Weekly Broker Wrap: Australian Banks And Other Bubbles

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-Impact from Ford closure
-Aust dollar to go lower
-Bank yield rally could be ending
-Where are the asset bubbles?
-Election boosting ad spending
 

By Eva Brocklehurst

Whenever major employers close up shop there's repercussions for other businesses and sectors, which may not be obvious at first glance. Ford Australia's decision to de-camp from manufacturing in Australia by 2016 is a case in point. Ford will shut down its Victorian car building plants at Geelong and Broadmeadows. These facilities employ 1200 people. The decision has thrown the spotlight on the durability of the other car manufacturers in Australia – Toyota, with its factory at Altona, Victoria, and General Motors Holden with a plant at Elizabeth, South Australia.

The Australian real estate investment vehicle, CFS Retail Property ((CFX)), is the most exposed to the shopping centres that are near these plants. UBS estimates CFS has 10% of net operating income from centres exposed to these locations while Westfield Retail ((WRT)) has 1% of assets that are exposed, at Westfield Geelong. UBS is Underweight on domestic discretionary anchored malls, which includes CFS, Westfield Retail and GPT Group ((GPT)). The March quarter updates from retailers underlines the deteriorating operating metrics for shopping centres as a whole and increased unemployment in the above locations will make that worse. Westfield Group ((WDC)) is more immune, given exposure to improving US markets and an appreciating US dollar.

The economics team at UBS has reduced Australian dollar forecasts, revising the currency to US95c, from US$1.00, for end of 2013 and US90c, from US95c, by mid 2014. Westfield has increased exposure to US dollar earnings, to 30-40% in 2014 from 15% in 2011. UBS estimates a 10% movement in the AUD/USD exchange rate alters earnings by 3-4%. Admittedly, some of this growth may be offset by dilutive asset sales.

UBS notes the Australian dollar has suffered more than most during the US dollar's recent advance, which has occurred along with expectations the US Federal Reserve may reduce quantitative easing (QE). This has coupled with the Reserve Bank's recent lowering of the cash rate, eroding the Australian currency's yield advantage. Commodity price weakness is a factor. The risk of another seasonal drop in the iron ore price could be just the catalyst for the Australian dollar to go lower. This time capital inflows are not enough to balance this out and there is a likelihood the Australian dollar will "re-discover" its commodity currency roots.

One final cut to the cash rate is expected over the next few months. UBS suspects, even if the RBA does not move, the easing bias will be maintained until 2014. If the rate cut eventuates then this could further undermine the Australian dollar's yield advantage and lower the cost of carry for fresh short positions in the currency. Moreover, the bond market is already heavily bought by foreign investors and UBS suspects that, after three years of accumulation, FX reserve managers have hit their benchmark exposure levels to the Australian dollar. As the mining boom peaks, investment flows will be smaller on that front.

This doesn't mean there will be a complete exit. Reserve managers have a very long term investment horizon and the country's AAA status and strong fiscal position are still major attractions. There are also structural factors at play, with the shift into Australian dollar denominated assets part of a long-term transition to a multiple reserve currency system, in the analysts' view. Nevertheless, UBS notes with interest the sudden absence of bids from private wealth managers since the downside break with parity  to the US dollar. Support for the Australian dollar will come from improved GDP growth both locally and globally. Moreover, commodity prices are still expected to remain around double their historical averages, not consistent with a sharp correction in the currency below US90c.

Lower interest rates, the increasing rarity of Australia's AAA rating and favourable economic conditions have supported investment in Australian banks. Conditions should stay supportive but Citi suspects the yield rally could be at an end. The broker still has a Buy call on Westpac ((WBC)), ANZ Bank ((ANZ)) and Commonwealth Bank ((CBA)). It's just there's some risks to the rally looming. Rising interest rates are not an issue at present but any whiff of inflation would change that. Offshore, Citi expects interest rates/liquidity would tighten more so because of improved economic conditions and in this case monitoring the situation is paramount. All else being equal, a depreciation in the Australian dollar could result in higher interest rates and the sharp reversal in rates would pressure bank valuations.

Usually the market is sold off on global shocks. Beyond the direct influence on bank earnings, these shocks can lead to higher interest rates regardless of the level of the Reserve Bank's cash rate and a falling Australian dollar. Things to look out for on this score are further EU instability, sovereign debt problems, pandemics and adverse political or economic developments in  key trading partners. Shifting asset allocations are also a risk. To that end Citi flags the risk of infrastructure bonds in Australia, which may be seen as a substitute for bank shares and cash, particularly by retail/self-managed superannuation investors.

Macquarie thinks there may be an old fashioned "mortgage war" afoot. In a low growth environment competition returns to businesses that are generating higher than the group average return on equity. Of the majors, CBA and Westpac have stated they intend to target growth at system rates to stem market share loss. Here Macquarie thinks Westpac will have to do the most work, either dropping its standard variable rate, adjusting broker commissions and/or discounting more. A combination of these could cost 2-5% of earnings in FY14. The motgage broker channel may be the place to start. It is currently growing strongly in Macquarie's analysis and ANZ writes the most business this way.

Some advice on how NOT to invest from UBS. The broker defines an asset bubble as a valuation beyond the reasonable bounds of the fundamentals which could correct rapidly. On this basis there are five markets that fit this criteria. The main driver of bubbles is ultra-loose monetary policy. By pushing risk free rates to an unprecedented low level, central banks run the risk of creating a disorderly return to normal. The danger zone is when the central banks start to try and normalise policy. There are five candidates in the current circumstances for the bubble territory. These are: risk free rates – US treasuries, German bunds, UK gilts and Japanese bonds; credit; Asian real estate; emerging stock markets such as Indonesia, Philippines and Thailand; and Australian banks.

UBS finds Australian bank valuations are very stretched and the favouring of yield and good fundamentals should support them in the future. The trigger to a correction lies, as it does with most of the other four candidates, with any clumsy exit from the US Fed's QE policy. UBS' economics team in the US believes a scaling down of QE will happen in the first quarter of 2014. Despite this, other than a sell-off in risk-free rates after any QE exit, UBS does not think the Australian bank bubble will burst any time soon. Other potential risks are a downgrade to the sovereign rating, a housing market correction, trading book or funding issues, but these are unlikely.

US treasury yields are too low, as are German bunds. In UBS' opinion they should be closer to nominal GDP growth. Will the bubble burst there? Depends how well the Fed controls the long end of the curve. UK gilts are not as far from fair value and so may not be as problematic. In Japan, any sharp policy change after the elections in July may wield the big correction stick. For credit growth in both Europe and the US the analysts have been concerned for long time about the fact that liquidity vanishes in volatile periods. Therefore, here too the QE exit strategy is important. Asian real estate will suffer repercussions when QE is reduced as this will limit asset purchases and raise the cost of funding, notably Hong Kong real estate. UBS suspects the bubble may not burst with a QE exit in regards to emerging stock markets but many are expensive and relatively illiquid so there could be problems.

The federal election is on September 14. This will boost advertising spending in 2013, particularly on TV. Goldman Sachs estimate an extra $70 million boost to ad market spending in the second half of 2013. In fact, the longer lead up to this election has already produced more politically related advertising. The government has been increasing spending in digital areas at the expense of other media types. As digital spending tends to be less expensive this may mean lower political advertising spending overall. Goldman Sachs notes the key area of downside risk is mainly in print media. Ad market advertising is currently tracking 2-3% below the first half of 2012.

There are some differences this time. The early announcement of the election may mean some spending falls into the first half of 2013. More time to plan spending may produce cost effective campaigns too, as fewer ad spots are booked at high rates. Thus far, Goldman finds government advertising spending grew considerably in April and looks like lifting in May and June. Should total political advertising spending end up being weaker against previous years, it probably would be the result of more cost effective campaigning. Elections don't stop others advertising. Conventional wisdom has it that electioneering – elections usually happen in the third quarter – pushes other advertisers out to the fourth quarter, or pulls them forward to the second quarter. Goldman has found no basis for this and expects the extended election campaign will have no discernible effect on advertiser spending.
 

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