Weekly Broker Wrap: RBA Cuts And Slowing Growth

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This story features WESFARMERS LIMITED, and other companies.
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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

– JP Morgan has changed its view to no RBA cash rate changes until at least late 2012
– CS strategists have looked into a scenario for possible 150bp cuts by the RBA
– Deutsche Bank believes labour shortages will weigh on growth for engineers and contractors
– Citi economists cut global growth estimates, again
– Goldman Sachs' Analyst Index records steepest drop since August 2009

By Rudi Filapek-Vandyck

The week that was saw economists at JP Morgan changing their view to "no changes" to the RBA cash rate until at least the end of 2012. At Credit Suisse, however, market strategists feel sympathy for a scenario that sees the RBA start cutting rates next year. Under such a scenario, Credit Suisse prefers media stocks and retailers while banks, traditionally positively leveraged to falling interest rates, would be held back by a rise in bad debts.

CS's favourites in media are Seek ((SEK)), Fairfax ((FXJ)) and STW Communications ((SGN)) while JB Hi-Fi ((JBH)), Super Retail ((SUL)) and Wesfarmers ((WES)) are most preferred in retail.

CS strategists argue there are some very good reasons as to why interest rates might be lowered in the year ahead. Discretionary CPI inflation is negative, plus core CPI inflation is slowing. Jobs growth is slowing and the unemployment rate is rising. And the Australian economy is yet to feel the impact of the global slowdown on commodity prices and mining capex. The latter factor in particular is currently dividing the expert community on interest rates: how much of an impact will the Australian economy feel from slowing growth around the world?

Enough, predict economists at UBS, to push the RBA in loosening mode by Q1 next year. UBS has taken the view that a.) Greece will default, and probably in an orderly fashion, in early 2012 and b.) things will get worse first, including financial markets, ahead of the event. UBS also believes the world will narrowly escape a recession, but will slow down nevertheless. So expectations will come down further, and the RBA will thus cut twice in February and March, before going on hold for a prolonged period.

Deutsche Bank analysts published an in-depth study into the prospects for capex spending by energy companies and miners. Their conclusion is that projects will face delays, cost overruns and margin compression due to the lack of sufficient skilled labour. This will have major repercussions for the engineers and contractors servicing these projects. Deutsche Bank believes sector growth will not match current high market expectations in the years ahead. The analysts believe smaller projects in the oil and gas sector in particular are at danger.

Analysts at Goldman Sachs also updated their views on the sector, but with a significantly more positive view. Goldman Sachs thinks Australian service providers will mostly lose out in LNG contracts as foreign competitors have more experience, but when it comes to coal and iron ore most of the contracts should be awarded locally. Goldman Sachs cannot help but predict a wall of contracts hitting Australian engineers and service providers, despite all the global uncertainties. The stockbroker's favourites are Boart Longyear ((BLY)), UGL ((UGL)) and WorleyParsons ((WOR)) amongst larger caps and Sedgman ((SDM)), Imdex ((IMD)) and Ausenco ((AAX)) amongst smaller caps.

As expected, falling commodity prices have forced many an analyst to review previous forecasts and assumptions. Newly published sector reports seem to display one clear trend: lower oil price forecasts for this year and next. Gone are the days of US$130/bbl and higher price estimates. Instead, the global expert community seems to settle for range trading in the year ahead. Opinions remain divided about what's really going on with copper and other industrial metals. There's one thing that unites all commodities analysts at this stage: mining and energy stocks are ultra-cheaply priced.

Yet, say economists at Citi, global growth forecasts continue to decline and in such an environment cyclical, growth leveraged stocks such as energy and resources can stay cheap for much longer. Citi economists cut their global growth forecasts only weeks after having already done so. The new forecasts are for 3% growth this year and 2.9% next. These projections compare with 4% global growth in 2010. The direct consequences of this will be cuts to interest rates, lower interest rates for longer and more sovereign ratings downgrades in Europe on a 3-6 months horizon. More quantitative easing from the Fed should only be expected when deflation rears its head again, predict the economists. And oh yes, USD and JPY will be the main beneficiaries in FX markets.

Note that should Credit Suisse's scenario of a 150 basis points cut by the RBA by late 2012 materialise (as currently priced in by Australian bond traders) then the Australian housing market should experience some kind of a revival in 2013, also helped by the fact CS anticipates by then the Australian government will have increased the annual allowance for fresh immigrants. Stocks that should benefit include GWA International ((GWA)) and Alesco ((ALS)). Also, such a scenario could well push AUD/USD as low as 80c, predict CS strategists.

Meanwhile, global earnings estimates continue falling with Goldman Sachs reporting its proprietary Goldman Sachs Analyst Index (GSAI) has now fallen below the 50 mark (signaling more analysts see contraction in their sectors than expansion) for the first time since August of 2009. GSAI dropped more than 8 points to 43.3 in September with the largest drag coming from the new orders index, which plummeted 22.5 points to 28.6 – apparently the largest fall in the history of the index.

Finally, we found it interesting to read analysts at Macquarie had a Big Discussion about the stockbroker's Conviction Calls, labeled Macquarie's Marquee Ideas, with some of the picks experiencing a wave of selling pressure moving upon them this month. However, in support of the analysts' convictions, no changes were made – none at all! For the record, Macquarie's Marquee Ideas, currently contains 12 stocks (in no particular order): SAI Global ((SAI)), Rio Tinto ((RIO)), Sky City ((SKC)), Mineral Resources ((MIN)), QR National ((QRN)), Challenger ((CGF)), OceanaGold ((OCG)), Fletcher Building ((FBU)), Amcor ((AMC)), Echo Ent Group ((EGP)), Seven Group ((SVW)) and Westpac ((WBC)).

Colleagues at Goldman Sachs conducted a similar review and they got rid of copper producer PanAust ((PNA)) on the expectation there will be more pain as the world slows down. GS's Conviction List only contains seven stocks (in no particular order): BHP Billiton ((BHP)), Iluka ((ILU)), National Australia Bank ((NAB)), News Corp ((NWS)), UGL ((UGL)), Wesfarmers ((WES)) and Woodside Petroleum ((WPL)).

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