Weekly Broker Wrap: Downward Shifts Accelerating

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This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Rudi Filapek-Vandyck, Editor FNArena

The world changes a little every day, but for investors in the Australian share market the week past was fully packed with major shifts in expectations and projections, showing just how much things have turned for the worse in a matter of only weeks. Most economists in Australia had been expecting to see more rate hikes as recently as in August, but now the trend is reversing towards expectations of another rate cut in December, after the RBA surprised most with a cut on Melbourne Cup Day. JP Morgan changed its house view this week to four more cuts (100 basis points) for each of the next RBA meetings, starting in December. It was only weeks ago when JP Morgan predicted there would be no change in the official cash rate through to December 2012.

Both Goldman Sachs and AMP's Shane Oliver reiterated their prediction of a December rate cut by the RBA next week. The European Central Bank is widely expected to continue to cut interest rates in the months ahead as eurozone economies, including Germany, sink into negative growth this quarter and next.

Meanwhile, forecasts for economic growth in Europe, in China and in Australia continue to fall. Note: that was before this month's HSBC Flash Estimate of China's PMI took everyone by surprise with a preliminary reading of 48, signalling contraction for the sector in November. Still, not everybody is convinced this may see Chinese authorities pull the stimulus lever sooner rather than later. As a sign of how much the world remains divided on this matter, RBS released two opposing views on China this week. One, from the team of China-watchers in Hong Kong, is predicting China will start stimulating its economic activity again, soon. Another report, from analysts in Australia (who just returned from a trip to China), predicts the Chinese will wait and take no more than baby steps in the meantime. Probably no surprise then, the team of Australian analysts remains bearish on commodities in the short term.

Meanwhile, earnings estimates continue to weaken and growth has now all but disappeared for the main constituents in the Australian share market for 2012. Consensus expectations for all the major banks are for growth in low single digits only, previous double-digit expectations for BHP Billiton ((BHP)) and for Woodside (WPL)) have by now turned into single digits (and still falling) and for Santos ((STO)) the year to December next year is already anticipated to mark a year of negative growth. The likes of Newcrest Mining ((NCM)) and Fortescue Metals ((FMG)) should still grow strongly, but expectations are weakening for those companies too.

US analysts at JP Morgan cut their investment rating for commodities to Underweight, predicting more losses for the next six months. Oil price forecasts across the globe for the months ahead are falling, while estimates for steel demand in 2012 are sliding too. No wonder then that analysts who cover Real Estate Investment Trusts (REITs) in the Australian share market are anticipating renewed interest for the sector in December when most of the A-REITs listed on the ASX will declare and pay out an interim dividend.

The absence of meaningful growth in Australia is forcing banks to look overseas, report analysts at Citi. Apart from ANZ's ((ANZ)) well-publicised ambitions in Asia, management at CommBank ((CBA)) is also looking for options in the region, while Citi knows of previous interest at Westpac ((WBC)) for a potential foray into the Indonesian banking sector, but without follow-through. Thus far, National ((NAB)) remains absent in the Asian banking theme. Investors are hereby reminded Woolworths ((WOW)) is also believed to be looking at India for its next leg of operational expansion. In addition, while share prices might possibly remain depressed for longer and substantial earnings growth may not occur next year for large mining companies, they are still expected to generate copious amounts of cash which is why commodity analysts anticipate a wave of M&A deals for the sector in 2012.

One of the extra-motivations for M&A is one of rising costs and a sector report by Citi during the week again highlighted just how much mining companies around the globe are battling to keep their costs down. Citi's conclusions are that current methodologies used by most commodity analysts do not accurately reflect the real cost levels for most mining companies. More downside potential, thus.

One positive is that, while at prima facie the correction in commodities prices since August looks eerily similar to the Big Sell-Off that took place in 2008, commodity analysts continue to express their belief that a repeat of the 2008 Book of Commodities Armageddon is not on the cards. Commodity analysts at Barclays reiterated the point in a dedicated sector report published during the week.

No surprise, small caps specialists at BA-Merrill Lynch see little respite for small cap stocks in the Australian share market in the short term as most indicators continue to point towards ongoing headwinds. The team has nominated eight names investors should nevertheless consider given high quality operations with minimal risk to earnings forecasts and reasonable valuations: Ausdrill ((ASL)), McMillan Shakespeare ((MMS)), Bradken ((BKN)), Flight Centre ((FLT)), SAI Global ((SAI) and Saracen Mineral Holdings ((SAR)). In the micro-end of the sector BA-ML likes Technology One ((TNE)) and Mastermyne Group ((MYE)).

Strategists at BA-ML observe how high correlations are popping up everywhere in a sign that generalised macro-economics are leading price actions instead of fundamentals. This, conclude the strategists, has turned the Australian share market into a high beta market and thus a no-go for many foreign investors. High correlations inside the share market also implies many stocks are trading on similar valuations while their earnings growth profile differs, again highlighting how individual fundamentals are being ignored. This, say the strategists, means that in some cases short term earnings risk may be underpriced.

Stocks trading at PEs close to the market average but having experienced significant downgrades to earnings include Ten Network ((TEN)), David Jones ((DJS)), Myer ((MYR)), Aristocrat ((ALL)), The Reject Shop ((TRS)), Perpetual ((PPT)), AMP ((AMP)), IOOF Holdings ((IFL)), CSR ((CSR)), GWA Holdings ((GWA)), Computershare ((CPU)) and Boral ((BLD)). Conversely, BA-ML reports stocks with high forecast earnings growth for 2012-14, limited recent downgrades and no significant valuation premium to the market include Crown ((CWN)), News Corp ((NWS)), Super Retail Group ((SUL)), JB Hi-Fi ((JBH)), Wotif.com ((WTF)), Ansell ((ANN)), Sonic Healthcare ((SHL)), Asciano ((AIO)), Leighton Holdings ((LEI)), Brambles ((BXB)), Toll Holdings ((TOL)) and Amcor ((AMC)).

Commodity analysts at UBS suggest the weakness in thermal coal prices is opening up opportunities in equities on a twelve month horizon. In Australia, UBS likes Whitehaven Coal ((WHC)) the most.

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