Weekly Broker Wrap: Outlook, Bulks, Housing And Global Economics

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Pressure on defensive yield and growth stocks; Citi downgrades BHP & RIO; housing outlook muddied; Money3 expands; Citi's view on IMF/World Bank meetings.

-UBS cautions about the retreat of the defensive income trade
-Citi takes more bearish view on bulk commodity prices
-Housing approvals surge but commencements starting to decline
-Developed world monetary policy seen stagnating
 

By Eva Brocklehurst

Market Outlook

UBS observes the outperformance of defensive yield and growth stocks that has dominated the market in recent years has turned in the September quarter. Super-low long bond yields and stretched valuations are unwinding as investors envisage a tightening of rates by the US Federal Reserve and tapering of European Central Bank asset purchases.

This has put pressure on the income trade, which has retreated around 13% in the broker's calculations. UBS remains cautious about the defensive income trade – defined as Australian Real Estate Investment Trusts, infrastructure and utilities – given the size of the rally over the past 4.5 years.

The retreat in long duration “growth” trade has been less dramatic but the broker does note increased disappointment with specific stocks in the high price/earnings ratio end of the market. Stocks such as Medibank Private ((MPL)), TPG Telecom ((TPM)), Vocus Communications ((VOC)) and Blackmores ((BKL)). Earnings results have also been underwhelming in some highly rated stocks such as CSL ((CSL)), Seek ((SEK)) and REA Group ((REA)).

In this unfolding scenario the broker retains a modest overweight position in resources and continues to be overweight in a select group of premium rated stocks such as Aristocrat Leisure ((ALL)), Brambles ((BXB)), Healthscope ((HSO)) and Sirtex Medical ((SRX)) as well as more moderate premium stocks such as Orora ((ORA)) and Star Entertainment ((SGR)).

BHP, RIO And Bulks

Citi has downgraded BHP Billiton ((BHP)) and Rio Tinto ((RIO)) to Sell from Neutral with targets of $20 and $47 respectively. Both stocks have rallied strongly on the back of higher prices for bulk commodities. The broker expects these prices will pull back significantly later this year and into 2017 as demand softens. BHP is considered to be “the best of a bad bunch” because of its higher weighting to copper and oil.

China's stimulus and supply restrictions have driven the surge in bulk prices this year, for coal in particular, but this is expected to abate. Additionally, the broker observes a number of cities in China are attempting to cool house prices. Lower Chinese steel production is expected in 2017. The main risk to Citi's bearish view is further policy measures to support coal and steel prices, and monetary stimulus to support growth.

Housing

Recently the outlook for housing has been muddied by stronger auction clearance rates, a surge in approvals and house price rises, Morgan Stanley observes. The broker had expected housing market conditions would be peaking by this stage, with risks from a looming oversupply and macro prudential tightening.

The latest building activity data from the Australian Bureau of Statistics – from the June quarter – indicates that supply surged, with multi-dwelling completions up 37% quarter on quarter and 87% year on year. Morgan Stanley finds this lagged data consistent with the deterioration in rents this year and expects reported vacancy rates will continue to rise.

While approvals may have surprised, the broker notes commencements declined 25% in the quarter and this suggests that tighter credit conditions and weaker fundamentals may well be slowing activity. On a 1-2 year view the broker believes the housing boom has been responsible for driving the transition from capital expenditure in mining but the necessary slowing to re-balance the market will weigh on the growth outlook. Apartment settlement risk remains elevated, the broker believes, as foreign investors look to secure credit following the pull back by the domestic banks.

Money3

Money3 ((MNY)) is rapidly expanding into the non-conforming automotive loan market. Bell Potter initiates coverage on the stock with a Buy rating and a $2.40 price target. The basis of the broker's call centres on the 20% growth achieved in FY16. The company has guided to FY17 net profit of $26m and this implies a further 20% growth in earnings per share.

Bell Potter believes the funding environment for Money3 continues to improve and the positive outlook relates to cheaper funding over the medium term. The company has recently consolidated its lending platform and the broker envisages upside to this more streamlined operation in the years ahead. The broker is yet to factor in the significant opportunity to enter new markets, such as moving up the credit quality ladder in automotive lending.

Global Economics

Citi met with a number of organisations at the IMF/World Bank annual meetings and observes monetary policy in advanced economies is increasingly out of ammunition while fiscal policy is not quite ready to do the heavy lifting. There was little agreement among the officials on what the next major moves would be and on the relative merits of various policy options.

Growth concerns globally have eased and Citi suspects the worst may be over for emerging markets, although there are few signs of a significant cyclical rebound in growth. The broker notes many of these countries have experienced stronger exchange rates of late, limiting prospects for export-led growth to return. The broker also observes concerns about emerging markets in the context of a potential hike by the US Federal Reserve in December have diminished considerably.

Citi confirmed its view that central banks which are considering reducing asset purchases, such as the Bank of Japan or the European Central Bank, were not doing so with any intention to tighten policy. The broker has a clear sense that it would be good for the ECB to move away from its pre-determined large asset purchases, and there are growing expectations it may reduce the monthly purchases to below the current EUR80bn/month.

The US Federal Reserve expects to hike rates soon, with several speakers recently indicating that this could occur at the December meeting. Politics is becoming important, with the upcoming US election and the risks from Britain's exit of the EU. Brexit is expected to become more complicated and statements by the new UK leadership have been greeted with some concern. The sharp fall in the value of the pound as well as the media and other reactions to the latest statements are viewed as a stabilising constraint on future UK policies.

A common sentiment is that even though global growth is quite weak by historical standards, growth is steady and the risks of a sharp downturn have receded. China did not feature prominently in the discussions, unusually, with little expectation for meaningful policy changes to address the nature and scale of imbalances in the economy. Nevertheless, most of those canvassed thought that China had policy tools to prevent growth from deteriorating sharply for some time to come.

Most European officials reject any further material increases in capital requirements for banks and Citi observes some sizeable differences of opinion with their US counterparts.
 

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