Weekly Broker Wrap: The Strong Dollar, Sober Advertising And The Aldi Effect

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-Higher $A with low cash rate
-Pharma tops popularity stakes
-Advertising spending just modest
-Aldi gives Woolies a headache
 

By Eva Brocklehurst

What's going on with the cash rate in connection with the Australian dollar? JP Morgan asks the question as the cash rate starts 2013 at a record low of 3% and the Australian dollar sits well above parity against the US dollar. Normally, the lowering of the cash rate in turn lowers the attractiveness of Australian investments and hence the Australian dollar weakens. Now JP Morgan believes the Australian dollar is set to remain high regardless, retarding domestic growth as it weighs on non-mining, trade-exposed sectors.

Historically speaking, a cash rate of 3% would imply that monetary conditions are very loose but, based on the JP Morgan monetary conditions index, conditions in the real economy appear restrictive. Why? There has been a breakdown in the transmission mechanism that has seen the currency remain elevated despite a lower cash rate. This is in large part because major central banks are implementing unconventional easing programs, flooding their economies with cash and low interest rates for a sustained period. JP Morgan contends that even if the RBA eases Australia's cash rate further, high foreign demand for Australian bonds, a still favourable interest rate differential, and higher relative growth prospects, are likely to keep the local dollar well supported.

The disconnect in the transmission of softer cash rates to the currency is highlighted by an analogy the analysts present regarding the Bank of Japan's policy predicament. Japan badly needs to fuel growth in its stagnant economy and has set a new inflation target. Although JP Morgan is not predicting this, if the BoJ is able to achieve its FY14 inflation target of 0.9% and 2% beyond 2014, over time USD/JPY could reach 105, which is equivalent to an Australian trade weighted index in the vicinity of 81, a new all-time high. The Australian dollar would stay elevated and the pressure on the local exporters would increase. Such a scenario would place the RBA in a difficult position, perhaps needing to offset tightening economic conditions with an even lower cash rate.

There is a potential alternative scenario. It all depends on whether Japan's new inflation target is achieved via an improvement in broader Asia-Pacific growth prospects. This would lift local exports and make the argument for a lower cash rate weaker. It would also mitigate, to some extent, the effect of the higher Australian dollar. Over the coming year, in JP Morgan's view, the key will be whether the pick up in Japan's economy spills over to the rest of the region, and whether achieving higher inflation is the result of simple currency effects or stronger real growth.

BA-Merrill Lynch has conducted a global fund manager survey and found investor sentiment is quite optimistic this month. Last month the majority thought the next big event was likely to be be a US debt downgrade or a Spanish bail-out. In February, it is more likely to be the breaking of the 100 level in the US dollar-yen exchange rate. Unchanged at a multi-year high of 48, BA-ML's Risk & Liquidity Index indicates clients are risk bullish, as does the fact that only 5% of those surveyed see lower long-term yields in 12 months time. Asset allocators are overweight equities, underweight bonds and cash. The emerging market overweight rating remains high. There was some small rotation from European to US equities and optimism edged up toward Japanese equities.

Many measures of market sentiment in BA-ML's new Bull & Bear Index are warning that risk assets are now vulnerable to bad news after a seven-month rally. Growth expectations rose to their highest level since February 2011. The index shows investors want companies to pursue growth, as 48% say companies should use cash to increase capital expenditure versus just 12% demanding debt repayments. While inflation expectations continue to rise, two thirds of clients still believe both the rate of global economic growth and inflation is likely to be below trend in 2013.

Pharmaceutical is now the world’s most popular sector, according to the survey. Investors are moving out of energy, materials and technology, which is down to its lowest overweight rating since Feb 2009. The positioning in both banks and consumer discretionary sectors rose to multi year highs but weightings in both telecom and utilities dropped close to their lowest levels since 2004. If you're a contrarian, BA-ML tips you should take profits in US real estate plays, reduce allocations to emerging markets, look for some upside to laggard commodity and resource plays, buy telcos and utilities and continue adding to Japanese equities on any dips.

JP Morgan has conducted an Australian media buyer interview and found out that advertising spending is expected to track GDP in 2013, growing 2-3% in real terms. Ratings performance in the next few months is expected to determine how much volume growth does materialise. Longer term, the TV market share is expected to remain steady. TV advertising spending is expected to average a similar level of growth in 2013 as the overall ad market. Sports are also likely to continue taking a large share of TV advertising dollars, although the buyer differentiated between the major sporting events, which should continue to sell at large premiums, versus secondary sports products. The buyer also thinks ratings declines are more likely to be from fragmentation of viewing onto other platforms.

For Deutsche Bank, 2012 was sobering for advertising. It's likely to stay that way. A flat-lining market is expected in the first half of 2013, with about 2.6% growth in the second half. This will benefit from a recovery in the economy and federal elections. Within the ad categories, Deutsche Bank expects online to grow at 17% in 2013, offset by weakness in traditional media, down 4.6%. It's the traditional media, especially publishers such as Fairfax ((FXJ)) and APN News ((APN)), that will continue to find the going hard. They are expected to report 24% and 27% earnings decline respectively. Within the broadcasting space, whilst Prime ((PRT)) is expected to report 10% earnings growth on strong market share gains, Seven West Media ((SWM)) and Southern Cross ((SXL)) are expected to report earnings decline of 18% and 23% respectively.

So, which media stocks does Deutsche Bank prefer? News Corp ((NWS)). The broker considers it has the fastest long term growth prospects among the majors, with a sizable buyback as well as valuation upside in the planned separating of publishing from broadcasting. Deutsche Bank is joined by three others on the FNArena database that consider News a Buy. The broker also maintains a Buy recommendation on Prime given its attractive market position and valuation relative to the rest of the sector. Again, there are three other Buys on the database.

Ten ((TEN)) and Southern Cross are suffering from poor ratings performance in a challenging ad market. Ten has four Sell ratings on the database, three Hold and one Buy. Back in December Credit Suisse raised it to a Buy, punting on the potential for a buy-out. Deutsche Bank believes Seven West Media is highly leveraged to the ad market and the macro environment. In an environment where interest rates are low and there is potential for the economy and the ad market to improve, the broker thinks risks remain to the upside. Interestingly, on the FNArena database SWM has a complete suite of Buy recommendations.

What has Aldi done? Given the supermarket chains a headache for one. Feedback obtained by UBS suggests Aldi had a very strong finish to 2012 and customer acceptance of the foreign brand is strong. UBS estimates Aldi grew sales by around 20% in 2012 and the newcomer is currently taking between 40 and 80 basis points of growth from the major chains per annum. This could escalate to 50-90 basis points once the South and Western Australian roll-out begins. ABS estimates put its share to around 6% down the east coast of Australia. UBS believes Woolworths ((WOW)) is most affected, noting industry surveys suggest one in two new shoppers to Aldi do a main shop at a Woolworths. The broker expects sales growth and customer take-up in SA/WA to accelerate at a faster rate than the initial launch in the eastern states, given the increased brand awareness.

For the sector as a whole, UBS finds consumer staples continue to look expensive and Wesfarmers ((WES)), the owner of Coles, is its preferred exposure. UBS believes the supermarkets are expensive. Earnings upgrades are needed to drive out-performance, which the broker thinks is unlikely near term.
 

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