Treasure Chest | Jul 05 2013
– Australian index PE now at average
– Resources to struggle, USD stocks positive
– Opportunities in commodities
– Emerging market weakness overdone
By Greg Peel
The ASX 200 began its rally in June last year with the ASX 200 closing at 4094 on June 29, 2012. The index peaked at 5221 in May this year, showing a 32.9% total return (price plus dividends) to that point, on Morgan Stanley’s calculations. From the peak the index fell 7.6% in total return to the June 28 close of 4802.
As investors chased yield in the rally, the Big Four banks plus Telstra were responsible for around half the total return for FY13. The materials sector finished down 1.17% and capital goods down 0.34% year on year. A combination of Fed tapering talk and RBA rate cuts triggered a fall in the Aussie dollar which sparked the pullback, mostly driven by the exit of US and other foreign investors. In the pullback, materials lost 2.19% in total return and the banks 1.79%, and were the main drivers.
The consensus forward price/earnings multiple for the ASX 200 is now trading at 13.4x, notes Morgan Stanley, in line with the ten-year average. The PE fell by 8% from the May peak but finished FY13 25% higher year on year, driven by rising prices meeting flat to negative earnings. The telco sector, which Telstra dominates, remains 16% above its ten-year average PE while utilities (-13%) and materials (-12%) are trading at the biggest discounts to the average.
The FY13 net index earnings forecast finished June at a consensus of 2.6% negative growth ahead of the August reporting season. The FY14 forecast sits at 10.1% positive growth. All sectors boast positive FY13 growth earnings forecasts, notes Morgan Stanley, with the exception of materials (-24%) and consumer discretionary (-13%).
Clearly the Fed’s move to outline a possible QE tapering timetable proved the main trigger of the pullback from May, and subsequent volatility, exacerbated by weaker data releases from China. US bond yields have risen in anticipation of Fed tapering. UBS expects tapering to begin before year-end. If bond yields rise from low levels, that is “normalise”, equities should also rise, UBS notes. Rising yields in such a case imply an improving economy, and US equity valuations are not yet stretched.
From the Australian point of view, the resources sector (particularly mining) will continue to struggle, suggests UBS, unless global and Chinese growth shows “at least some moderately improved momentum”. The tightening of credit for the sector will act as a dampener for the time being. The UBS commodity team has a “tactically negative” call on the iron ore price for the next few months.
Popular Australian stocks over the past two months have been the US dollar earners, which have performed well. UBS still sees this trade as having further to run, and on the flipside remains moderately underweight the “yield theme”. The strategists expect to add more exposure to domestic-based stocks following the August result season and/or the federal election.
Commodity markets have been hit by weak macro sentiment and a flow out of commodity funds in the past few weeks which have overshadowed “solid fundamentals” in many commodities, CIMB believes. The analysts expect ongoing improvement in fundamentals over the northern summer. The problem is markets appear to be already pricing in Fed tapering, despite its lack of certainty, and weak PMI numbers and tight liquidity in China have driven a sharp correction in risk assets globally. The Fed and China will remain headwinds for commodities over coming weeks, suggests CIMB.
CIMB is thus maintaining a Neutral weighting in commodities in general, but sees opportunities in specific commodities driven mainly by supply-side issues. The analysts are positive on base metals, with copper the stand-out, believe oil will gradually move higher in coming months, and suggest iron ore will remain under pressure although the downside is limited.
Gold is one “commodity” under pressure. Unless the gold price rebounds to above US$1500/oz, claims BA-Merrill Lynch, many global gold miners will have to respond in one or more of the following ways: cut dividends, reduce exploration, sell non-core assets, refinance debt or issue equity to fund cash short falls. Gold is currently around US$1250/oz.
Emerging Market (EM) equities have been badly hit since Fed taper-talk, notes Citi’s global strategists. The benchmark PE is now below 10x. When EM and European PEs fell into single digits in the first half of 2012, equities rebounded strongly, they point out.
On the other hand, many investors fear EM equities are currently a “value trap”. This implies investors can be “trapped” by assuming a PE below average or historical levels must by default mean “value”. Rising EM current account deficits, GDP downgrades, excess capital spending, a rising US dollar, falling commodity prices and overvalued bond prices are all reasons offered as to why low PEs are justified, not attractive. However Citi’s EM strategist disagrees with this assessment.
He believes many of these concerns are overdone. Current accounts and equity performance are not well correlated, he notes. Commodity prices are falling on supply-side factors rather than demand-side factors and emerging market GDPs are still outperforming developed market GDPs. And EM economies are now less US dollar sensitive than they used to be.
Citi believes plenty of bad news is now priced into EM equities and that the risk is to the upside, with Asia favoured.
While the US and Chinese central banks have been in focus these past couple of months, so too has the Bank of Japan. Having shot up like a rocket on Abenomics and BoJ money printing, the Japanese stock market corrected just as sharply on fears none of it would work, leading to a period of substantial volatility.
Volatility began to subside towards the end of June and Citi expects a further reduction in July. Concerns over Fed tapering and developed economy weakness should wane over time, suggests Citi, while earnings improvement and evidence of steadily recovering economies in Japan and the US should stabilise the Japanese market and send equity prices upward once more.
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