Brokers Play Defensively, Highlight Foreign Earners

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-Nervousness around for some time
-Brokers favour US dollar earnings
-And those services enjoying lower AUD
-And stocks with reasonable yield
-Resources not the whole Oz/China story
 

By Eva Brocklehurst

A word of advice from finance professor Victor Fang: don't panic. The associate professor at Deakin University believes an extended period of volatility is underway in global markets. He considers Australian investors are trapped in a similar situation to that which occurred during the global financial crisis of 2007-08. The former banker maintains that just because Australia is not financing Greek debt and local investors are not in the Chinese share market does not mean Australian investments are unaffected.

This uncertainty means investors in Greece and China are pulling out of equity markets and moving to the relative safety of government bonds. As long as the nervousness prevails this will continue. Of the two, Chinese volatility presents the greatest threat, given this country is Australia's largest trading partner and prospects for Australian commodities are tied to its economic growth.

Morgans has a preference for leveraging the superior growth dynamics in the US amid further downward pressure on the Australian dollar. The US is currently providing stronger consumption, housing activity and exports. The broker notes this should help Australia as it transitions from mining to services, although accepts this transition has been painfully slow. China's transition towards consumer-led growth is also unsettling, Morgans acknowledges, and this is clouding Australia's outlook.

Morgans currently favours those companies with defensive qualities such as Amcor ((AMC)) and Orora ((ORO)) as they have a strong presence in the US. In terms of stocks in the surging building sector the broker cautions investors to tread carefully, given valuations are somewhat pricey. The broker's key ASX recommendations in the health sector are CSL ((CSL)), Ramsay Health Care ((RHC)) and ResMed ((RMD)). In telcos, sector valuations appear stretched and the broker has Reduce recommendation on a number of stocks. However, Telstra ((TLS)) is considered a crucial part of any portfolio.

Online media had a horror June quarter but Morgans believes the sell-off is overdone. The broker expects marginal investors will return to the sector over the next half and prefers Seek ((SEK)) and iProperty ((IPP)), which are able to deliver double digit earnings growth for some years to come.

UBS is overweight stocks which benefit from a weaker Australian dollar. That is, US dollar earnings. This view has stood up while the Australian dollar has fallen over the past two years. The Australian stock market's resource sector weighting tends to act as a hedge against a lower Australian dollar given a positive correlation between the currency and commodity prices. Outside of resources, Australia is very underweight in manufacturing and overweight in services in terms of listed stocks. Services, such as tourism and education, should benefit from a lower Australian dollar but this exposure is difficult to access via the equity market, the broker acknowledges.

Of the investable large cap stocks that derive a sizeable benefit from the lower currency, UBS considers most are via foreign domiciled earnings. US dollar exposure is the largest single exposure. The broker's basket of stocks which are attractive in this setting appear to be priced for a spot exchange rate, not for a lower Australian dollar. Hence, valuation is not considered onerous. Based on analysis of exposure to the US dollar earnings, fundamentals and valuation UBS' strongest conviction stocks are CSL, ResMed and Incitec Pivot ((IPL)).

The main question for Morgan Stanley is that after so much quantitative stimulus, just what will trend growth be and how strong will the trajectory be? While the broker's 12-month index target of 5650 for the ASX200 reveals modest upside of 3.5% from current levels, near-term risks remain to the downside until greater conviction on growth can be justified. Morgan Stanley continues to hunt for opportunities among foreign earners, stocks with reasonable yield and growth, and financials ex banks. In terms of foreign earners the broker's focus includes Macquarie Group ((MQG)), James Hardie ((JHX)), Goodman Group ((GMG)), Brambles ((BXB)), Ansell ((ANN)) and ResMed. Tabcorp ((TAH)), AMP ((AMP)), Super Retail ((SUL)) and JB Hi-Fi ((JBH)) offer reasonable yields and growth, in the broker's view.

Credit Suisse observes the Australian and Chinese business cycles are now highly correlated and resources trade alone cannot explain the whole story. While Chinese banks may not follow Australia's credit cycle, since 2011 growth in Chinese bank credit in Australia has been quite highly correlated with capital outflows from China. Credit Suisse calculates for every US$100m in capital outflow from China, there is around $4m of Chinese bank credit created in Australia. Recently, the pace of Chinese capital outflows has slowed as authorities clamp down on leakages from the system. This points to reduced capital inflow into Australia, in the broker's view.
 

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