Treasure Chest: Equity Strategy 2013

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By Greg Peel

Standard Life Investments notes global economic growth has slowed significantly into 2012, but head strategist Andrew Milligan expects a growth recovery for the world's three largest economies – the US, Japan, and China – in 2013. Markets are already pricing in successful action by central banks to achieve this, so the risks are high if policy errors are made. Fiscal austerity remains a major hurdle, with government spending cuts in the US a risk to a moderate recovery next year.

Milligan expects Chinese growth to stabilise around 7% in 2013, but as structural imbalances become more noticeable, difficult reforms are necessary to ensure a recovery is sustainable. Monetary policy alone is not the answer. The banking system is being shored up in Europe, but not enough action is being taken to boost economic activity, Milligan believes.

Morgan Stanley is concerned the 2012 run-up in developed world stock markets has left no buffer for bad news, in particular significant earnings misses in the US and Europe. MS also sees significant risk surrounding fiscal policy in the US and politics in Europe, which markets are underestimating in the analysts' view. In short, markets are “normalising” long before there are signs of life returning to “normal”. The sharp outperformance of stocks over bonds in the past year suggests a marked improvement ahead in developed world growth. Is this justifiable?

Morgan Stanley's Gerard Minack clearly does not believe so, but Minack admits he has been left behind all year on the PE expansion (reflecting improved sentiment) that MS did not forecast. The mining & minerals sector has seen its PE expand by over 50% globally, for one. Yet rising PEs are increasingly inconsistent with falling earnings expectations. Globally, the metals & mining sector has seen the biggest reduction in earnings expectations.

China is clearly key.

Citi feels the market is currently struggling to see things as either black or white, and the investment community appears to be waiting for some sign of safety before stepping back into the fray after the strong run-up from June. All is now in limbo as we await the three E's – earnings, elections and economics – to become more clear.

Yet Citi has provided some interesting insights. While there seems to be a general consensus that sell-side (stock broker) forecasts for 2013 are still too high (in the US), the fact the buy-side (fund managers) believe this means the market is already adjusted for what it sees as overblown expectations. This limits downside risk, Citi suggests.

Citi also notes the Fed's bank lending standards survey provides a leading indicator which suggests a rebound ahead from the US summer slump in business activity, which should help buoy stock prices into 2013. In short Citi is bullish US equities in 2013.

This does not mean all the bad news is over – not by a long chalk. Citi's global economists expect Portugal's sovereign rating to be downgraded further in the next 2-3 quarters with France moving to negative watch, while over the next 2-3 years Citi expects downgrades for many EU countries as well as the UK, Japan and the US. Citi still thinks Greece will exit the euro, but not as early as the economists had previously assumed.

However the counter to the above will be ongoing naked QE from the Fed after Operation Twist expires in December, the OMT and further rate cuts from the ECB, an imminent resumption of QE from the Bank of Japan and a larger than expected expansion of QE by the Bank of England, Citi suggests.

Shifting to the Australian picture, Deutsche Bank notes the past month has seen forecast earnings downgrades for 114 of the ASX200 companies and upgrades for only 72. Over the past four months, forecast forward earnings have fallen a net 9%. Yet at 12.9x Australia's market PE is in line with the US and above most other markets. 

A clue may be found in Australia's net dividend yield, which at 4.9% well exceeds the world average 3.0%, and with bond yields low across the developed world, Australia should remain attractive to offshore investors.

Deutsche nevertheless echoes Morgan Stanley's concerns on the PE front. Australia's PEs are now well above the two-year average and approaching the ten-year average. Mining's sector PE has almost returned to that of the 2003-2007 bull market – the “super cycle”, stronger for longer”, look out here comes China omigod bull market.

“We stay cautious,” says Deutsche.

UBS is more inclined to run with the pack. Stocks have been rallying recently on signs of improving momentum in China and the US and a reduction in European tail risk, the strategists note. Yet stocks still look “very cheap” versus bonds.

After this consolidation has run its course, UBS sees stocks continuing to push higher on improving macroeconomic data. The improving data suggests retaining a pro cyclical (beta) stance within portfolios, UBS believes, and cyclical rotation should continue given the extent of underperformance previously, the relative expensiveness of safety, and improving global growth.

UBS is not so cautious on resource stocks and remains Overweight on expectations of higher iron ore prices and better Chinese growth momentum. The strategists also see value in industrials and have singled out Incitec Pivot ((IPL)) and Orica ((ORI)) as preferences. They also see the US recovery as retaining its attractive theme but finds the obvious exposure choice – James Hardie ((JHX)) – as very expensive and prefers to play the US via News Corp ((NWS)), Brambles ((BXB)) and Incitec.

In other changes to the UBS Model Portfolio, the strategists have added Caltex ((CTX)), Challenger ((CGF)), Persues Mining ((PRU)), Primary Health Care ((PRY)) and Westfield Retail Trust ((WRT)). Out go Alacer Gold ((AQG)), QR National ((QRN)), ResMed ((RMD)) and Stockland ((SGP)).

The chase for yield has been a theme for some time now in the Australian and global markets, thus rendering some yields plays no longer attractive. Macquarie maintains a “filtered yield portfolio” which has provided a total return of 9.7% since its inception in May on a “forced” 20-stock portfolio of equal weightings. The analysts have now updated the portfolio with some changes.

DUET Group ((DUE)) enters the portfolio and also the top five of yield choices, which includes Metcash ((MTS)), Telstra ((TLS)), National Bank ((NAB)) and United Group ((UGL)).

Other additions to the portfolio include Transurban ((TCL)), APA Group ((APA)), Challenger, Lend Lease ((LLC)), Goodman Group ((GMG)) and Investa Office ((IOF)). These stocks are included at the expense of earlier constituents Bendigo & Adelaide Bank ((BEN)), JB Hi-Fi ((JBH)), Westfield ((WDC)), Brambles, Coca-Cola Amatil ((CCL)), Suncorp ((SUN)) and Woolworths ((WOW)).

Rounding out the balance of the 20-stock portfolio are the other three Big Banks ((ANZ)) ((CBA)) ((WBC)), Mirvac ((MGR)), Dexus Property ((DXS)), Commonwealth Property ((CPA)), GPT Group ((GPT)), Amcor ((AMC)) and Wesfarmers ((WES)).
 

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