Weekly Broker Wrap: China And Europe On Their Mind

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– Concerns about China remain dominant
– Analysts returning from country visits report small exporters in China are struggling for survival
– Hard landing for China only seen as a worst case scenario, while Beijing can still act
– Global funds managers remain cautious, with cash at elevated levels, Australia least preferred exposure
– Financial stocks are the least liked

By Rudi Filapek-Vandyck

Small and medium sized companies are doing it much tougher than is apparent through official statistics, but the central bank is unlikely to provide any relief until there's more evidence that inflation has peaked and is definitely on its way down.

The above description would fit in well with the current situation in Australia, but it is a conclusion that is increasingly being drawn by analysts returning from visits to China. The underlying theme thus implies that while the short term focus is on Europe and on whether divided Europeans can work out a confidence boosting solution to their common problems, any sustainable rally in resources and energy stocks remains dependent on a change in policy in Beijing and it doesn't appear that's going to happen this month or next. Even though, it must be said, there are initial signals the Chinese are preparing for some loosening in policy as economic growth continues to slow down.

The bulk of stockbroker research in the week past was dedicated to China, with analysts trying to find answers to questions such as "what is happening with iron ore prices?", "how long before authorities stop tightening?" and "how big a problem is the shadow lending system?" Most answers provided were positive, though not necessarily immediately so. Most analysts believe downwards pressures on iron ore prices might well last into 2012, but a bounce is still expected next year. Authorities in Beijing don't seem keen on loosening policy just yet but inflation should have peaked and many smaller sized exporters are struggling for survival now.

And yes, the shadow banking system is alive and kicking but Beijing is on its trail and it remains unlikely we're heading for another subprime crisis in the Middle Kingdom, even though it is but a reasonable assumption to make that Chinese banks will see an increase in non performing loans. Those same Chinese banks are believed to have become much more reluctant in their lending practices and this puts them in a similar position as banks elsewhere.

"Europe" mostly figured in research reports that tried to estimate how much of an impact a worsening crisis could possibly have on China. According to Barclays, under a worst case scenario China could face its very first hard landing since the nineties, but that remains the worst case scenario and with the caveat that authorities in Beijing do still have firepower ready to provide stimulus if and when necessary.

Meanwhile, risk appetite remains low as once again revealed in yet another global funds managers survey by BA-Merrill Lynch. The October survey revealed overall sentiment regarding what can possibly await the world in 2012 remains bearish; growth expectations for China are now at the lowest level since early 2009. No wonder, cash levels remain at elevated levels (5%) and funds managers continued to reduce their exposure to commodities and equities this month.

No surprise either, financial stocks are the least loved of all with BA-ML reporting never in the history of this survey has the overall exposure of global funds managers to finance stocks been as low as it is today. A net 50% of all global managers is now net underweight financial equities. Amidst the re-shuffling that is currently going on, funds managers remain Overweight Emerging Markets (though they are selling) and overall sentiment has improved towards Materials and Energy stocks. The number one favourite country is Russia, while many managers retain an Overweight allocation to China. This seems at odds with the growing concerns about China's economic growth prospects. According to the survey, no less than one third of managers believes China might face a recession in the next twelve months.

The stand-out negative news from the survey is that Australia remains the world's least liked market with the survey indicating a net 13% of global funds managers are today Underweight the Australian share market. A net 35% of managers is sitting Overweight in cash. According to BA-ML, this is the highest percentage in cash since March 2009.

Cash is still King thus, and Australia the place not to be, according to global investors.

In the background of all of this, earnings estimates are still in decline and strategists here and there have observed 2012 is already looking like nothing that was being anticipated only a few weeks ago. Alas, those same strategists also believe earnings estimates across the globe have further to fall still.

In Australia, Credit Suisse again placed question marks on dividend expectations for insurance companies. Citi's Small Caps specialists believe small cap stocks in Australia are on balance less attractive than their larger peers, though the analysts continue to see value in small cap resources stocks. Citi's favourites are Forge Group ((FGE)), Flight Centre ((FLT)), McMillan Shakespeare ((MMS)), Southern Cross Media ((SXL)), Super Retail Group ((SUL)), QRxPharma ((QRX)), Henderson Group ((HGG)) and NIB Holdings ((NHF)).

Investors should note this list was made up before Super Retail announced its intention to acquire the Rebel Sport operations which subsequently led to stockbrokers removing their Buy ratings, including Citi.

Citi's most preferred small cap resources stocks are Gindalbie ((GBG)), Grange Resources ((GRR)), Mirabela Nickel ((MBN)), Medusa Mining ((MML)), OceanaGold ((OGC)), Resource Generation ((RES)) and Regis Resources ((RRL)).

UBS, whose global strategists turned more positive on resources stocks the previous week, reshuffled its Model Portfolio by adding more "risk" and a little bit less "defensives" as the latter have now outperformed the former whole year and it seems about time for some sort of a catch-up, reasons UBS. The stockbroker's Model Portfolio has now seen the inclusion of Fortescue Metals Group ((FMG)), Whitehaven Coal ((WHC)), Stockland Group ((SGP)) and Boral ((BLD)), while three stocks have been dropped: Gloucester Coal ((GCL)), Transurban Group ((TCL)) and Crown ((CWN)).

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