Weekly Broker Wrap: Rotation, Holden, Oz Outlook And Bond Correlation

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This story features ORIGIN ENERGY LIMITED, and other companies.
For more info SHARE ANALYSIS: ORG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-A Fed tapering puts spotlight on cyclicals
-Holden's impact on confidence
-Australia passes the sweet spot
-Tapering, bond correlation and stocks
 

By Eva Brocklehurst

The US economy seems to have the life the Federal Reserve has been seeking. Other major economies are weaker, while the US dollar needs to strengthen. This adjustment process will dominate the market next year, in CIMB's opinion. High yielding defensive stocks have outperformed in the era of searching for yield. The great sector rotation is now in train.

CIMB expects global and domestic cyclical stocks will outperform next year. The gloss will come off health care, after a stellar performance in 2013, but the broker still expects that sector, along with energy and industrials, to achieve increasing returns on capital. CIMB considers there's a benefit to being exposed to cyclical stocks with US-dollar based revenue. Specifically, the stocks listed for improving returns include Origin ((ORG)), New Hope Corp ((NHC)), WorleyParsons ((WOR)), CSL ((CSL)), ResMed ((RMD)), Seven ((SVW)) and Leighton ((LEI)). Diminishing returns are expected from OZ Minerals ((OZL)), Iluka ((ILU)), UGL ((UGL)), Goodman Fielder ((GFF)) and Imdex ((IMD)).

The broker remains positive on the domestic economy and thinks the Reserve Bank has policy in the "just right" category. A broader improvement will depend on the stronger US dollar. Mining investment is expected to decline for several more years but the terms of trade should be resilient on the back of improving thermal and metallurgical coal prices. The broker's other stocks with a positive outlook include Alumina ((AWC)), Aristocrat ((ALL)), Orica ((ORI)), Primary Health ((PRY)), Southern Cross Media ((SXL)), Transpacific ((TPI)) and Transurban ((TCL)). CIMB thinks banks, Telstra ((TLS)), consumer staples and utilities will underperform as the market prices in less stimulus from the US Fed. The broker likes domestic cyclicals with exposure to the consumer and housing sectors. The drag on the market in 2013 came from materials but CIMB thinks this sector will be one of the engineers of growth next year – because of better global prospects. Investors are recommended to position for returns in transport, outside of the airlines, and the broker is not wasting time trying to pick a bottom in the mining services sector.

It's the great rotation for Holden too. Citi thinks the decision to pull out of manufacturing in Australia was inevitable. Ongoing government support to keep the company manufacturing cars was not a long-term option and the broker does not think even a significant fall in the Australian dollar would change the decision. This is only one of the factors that drove General Motors' decision. Citi suspects that, because of the high profile nature of the business, the decision may have a short-term negative impact on consumer confidence. The decision will also crystalise debate around the decline in Australia's manufacturing sector. The broker thinks, as the manufacturing sector continues to decline from its current 7% share of nominal GDP and 8% share of employment, that the government will need to pursue policies that make the economy flexible and competitive in skills and investment across a range of industries. Productivity would be a good place to start.

UBS considers the "lucky country" may be running out of luck. The past two decades have supported Australia's improved living standards. Demographics have been supportive as has a boom in the terms of trade. The country is aided by strong migration and record births and has least worst demographics of the major economies. While supporting GDP currently, it's not enough, given budget pressures and the need to ramp up spending on an ageing population. Treasury forecasts that per capita income will drop to 1% year on year in the next decade. The RBA deputy governor, Philip Lowe, thinks the long-term outlook is much weaker and the demographic "sweet spot" has passed. UBS expects growth to remain moderate in the near term, with an improving global backdrop allowing GDP growth to recover to trend in the next year. This suggests to the economists the RBA will keep the cash rate steady at 2.5% until 2015 before commencing a modest tightening cycle. The major risk to growth is, as usual, a slowdown in China.

One of the dilemmas for the RBA, in Citi's view, is the fact that lending to investors for housing is too hot, up 8.2% in October and continuing a rising trend. Lending to first home buyers, in contrast, is weak. Business conditions are still underperforming relative to confidence as well. The broker does not think there's need for further rate cuts and believes the central bank must be hoping that pent up demand for established homes, which is pushing up prices, particularly in Sydney, will run its course.

Another word on the Fed tapering. This time from BA-Merrill Lynch. The economists think the Fed will start tightening in March and finish in December 2014, noting that reduced liquidity is likely to increase the price of money. With this in mind, stocks that could perform, or otherwise, are screened relative to their historical correlation with bond yields. So, in terms of Australian stocks those that have low or negative correlation, and have seen minimal falls in prices since May, could actually underperform when tapering begins. These include AGL Energy ((AGK)), Sydney Airport ((SYD)), SP AusNet ((SPN)), Spark Infrastructure ((SKI)), Transurban, Ansell ((ANN)), Ramsay Health ((RHC)), ResMed, Coca-Cola Amatil ((CCL)), Woolworths ((WOW)) and Harvey Norman ((HVN)). Those that have a high correlation with bond yields could benefit from steepening yield curves and they include BHP Billiton ((BHP)), BlueScope Steel ((BSL)), Incitec Pivot ((IPL)), Orica, Rio Tinto ((RIO)), Sims Metal ((SGM)), Caltex ((CTX)), Oil Search ((OSH)) and QBE Insurance ((QBE)).

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