Weekly Brokers Wrap: RBA Rate Cut A One-Off

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– If the RBA cuts this week it will likely be a one-off, not a change in trend
– It is unlikely that Europe's problems are over anytime soon
– Odds on the rise for a FOMO rally
– JP Morgan doesn't see much upside for Australian equities
– Global earnings forecasts continue falling
 

By Rudi Filapek-Vandyck

Economists remain divided on the subject but if the RBA delivers a rate cut on Melbourne Cup Day it will be a one-off rather than the start of a new cycle of monetary loosening, say those economists in favour of the cut, as well as many others. The general view is that the RBA might just decided to slice off 25 basis points from its mildly restrictive 4.75% cash rate, to bring it back to "neutral", simply because the Reserve Bank can.

Inflation has taken friend and foe by surprise by subsiding much faster than anticipated. The unemployment rate has ticked higher. The outlook for the Australian economy as a whole remains strong on the proviso that miners and gas producers stick to their record high capex ambitions. China is slowing but seems to be able to avert worse case scenarios.

A one-off interest rate cut is thus likely to bring some relief to companies and sectors in Australia that have been doing it tough under the RBA's restrictive policy over the year past. For investors in the share market, it remains yet to be seen whether the past can be taken as a guidance were the RBA to deliver a one-off rate cut this week and then nothing more. Banks' share prices have already performed strongly, as they usually do in the lead-up to a rate cut and investors have been positioning themselves into shares of retailers too. However, some market specialists question whether the latter choice will prove beneficial for much longer given the predicted one-off nature of the RBA move.

It is for this reason that market strategists at RBS pointed their clientele into the direction of property developers. RBS reckons retailers will only enjoy mild relief among many challenges for the sector in Australia, but the local property sector should improve more, while share prices for property developers look equally cheaply priced. Traditionally, media companies used to be among the main beneficiaries of rate cuts, but this time around overall sentiment towards the sector remains tepid at best. A dismal financial report issued by Ten Network ((TEN)) which caused a general response from stock analysts to the tune of "too early to get excited" might have further contributed to this as well.

The other Big News from the week past was, of course, the fact that an impotent and divided Europe has finally managed to come up with a plan that should stop the rot in the global financial system, at least for now. As with whether the RBA will act or not this week, there is no universal agreement on what the Ultimate (?) European plan will achieve other than knee-jerk relief rallies for risk assets across the world. According to some, it's all too little too late and European economies will suffer a recession that potentially stretches into 2013. Others are more hopeful, but readily admit the announcement made this week can only be the start of a lot of work that needs to follow through to make Europe less of a basket case that continues to threaten the wellbeing of banks and citizens in other parts of the world.

For most investors in equities the main question on their mind will be whether the October relief rally can last into November-December, and maybe even into the new calendar year? Market strategists at GaveKal are hopeful this may well prove to be the case. All equity markets need right now is further confidence that European leaders are united and working towards a final solution, argues GaveKal. With economic data in the US surprising to the upside and the Chinese economy improving, this may well provide investors with enough ammunition to continue buying equities.

GaveKal is certainly not the only one with such view. One would have to acknowledge that, with funds managers sitting on elevated levels of cash, the risk for equities might well rest with those funds managers panicking if equity markets continue to rise. Such a "Fear Of Losing Out" (FOMO) rally could push equities much higher by year-end. But will it happen?

Market strategists at JP Morgan revealed their skepticism this week by stating they really do not see much "genuine" value in the Australian share market. JP Morgan believes macro-risk such as "Europe", is only one factor weighing on equity valuations in Australia. An erosion of corporate profitability is a much more important story, suggest the strategists, and one that receives much less attention in the media. Anyway, JP Morgan doesn't see the local share market's valuation rising above 4600 and has now set its index target at 4250 for year-end and 4600 for June next year.

On Friday, the ASX200 closed at 4353.

An interesting point highlighted in JP Morgan's analysis is that both banking stocks and miners seem undervalued at present but that the real upside will likely prove smaller than investors would be inclined to think. In the banks' case, this is because of the risks that could potentially rub off from a serious global meltdown (one that has just been averted by Europe this week past) and investors are likely to continue being cautious because of such risk. In the case of the miners this is because margins will come under pressure, first from capex and rising costs, next from falling prices.

Everyone, states JP Morgan, is convinced prices will come off the boil at some point. It's simply a question whether it will happen gradually, or via a big shock, and exactly when.

The latter theme is one that is currently dominating outlooks for US corporate profits too. Viewed from many angles, corporate profits in the US are as healthy as they've been in a long time, but for how long can this Goldilocks scenario continue? Profit growth is already slowing down. Assuming this trend will continue in the coming quarters, what will the effect be on investors' overall mood?

Globally, and as indicated in the past week's Market Insight (see FNArena website), earnings forecasts are in decline. Not just in Europe, but in Australia, the US and Emerging Countries too. Equity markets do not always take guidance from earnings or forecasts, and they certainly have not done so in October, but if history can be our guide, falling forecasts tend to exert downward pressures that limit potential investment returns.

It'll be interesting to see whether a seemingly better than anticipated US economy can force a break in this downtrend.

I leave the final words with economists at ANZ Bank who were quick in responding to the escalation in crisis between Qantas ((QAN)) and the unions over the weekend: "A short-term grounding of the fleet would have limited economic impact but be of considerable nuisance value for travellers and another blow to Australia's tourism industry already struggling under a high AUD. If the dispute drags on, it would have more serious implications for Australia's tourism industry and associated services and some impact on the various supply chains relying on air freight. This would be a further negative for Australian business confidence at a time when confidence in many industries is already somewhat brittle."

An extra motivation for the RBA to act?

 
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