame while middle to higher income areas should trade sideways with affordability falling and rates remaining unchanged. The top end should continue to rise with overseas investors from Europe and Asia continuing to look at Australia as a safer location to park wealth. Recent housing finance data is beginning to show signs of affordability and consumer confidence taking effect. In a longer term thematic, we expect future generations to prefer renting than buying property with rising cost of education, housing and lower wages to make housing affordability harder without substantial assistance from their parents.
Tax Loss Selling: Be aware that we are headed for tax loss selling period where substantial underperformers/outperformers are likely to see selling pressure and open up buying opportunities. But be careful to not sell cyclical low stocks as they may become M&A targets very quickly as private equity is cashed up after number of floats.
Unemployment Outlook: The accumulated unemployment tidal wave from car industry, airline industry, telco industry, finance industry, manufacturing industry, M&A job cuts, outsourcing to Emerging Markets, government job cuts and the ever shrinking mining industry cuts will create a vacuum for jobs and drive unemployment to 6.5% in the next 12mths. We do not see any government policy or global macro changes that can create jobs in the short term to limit this damage. The infrastructure job creation will only start in 2016 and will only deliver jobs that will pay much less than the jobs being lost over the past few years.
Taxation Outlook: Due to the current fiscal policy of the government, we expect overall taxation to increase in the next few years to cater for falling overall tax revenue on federal and state levels. We expect GST to be raised once the state elections and asset sales are out of the way. The structural decline in the budget has not been addressed as it is a revenue problem. The current policy solutions are no more than nipping at the edges with minor spending cuts.
Currency Outlook: We maintain our view that AUDUSD will settle around 94 cents (i.e. remain in 87-94 cents band) in the short term and then track down to mid 80s. We need to see substantial US or China growth risk for currency to break the recent trading pattern…now 94.4 cents.
Interest Rate Outlook: We maintain our view that our rates will remain unchanged at the current low level atleast till 2015Q2. We have to see substantial collapse of consumer sentiment from current low levels to force RBA to change lower. RBA can’t afford to support any more asset bubble inflation with lower rates despite global Central Banks keeping rates at historical low levels. More and more brokers are now moving back their rate rise expectations well into 2015.
POINTS OF INTEREST IN S&P 300 STOCKS BY SECTOR:
• Energy stocks were mainly positive with Middle East worries. We maintain our preference to the bigger players such as STO and WPL with OSH improving with recent upgrade. Big moves> UP: SEH (+3%); DOWN: ERA (-4%), PDN (-3%)
• Material (Ex Mining) stocks were mainly positive. We maintain our preference to packaging stocks such as AMC and ORA while NUF beginning to look good on the long term food thematic and ABC and DLX on the housing cycle. Big moves> None
• Mining (Ex Gold) stocks were mainly positive. We maintain our preference in the big miners BHP (+1.39%) and RIO (2.55%) while ILU is coming back into the picture with recent updates and management outlook. Big moves> UP: ARI (+7%), AGO (+6%), TGS (+5%), SIR (+5%), BCI (+4%), FMG (+4%), MGX (+4%), IRN (+3%), SYR (+3%); DOWN: BRL (-6%)
• Gold stocks were mainly positive with stable spot gold price. We continue to like low cost producers like NCM, BDR and SAR. Big moves> UP: PRU (+6%), SLR (+5%), TRY (+5%), RSG (+4%); DOWN: OGC (-8%), IAU (-5%), SBM (-4%) > New MD/CEO announced
• Industrial stocks were mainly positive. We maintain our preference in CCP and SEK. We continue to see high risk in mining service companies due to China risk, commodity price volatility and resource sector capex decline from 2015. Big moves> UP: MLD (+4%), MXI (+4%), RCR (+4%); DOWN: EHL (-9%), ANG (-5%)
• Consumer stocks were mainly positive. We maintain our preference in ALL, FLT, AGI, SWM, SXL, PRT and TGA while remain a fan of other media stocks like TEN now at 25 cents despite the problems and FXJ and APN on M&A. We also like CTD on any pullback below $6…it’s a FLT in the making. We see big risk to discretionary retail stocks like DJS, HVN, JBH, MYR, NCK and TRS in falling consumer sentiment. Despite the downgrade FLT looks good value long term for global tourism exposure with recent pullback below $47. Despite the downgrades we like PBG around $0.50 due to the brand value. KMD and PMV are other retailers with good global brands in tough markets. Despite the recent downgrade SUL is a quality stock that offers consumer experience that will see it recover with consumer sentiment. Big moves> UP: FWD (+4%), KMD (+4%), BRG (+3%); DOWN: BBG (-4%), WTF (-4%)
• Staple stocks were very positive. We maintain our preference in WES and WOW. SHV is beginning to look interesting close to $5 with Asian low fat protein demand despite recent crop issues. We continue to like GNC after it was sold down below $8 after the bid was blocked by ACC. We feel such a unique asset will get taken over with government unable to put up the cost of infrastructure upgrades needed for the industry. Big moves> UP: GNC (+3%)
• Healthcare stocks were mainly positive. We maintain our preference in ANN, RMD and our pet favourite GXL. RHC is a buy on any pullback with population ageing and government cutting healthcare budgets. GXL announcement of cap raising and acquisition makes it an even better growth story. ACR looks like finally recovering from the lows after it was smashed on the growth scare story by a certain broker…there should be more upside in this story. ANN is getting a lot of airplay with number of brokers upgrading after the event. Big moves> UP: ACR (+11%), MSB (+5%); DOWN: PBT (-7%)
• Banks stocks were positive. We maintain our preference in ANZ and NAB as they offer best global exposure out of the big four. Big moves> None
• Diversified Financial stocks were mainly positive. We maintain our preference in MQG for the global exposure while HGG and BTT are worth a look on any pullback. Big moves> DOWN: TRG (-4%)
• REIT stocks were mainly positive. We maintain our preference in SGP and LLC to get housing and construction exposure while MGR, ALZ and DVN look interesting with housing exposure. Big moves> UP: AOG (+5%)
• IT stocks were mainly positive. We maintain our preference in CPU while remain big fan of ALU, CRZ and IPP in the long term. Big moves> DOWN: SLX (-5%)
• Telco stocks were slightly positive. We maintain our preference in TLS while remain big fan of TEL and IIN in the long term. Booming NZ economy should put more attention into recovering TEL. Big moves> None
• Utility stocks were slightly negative. Big moves> None
• Overall positive day on good volume.
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Baillieu Holst Ltd
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