Weekly Broker Wrap: Aust Cyclicals And Infrastructure, Global Fund Allocations

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-Domestic cyclicals opportunity
-Uphill battle for infrastructure capital
-Engineering construction to decline
-Fund manager focus on US assets
-Global austerity out of vogue 
 

By Eva Brocklehurst

There is a more favourable light shining on Australian domestic cyclical stocks but how bright is it? There may be improving data and housing turnover but JP Morgan thinks the light is limited. Prospects for the labour market remain bleak and consumer spending is already at a trend-like growth rate so there's little upside potential there. Moreover, affordability is a brake on housing and bank funding constrains growth in credit. This means investors need to be selective when picking stocks with domestic economic leverage.

JP Morgan has a check list for this. It involves whittling down holdings in stocks which have little else to recommend them other than defensiveness and yield. Hence, the broker is tempering the underweight ratings on banks and staying overweight on global exposures, particularly energy stocks. Stock specifics do get in the way but, overall, JP Morgan believes the recovery story is more a short-lived stock market rotation than a new phase of economic growth in Australia. Still, the so-called recovery trade does underpin risk appetite more generally and undermines the relative prospects of defensive sectors. Even for the more sceptical investor, struggling to find rewards at the pointier end of domestic growth, it makes sense to trim defensive names, in the broker's view.

So, back to the check list. The broker favours those stocks with a narrow rather than broad focus. For example, house building, which dredges up Mirvac ((MGR)), Stockland ((SGP)) and Boral ((BLD)). Along with this is an observation that the micro matters more than the macro. If the house view turns out to be too pessimistic about the local economy, JP Morgan thinks it will be a small mistake. The probability of a long upswing is considered very low. So, the micro focus is on cost reductions which can support earnings if the recovery does not live up to expectations. The broker cites Boral and Asciano ((AIO)) in this category. Those that have several options while waiting for a stronger top line such as David Jones ((DJS)), where there's property and online sales to consider, or Toll Holdings ((TOL)), where there's the option to abandon international.

The other item is the Australian currency. Those inclined to be more upbeat on domestic growth should consider reducing weighting in stocks that benefit from a weaker Australian dollar and lean to domestic exposures which gain, such as importers and Qantas ((QAN)). The broker hastens to add that it's not in that camp. The currency is seen as a potential hedge to the economic rebound. BlueScope ((BSL)) is a case in point. If the recovery withers the Australian dollar will likely follow, and this should buffer BlueScope. Whilst a rally in the currency would be painful for such a stock, the Reserve Bank would feel the need to respond, in the broker's view.

Resource capital expenditure has likely peaked this year so infrastructure needs to step up to the plate in FY14. The change in Australia's government looks positive for infrastructure spending but Citi does not think it changes the outlook for a decline in infrastructure spending over FY14-15. The government intends to increase road spending by $4.6bn over FY14-17 and plans a bigger role for Infrastructure Australia in project planning, with the potential introduction of infrastructure bonds and 30-year Commonwealth guaranteed infrastructure bonds.

Still, with 80% of infrastructure spending funded by the states and state budgets under pressure the majority of spending will fall to the private sector. Changes to the Public Private Partnership model have increased private sector capital requirements for road and rail projects and long lead times means spending may not stabilise until FY16. Citi notes government asset sales will play an increasing, but limited funding role, given high value electricity poles and wires are off the near-term agenda.

Citi expects engineering construction spending will fall 13% over FY14-15 and be flat in FY16. Growth in roads and telecommunications will be offset by declines in power, rail and port development. Leighton Holdings ((LEI)) is considered the most exposed stocks to Australian infrastructure spending as it is 50% of group revenue. This is followed by Downer EDI ((DOW)) and UGL ((UGL)) at 45%. The broker has made minimal changes to earnings forecasts associated with this report, with forecasts already capturing the weaker outlook for infrastructure, as well as resource-related capex. Downer EDI is the preferred exposure and Monadelphous ((MND)) the least preferred.

Taking a look at the latest Australian Bureau of Statistics data on capital expenditure, UBS notes the surprise bounce in mining capex in the June quarter coupled with a larger than anticipated downgrade in capex intentions. The FY13 change in mining capex was the slowest in three years. Total capex rose 4.3% quarter on quarter in June to $40.3bn against a quarter-on-quarter fall of 4.1% in the March quarter to $38.6bn. In terms of capex intentions, the third estimate for 2013/14 rose to $159bn versus $156bn in the second estimate in the prior quarter. UBS calculates that this implies a contraction of 1%, year on year, a much larger than anticipated downgrade on the 13% growth forecast in the previous quarter. With regard to mining capex intentions in 2013/14, UBS' estimates imply a 4% year-on-year decline and the economists conclude that capex intentions are levelling off but not falling off a cliff – yet.

BA-Merrill Lynch's September global fund manager survey shows investors are positioned for the outperformance in assets tied to the US economic recovery. This includes cyclical stocks and banks, as opposed to those that are tied to China, such as commodities. Despite the fact that the hard landing for the Chinese economy has not eventuated, investors are bearish on emerging market equities. A net 18% of the global investors surveyed are underweight on this area. A record net 92% of emerging market fund mangers are now overweight on Russia, more than doubling the number since August.

They're all avoiding South Africa. Allocations to China and Mexico improved to a net 58% overweight and 8% overweight respectively. By sector, three out of four investors are overweight on consumer discretionary stocks, whereas financials allocation drops to net 25% underweight. Asia-Pacific fund managers report a dramatic rebound in China allocations from neutral to net 27% overweight in September, consistent with the rebound in Chinese growth expectations. India has fallen out of favour and is a net 27% underweight. By sector, the big jumps in allocation in the region was to energy and automotive at the expense of telcos, pharmaceuticals and media.

The bottom line from the fund manager survey is that bond market fear is greater than equity market greed. Merrills notes, five years on from the collapse of Lehman Bros, investors are happy to be long on assets tied to the US real estate market and macro areas such as developed markets, cyclicals and banks. In contrast, assets tied to China, such as emerging markets and commodities, and bonds and defensive stocks, are out of vogue. The survey found that, compared with five years ago when 70% of investors wanted corporations to slash debt, today just 11% call for this. Austerity is not the buzz word any more and 54% of investors want companies to reduce cash and boost capital spending, an 8-year high. Three out of four investors believe bond yields will be higher in 12 months and fixed income allocations have been reduced to 7-year lows.
 

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