Weekly Reports | Nov 07 2011
This story features MICROBA LIFE SCIENCES LIMITED.
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By Greg Peel
It must be noted that FNArena's Weekly Broker Wrap collates analyst views throughout the week and that last week, like many before it, featured a rollercoaster ride in response to headlines out of Europe. It also featured an RBA rate cut on Tuesday. In articulating their views last week, analysts were unaware the fate of Europe could yet come down to a vote of confidence in the Greek prime minister.
The October bounce in equity markets, reflecting global hope that a European solution was almost in place, confounded many investors in its speed, suggest Citi's North American equity strategists. Many have been left with losses having remained in overly defensive positions and having not participated in the rise. The bottom line is that markets were extremely and overly optimistic in April, but ahead of October forecasts had become “excessively dire”, the strategists believe.
Citi believes valuations in the US are still generally attractive even taking the bounce into account. Yet deep-rooted scepticism following three years of volatility is ensuring that sentiment remains poor. Corporate earnings forecasts have been coming down but Citi notes that “sell-side” (brokers) estimates are being ignored by the “buy-side” (fund managers) which has pitched its own forecasts much lower. Citi believes these outlooks are too pessimistic.
Given this poor sentiment and the large cash holdings in the market which reflect such sentiment, combined with reasonable credit conditions (low Fed rates), Citi believes equity markets have more upside potential. We are nevertheless not talking “boom” given there's clearly still more to be done in Europe and let's not forget the ever present factor in the background, being US fiscal policy wrangling.
FNArena has often pointed out that Australia has been among the poorer performing equity markets in the years following the GFC. Since the start of 2010 the Australian market has declined whereas the UK and US markets, for example, have risen. This seems incongruous given the Australian economy has been among the best performers in the world post-GFC, in stark contrast to the UK and US, but the point is that the Australian economy did not suffer as much as North Atlantic economies as a result of the GFC so while North Atlantic economies have been “bouncing” (gradually), Australia's has become two-speed with the strong Aussie dollar affecting significant pain across many sectors. On a net basis, corporate earnings forecasts have been falling for 18 months.
Earnings downgrades now appear to have eased somewhat, Citi's Australian strategists note. We've had a rate cut and the Aussie appears to have settled within earlier bounds. This suggests to Citi that the Australian market could now “do better” against the others. The problem is that valuations in the Australian equity market are not low when compared to others, and hence earnings growth will likely now be more constrained than it was pre-GFC. On that basis, the Australian market may still ultimately lag, Citi believes.
Writing ahead of the Greek coalition government announcement, Credit Suisse strategists suggest the European plan to leverage the EFSF up to E1trn may have been well received but the devil remains in the detail. The critical factor is to how this expanded EFSF will be funded. If the ECB is not a contributor to leverage then investors may have to take on the bulk of the risk, CS notes. With default risks lingering, investors won't necessarily be too willing.
FNArena notes that while the G20 leaders meeting provided the opportunity for European officials to seek indications of interest, and that the leaders were united in calling for an end to the European mess, no one much was prepared to step up to the financial assistance plate. China, for one, has been touted as a major player but even it appears to be holding off on any significant commitment. Germany is not keen on the ECB being the main source of EFSF leverage because by implication, German funds will be the most drawn upon. Meanwhile, Credit Suisse believes the ECB holds the key to resolving the crisis.
Even if stability can be found in Europe, it won't much change the global economic growth outlook, Credit Suisse suggests. Austerity will impact on Europe, financial conditions remain tight in China, and the US is once again approaching its debt ceiling.
The Credit Suisse strategists are expecting another RBA rate cut to follow in the first quarter of 2012. Locally they are Overweight discretionary retail and banks and Underweight resources. Weak global growth is likely to weigh on commodity prices, they believe, while RBA cuts will support domestic rate-sensitive sectors such as retail and the banks as well as REITs and utilities.
Whatever the fate ahead for the Australian equity market, RBS Australia believes the market is now structurally supported as a result of much reduced gearing levels compared with pre-GFC times. We are arguably in an accumulation phase, says RBS, and are looking for fundamentals that could “underpin an improving trajectory”. Improved corporate balance sheets are one such factor, and asset value supports such as M&A activity, dividend increases and share buybacks can be another.
RBS notes that while there have been some dividend increases and a handful of buybacks recently, these have not been as meaningful as company moves to merge and acquire. In the meantime, companies with lingering debt issues and cash realisation problems are being given a wide berth by RBS. To that end the strategists are short Goodman Fielder ((GFF)), Tabcorp ((TAH)) and Billabong ((BBG)).
Credit Suisse may be Overweight discretionary retail but the BA-Merrill Lynch strategists warn that one RBA rate cut in November does not necessarily a merry Christmas make. It takes time for lower rates to provide a boost to retail, Merrills points out. On the other hand, the 10% rise in the Aussie dollar over 2011 equates to an effective 200 basis point rate rise, Merrills estimates. If the Aussie remains elevated then the RBA will have to move harder on rates in order to boost the domestic economy.
On that basis the Merrills strategists are Underweight the consumer, building materials and media sectors, and suggests caution with respect to stocks such as David Jones ((DJS)), Myer ((MYR)), Boral ((BLD)) and Fairfax ((FXJ)). They do not rule out further earnings downgrades for these stocks. They recommend investors continue to base their portfolios around solid and sustainable yields, and as such Transurban ((TCL)), DUET ((DUE)), MAp Group ((MAP)), Tatts ((TTS)), Coca-Cola Amatil ((CCL)) and the major banks are suggestions.
One month ago, Goldman Sachs' equity strategists decided that the drop in market sentiment with respect to the turmoil that was August and September meant that Australian valuations (PEs) must fall. Applying lower PEs to forward earnings forecasts meant Goldmans reduced its end-2011 target for the ASX 200 to 4075 from 4450, mid-2012 to 4400 from 4800, and end-2012 to 4725 from 5000. But given the announcement of a European rescue plan, Goldmans now believes the macro risks dominating investor sentiment can begin to diminish.
What does this mean? It means we need to put all those PE s back up again of course. Hence last week Goldmans raised its ASX 200 targets to 4375 from 4075 for end-2011, to 4800 from 4400 for mid-2012 and to 4850 from 4725 for end-2012.
So let's forget August-September ever happened and net those target moves out. Goldmans now targets 4375 for end-2011, down from 4450, 4800 for mid-2012 (unchanged) and 4850 for end-2012, down from 5000. At least until the strategists change them again.
Goldman Sachs is clearly more optimistic about the “risk off” trade than Merrills. The strategists have now increased cyclical exposure in their model portfolio by adding Macquarie Group ((MQG)) and James Hardie ((JHX)) and reduced defensive exposure by removing Transurban.
The Macquarie analysts have also been playing around with model portfolios this past week or so. Macquarie publishes its list of “high conviction calls” which it brands Macquarie Marquee Ideas. Over the past week Macquarie has added Caltex ((CTX)) and Nufarm as Buy ideas. FNArena covered the Caltex reasoning last week in Playing The New Caltex .
The reasoning behind Nufarm relates to the company's upcoming debt refinancing. Debt concerns have been weighing on the Nufarm share price but Macquarie notes the company has received credit approved offers of $675m when $600m needs to be rolled over, and that negotiations are complete and legal documents are being drawn up. A successful outcome should thus not be far off, the analysts suggest.
Macquarie has also added a new stock as a Sell idea amongst its Marquee Ideas. That stock is Mesoblast ((MSB)), the reasoning behind which was covered by FNArena in last week's Mesoblast: Overvalued or Undervalued?
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