(Greek) Exit Strategies For Australian Stocks

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By Greg Peel

A couple of years back Australian stock analysts were looking to FY10 as offering a post-GFC trough for Australian earnings, FY11 seeing some clawback and FY12 offering cracking earnings rebound potential. Analysts have done nothing, on a net basis, but downgrade their earnings expectations ever since. To be fair, not many in the world predicted the GFC would not end but simply reemerge in Europe. To be realistic, analyst expectations of a consumer rebound and credit demand rebound were way off the mark.

Deutsche Bank notes that over the past month, consensus earnings forecasts have been cut for 119 of the ASX 200 companies with upgrades being afforded only 61. This is in line with the average of the past year, Deutsche notes, and leaves Australia's net earnings growth forecasts below most global peers. Miners were worst off over the month, seeing 52 downgrades to 15 upgrades, while industrials chimed in with 64 to 44 and the big banks saw 3 to 2.

While the Great De-Rating, as FNArena has been speaking of now for some time, continues, the magnitude of the most recent downgrades have been comparatively modest, Deutsche notes. Indeed over three months, net forward earnings forecasts have actually been rising a little. (Would it be sceptical to suggest thus providing scope for more downgrades ahead?)

The Deutsche analysts believe net downgrades are likely to persist in the near-term with a round of mining downgrades in the offing if commodity prices remain at lower levels. (There should be room for offset if analysts reduce their Aussie forecasts.) They are nevertheless still backing expectations of a second half 2012 recovery for commodities as Beijing steps up policy easing. Industrials have more room to fall as headwinds persist but Deutsche sees forecasts settling at lower growth levels rather than the no-growth levels of past years. There will be respite from the Aussie no longer rising, from an assumption major natural disasters are now behind us, and from assuming the industrial disputes which have plagued different sectors are settled for now.

Deutsche has rolled out some interesting stats for the historians out there. Australia's forecast stock dividend yield is now 2% above the bond yield which is close to the 2008 peak. Cyclical industrials are trading at a 16% price/earnings discount to defensives which compares to the ten-year average of 1%. On most recently reported earnings, mining stocks are trading under 9x which is the lowest level in 25 years not including the GFC period.

It all sounds rather encouraging, were it not for a little place called Europe. Given Australian net earnings are actually rising for the first time in a while – albeit still suffering downgrades to lower growth expectations – and valuations are historically very low, if uncertainty in Europe recedes, equities should see upside says Deutsche.

Yes – if.

My personal opinion on the matter seems to be running counter to most (but not all). The fear is that a Greek exit, even if orderly, could only spark rolling contagion. This may well be true, but I believe a ceremonious dumping of Greece from the eurozone could only bring a smile to every Johan, Jean, Juan and Giovanni across the rest of the zone. Now go and pay your taxes, they'd say, as they thumb their noses at Yanni. Throw in a zone-coordinated shift away from harsh austerity towards growth stimulus and Johan, Jean, Juan and Giovanni may well start feeling better about life.

Thus they may not see the value in making a run on the banks. The money earmarked for Greece will return to the eurozone firewall funds and will be ready to provide for bank recapitalisation. The ECB will open the floodgates and the remaining eurozone will be “ring-fenced”. Two years of exposure reductions will see the global fallout contained.

Yet I am but a humble journo and I could be very wrong, although:

“Markets are pricing the European threat more as a growth risk than as a financial crisis,” suggest JP Morgans equity strategists. “The implication is that a Greek exit either does not happen or does not trigger a disorderly capital flight from Spain and Italy. Those who disagree should still reduce risk, but we think that this is a plausible story: capital flows could pull the eurozone together instead of pulling it apart.”

On that basis, JP Morgan does not believe a highly defensive portfolio is justifiable at this level, even though the strategists' long-standing trading-range forecast for the ASX 200 is facing its “sternest downside test yet”.

JPM is putting its faith in the widely expected monetary policy response from China. The strategists are not expecting a 2008-style massive fiscal stimulus announcement, rather a trickle of pro-growth measures which could “wrong-foot the bears” at these low stock price levels. Chinese growth measures will clearly benefit commodity names, and on that basis JP Morgan advocates having exposure to industrial commodities.

The strategists are maintaining only a Neutral rating on the mining sector but favour the risk-reward balance of mining over the banks. Aussie banks have proven fairly resilient so far, suggesting that if the eurozone crisis does deepen and funding costs blow out, there is room to fall. If not, upside is more limited. In terms of exposure to actual defensive stocks, JPM points out low-yielding defensives have protected investors better in the correction than high yielders.

Of course, when we speak of monetary policy stimulus, we must not forget the RBA's capacity to provide further rate cuts. Australia's central bank is now in a rate cutting cycle, but the bad news is BA-Merrill Lynch believes this cycle is likely to deliver a much smaller reduction in interest rates to borrowers than previous cycles. We must remember that unemployment remains low and the RBA is very conscious of the pipeline of resource sector investment.

If rate cuts are fewer then it follows that benefits to rate-sensitive sectors will be smaller. It is already clear that the two rate cuts of late 2011 did little to boost the consumer and building sectors and there is no evidence the May double-cut has sparked a return to confidence either. Merrills suggest investors should remain Underweight domestic cyclicals, particularly given the structural headwinds which are also encumbering certain stocks (eg the online shift for retail).

Merrills prefers stocks which can deliver growth at a reasonable yield, and in that category the strategists like DUET ((DUE)), AGL ((AGK)), and Transurban ((TCL)).

On the “stay away from” side, Merrills suggests consumers will lack the confidence to jump into big-ticket purchases like cars and homes, which does not bode well for builders and developers. The strategists note Boral ((BLD)) is trading on 14x forward earnings and thus looks expensive. Weak business sentiment will mean an ongoing lack of advertising demand which means media stocks will continue to suffer. The strategists note Ten Network ((TEN)) is also trading on 14x. Ditto.

Smaller ticket purchases, on the other hand, are less dependent on confidence levels. Gaming and retail are thus Merrills preferred consumer exposures, with Tatts ((TTS)), Wesfarmers ((WES)) and Super Cheap ((SUL)) being favoured along with Toll Holdings ((TOL)) to do the deliveries.
 

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