Weekly Reports | Jan 17 2014
– Credit Suisse goes wild
– Citi still likes equities
– Economists argue over RBA policy
By Greg Peel
Credit Suisse’s local equity strategists have come up with some “wild ideas”. (Trying using the words “equity strategist” and “wild” in the same sentence yourself. Go on, try.)
At the beginning of each year the team gets together and goes wild, throwing up investment ideas for the year that are “not the core views of our analysts but are still credible and would have a disproportionate impact on stocks”. We’ll start with their global thoughts. Bear in mind these thoughts are variously bullish or bearish and mutually exclusive.
Global equities rally 20% plus. The European Central Bank implements QE. Chinese GDP growth slips below 6%. Japanese government bond yields spike. Stricter capital requirements are introduced for asset managers. Mining equipment spending bottoms. The Chinese steel industry sees massive capacity closures.
Now for the Australia-specific list.
Australian house prices rise by more than 10%. The Aussie dollar runs back up again, to post float highs. Australia develops a fully functioning credit market. Local companies become net “retirers” of equity [buybacks vs raisings] and not the world’s biggest issuers as they were in 2013.
But enough of these jolly japes.
Citi’s global research team began 2013 positive on equities, negative on government bonds and negative on commodities. Other than resilient strength in oil prices they were on the money, but admit to not quite picking a full 57% rally in the Japanese stock index.
This year Citi sees the GFC “tail risk” that began to fade in 2013 fading further in 2014, although risks still remain in the eurozone, in China, and in political processes generally. The team’s base case is marginal economic improvement overall, with a forecast global GDP growth of 3.25%. The political landscape in the US should become more accommodating and the implementation of tapering should have only minor consequences, including for emerging economies, Citi believes.
Citi continues to recommend overweight allocations to equities globally relative to other asset classes. The team does not see equity valuations as stretched given a positive view on corporate earnings growth in 2014, and sees scope for further increases in dividend payout ratios.
Let’s now focus solely on Australia.
From the economic perspective, the economists at Commonwealth Bank have divided the resources boom into four stages: the income boom (China emerges and commodity prices soar to unprecedented levels); the capex boom (now ending, in which vast sums are spent expanding production capacity); the export boom (now beginning, when all the new production is sold to China/Asia); and a fourth boom which requires an adaptation to slower China/Asia growth rates, with growth driven by the emerging Asian middle class consumer.
Before arriving at, and knowing how to deal with, the fourth boom, the challenge for Australia is to sell all the additional third boom tonnages for reasonable prices, says CBA, and avoid global deflation. The more complex challenge is to avoid the labour market consequences of the end of the mining capex boom through rising residential construction activity, consumer spending and non-mining business investment, including public infrastructure.
CBA notes consensus forecasts that the Australian economy will continue to run slightly below trend in 2014. This would be a little disappointing in an absolute sense, CBA suggests, but also means the relative outperformance of the Australian economy vis a vis developed economies over the past few years will give way to underperformance as those economies start to lift. Nevertheless, Australia should have no trouble marking its twenty-third consecutive year of positive GDP growth.
As the Fed’s QE program winds down, so will the Aussie dollar retreat. While this will restore some “normality” to the Australian economy, the positives and negatives still have to be managed. Australia must also avoid a housing bubble, warns CBA. Credit growth, lending standards and house price expectations must remain “well anchored”.
CBA believes the arguments for further RBA rate cuts put forward at the beginning of both 2012 and 2013 look less compelling at the beginning of 2014. The Aussie dollar has dropped a long way and interest rate sensitive sectors of the economy are responding to earlier cuts. CBA sees the commencement of interest rate normalisation (hikes) in late 2014.
Alliance Bernstein disagrees.
Alliance Bernstein acknowledges a pick-up in Australian household activity of late, as evident in the data, with improvement particularly notable in the housing sector. With building approvals on the rise, housing construction should make a positive economic contribution in 2014. Retail spending is also showing signs of recovery, with October-November numbers suggesting the best result since stimulus cheques were handed out in 2008-09.
It would be easy to thus conclude no further monetary stimulus is required. But Alliance Bernstein remains unconvinced.
The upswing in housing construction has been dominated not by single family homes but by multi-story apartment developments. This suggests the risk of a sharp contraction down the track (apartment blocks affect lumpiness and volatility in residential construction data). The jump in retail spending has been welcomed but is it sustainable? Household incomes remain soft, there is little sign of jobs growth, and wages are under downward pressure.
On the subject of unemployment, Alliance Bernstein is concerned about what is now finally being recognised globally as the elephant in the room of all “unemployment rate” numbers – the underlying participation rate. As Australia’s, or any, population ages, the work participation rate will fall, all things being equal. Australia’s participation rate has been duly falling as the unemployment rate has remained relatively steady. But Alliance Bernstein research shows the fall in participation rate is not being driven by retirements but by prime working-age males, who are clearly being discouraged by a lack of available jobs.
Alliance Bernstein’s final concern is simple. While an upswing in housing and spending activity is nice, it is unlikely to be sufficient to overcome the impact of the end of the mining capex boom. On that basis, weaker Aussie dollar notwithstanding, Alliance Bernstein sees further pressure on the RBA to cut rates in 2014.
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