Extend And Pretend

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– Global slowdown ahead in 2014
– QE not working
– SMEs the vital link
– FY15 the year for Australia

By Greg Peel

It was only last month markets across the globe were expecting an announcement from the US Federal Reserve that the central bank would start to taper its quantitative easing forthwith. It was not that the world saw a US economy able to sustain its own growth – indeed most believed the opposite – it was just that the Fed had appeared to have signalled such a policy intention.

It didn’t happen. But while the punters were initially angry the Fed let the markets believe tapering was about to begin, that anger has now given way to relief that QE was not wound back last month given the farce in Washington that has led to the US government shutdown. Even if the government is now reopened temporarily pending further discussions and a later deadline, the damage has been done to the US economy. And the whole charade could start again early next year once the extension ends.

It is now assumed tapering will be held off until at least toward the end of the first quarter 2014, and particularly so given the incoming Fed chair is a known dove. But while QE1 was critical in bouncing the US economy out of the GFC credit freeze, and QE2 became necessary due to the threat implicit in a crumbling Europe, QE3, as far as many are concerned, has achieved nothing. The US unemployment rate has come down but only because participation has fallen. Banks and big corporations are cashed up but not spending. QE3, many believe, is only serving to delay the recession the US has to have to clear the decks. The benefits of free money are simply not filtering down to the true economy – the small to medium enterprises (SME).

Saxo Bank believes global growth is headed for a slowdown whether central banks inside and outside the US continue quantitative easing or not. The only way an economic comeback can be achieved is if policymakers stop supporting the parts of the economy that don’t need or deserve support, Saxo contends, and start supporting the most important engine of economic and job growth – the SMEs.

When the world feared Fed tapering was about to begin, interest rates shot up sharply and so offered up a threat to economic recovery. This is one reason the Fed decided not to start tapering just yet, but clearly here there is a Catch-22. How does the Fed get out of it? Saxo Bank believes there’s more chance the Fed will end up increasing QE next year, not winding it back, when the central bank realises economic and job growth are just not happening.

A more likely end to QE will thus be brought about by markets coming to realise QE is not working. “The only way to stop the unprecedented monetary experiment is for it to fail to show that it is generating what should always be the number one priority,” says Saxo, “of more jobs and rising incomes”.

Saxo calls the Fed policy “extend and pretend”. The analysts suggest there may be another kick-up in risk appetite early next year when the Fed chooses to extend and/or increase QE, but we’ll still be in early 2014 when markets begin to realise that QE has lost its credibility. “QE will only be threatened as a policy tool when the markets reject it, rather than celebrate it”.

Thus while 2014 might look good to begin with, headwinds will start to build as the year rolls on. “2014 will be the year to clean up and prepare,” says Saxo chief economist Steen Jakobsen, “for a world that is increasingly more balanced, less leveraged and more proactively helping the one part of the economy we kept outside the loop throughout this cycle: the SME”.

On a slightly more micro level, balance is the Australian economy’s biggest challenge. The cause is known, says Morgan Stanley, and the answer is clear. Getting there is the hard part.

The Morgan Stanley analysts remain bullish on Australia, forecasting a 12-month rolling target for the ASX 200 of 5500. But the transition from resource sector-led economy to an east coast revival will be an FY15 story rather than an FY14 story, they suggest, in terms of corporate earnings. The signs are promising for a recovery in east coast housing activity, consumption and public infrastructure, and the hard landing risk for China has now been mitigated, the analysts insist. The greater challenge for Australia will be adapting to the shift in China’s internal growth drivers, that is, away from investment and industrial production and towards consumption and services.

Morgan Stanley believes the Australian stock market is nearing the end of a multi-year earnings downgrade cycle. Green shoots are starting to appear, but only when we look through to FY15. Price/earnings multiples based on FY14 earnings forecasts look fairly valued right now, suggest the analysts, thus valuation and growth assessments should be made with FY15 in mind.

Sector-wise, Morgan Stanley is keen on housing-linked sectors, consumer discretionary, diversified financials, insurers and energy. Using a top-down approach (individual stock analysts use a bottom-up approach, starting with earnings forecasts), Morgan Stanley has developed a Focus List of twenty preferred stocks.

They are AMP ((AMP)), Brambles ((BXB)), DuluxGroup ((DLX)), Domino’s Pizza ((DMP)), Flight Centre ((FLT)), Fortescue Metals ((FMG)), 21^st Century Fox ((FOX)), Goodman Group ((GMG)), Lend Lease ((LLC)), Navitas ((NVT)), Oil Search ((OSH)), Perpetual ((PPT)), REA Group ((REA)), ResMed ((RMD)), Stockland ((SGP)), Sonic Healthcare ((SHL)), Super Retail ((SUL)), Treasury Wine Estates ((TWE)) and WorleyParsons ((WOR)).
 

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