Australia | Jun 30 2014
By Mathan Somasundaram, Baillieu Holst Quant Strategy
Summary: Aussie market pulled back on tax related selling despite a flat global lead. Aussie market was down 0.91% with turnover was just above $4.3b. Credit data was slight positive locally while new home sales pulled back. We were expecting housing prices to stabilise as affordability has been stretched with real wages growth unable to keep up. We are expecting RBA to leave the rates as they are and trying to talk the currency down while the China PMI data should be positive given the recent trend of flash PMI improvements.
We were expecting a positive day today while the market decided to lock in profit before financial year end. Given the market pullback today and the potential positive news, we would expect to recover in the next few days. Market has already priced in majority of the negative macro news while brokers have downgraded for all the macro and stock level risks. Analyst have become so gun shy, the risk is low to standout and be a contrarian. We continue to feel that the market will start its positive run with the new financial year and find that result season is unlikely to be the “Valley of Death” as expected by most market pundits. Central banks around the world are expected to keep rates low for longer than the next 12mths and that will drive further investment into equities in the new financial year. We continue to favour TMT (Tech, Media and Telecommunication) sectors and expect them to outperform the Big Banks and Big Miners in the next 12mths.
Top 15 reasons why it’s time to get back in the market for the new financial year run (from Friday 27th morning)
– Markets are now mainly over Iraq and any related issues will be very short term similar to Ukraine and Syria
– US data remains positive despite Q1 slowdown while Euro issues will force ECB to come up with further stimulus plans
– China data has turned the corner and we expect Tuesday’s PMI data to further add to the positive view
– Iron Ore is back above $95 and we suggest adding back the big miners (i.e. BHP, RIO) to market weight
– RBA is not expected to raise rates till 2015Q3 at the earliest while house prices are beginning to flatten
– Rebalancing from overweight Yield thematic (i.e. Banks) and underweight Resources (i.e. Big Miners) to market weight
– Institutional Investors are away on School Holidays and Retail Investors historically push markets higher
– Market to benefit from re-investment of substantial dividends from ANZ, NAB, MQG and WBC being paid in early July
– Currency expected to trend down while market valuation will improve with better than negative outlook
– Tax loss selling driving market volatility to historical low levels with investors sitting on the sidelines with cash positions
– Brokers have downgraded commodity prices and pushed up currency outlook to levels we have had since start of 2014
– Expect brokers to start upgrading in early July (i.e. before the reporting season) to match positive macro outlook
– Government budget negotiation will water down the negative impact and currently priced into the market
– Corporates are increasingly moving on M&A for industry consolidation while cashed up Private Equity is on the prowl
Macro Events: Tonight – US May pending home sales; US June ISM manufacturing index. Tomorrow – Reserve Bank of Australia monthly board meeting; RP Data-Rismark June home prices; China June manufacturing PMI; China June HSBC Manufacturing PMI. US June auto sales.
Iraq war – the next generation: Unless you were hiding under a rock, Iraq was a basket case waiting to blow up after the war of last generation. Trying to measure non-western countries and cultures based on western standards are fraught with danger. Taking spin aside, Iraq will remain a mess for a number of years, if not decades, till it reaches a new equilibrium between all the domestic non-western parties. The best case scenario for equity markets is for US and its allies to talk tough, move on and let nature take its course. Despite the social and human loss, equity markets have a way of looking past these issues as short term (i.e. like Ukraine and Syria). Any argument that Iraq is different will reinforce the argument that it is all linked to energy and not humanitarian. No matter what happens, this chapter of Iraq war (i.e. the next generation) will end in another mass loss of life and create another generation of hatred aimed at the West. We have been in this situation before and we are very likely to make the same mistake again. Recent updates do not build me with any more confidence.
M&A Cycle: Businesses with strong cashflow and solid balance sheet in a falling consumer sentiment and low interest rate environment prefer to chase growth through cost cutting, share buy backs and M&A. Cost cutting cycle is coming to an end with further improvements requiring wage reduction or M&A. Wage cuts will take time to work through structurally and also will have political implications for the government. This leaves corporates either buying back shares or consolidating industries to drive better earnings per share growth. Private equity is sitting on the side lines with substantial war chest built up by floating number of stocks over the past 6-12 months. M&A candidates in media sector are TEN, SXL, PRT and APN likely prey while NWS, NEC and SWM are potential hunters. M&A candidates in retail sector are DJS, MYR and PBG are likely prey while Private Equity, PMV and global retailers are potential hunters. We are also seeing number of M&A activities in property and resource sectors.
Consumer Confidence: Tidal waves of unemployment coming in the next few years, rising cost of living pressures, falling real wages and budget worries have slammed consumer confidence down to multi year low. Recent Job Ads and Employment data further strengthens our argument that unemployment is going to get worse in the next 12-18mths. We continue to be negative on local cyclicals with slowing economy. Continued bickering, party politics, lack of long term planning and real policy reform will keep sentiment low. We expect the unions, pensioners and students to continue to keep the media fuelled for months to come. We expect the government to release the new welfare streamlining plans and I am sure that will get media attention and likely to be a further risk to consumer sentiment.
Property Prices: We continue to expect areas where substantial unemployment and middle to low income earners live (i.e. Canberra) to see property price decline in the next 1-2 year time frame while middle to higher income areas should trade sideways with affordability falling and rates remaining unchanged. The top end should continue to rise with overseas investors from Europe and Asia continuing to look at Australia as a safer location to park wealth. Recent housing finance data is beginning to show signs of affordability and consumer confidence taking effect. In a longer term thematic, we expect future generations to prefer renting than buying property with rising cost of education, housing and lower wages to make housing affordability harder without substantial assistance from their parents. The oversupply of units hitting major cities in the next 12mths will pull down house prices over time.
Tax Loss Selling: Be aware that we are headed for tax loss selling period where substantial underperformers/outperformers are likely to see selling pressure and open up buying opportunities. But be careful to not sell cyclical low stocks as they may become M&A targets very quickly as private equity is cashed up after number of floats.
Unemployment Outlook: The accumulated unemployment tidal wave from car industry, airline industry, telco industry, finance industry, manufacturing industry, M&A job cuts, outsourcing to Emerging Markets, government job cuts and the ever shrinking mining industry cuts will create a vacuum for jobs and drive unemployment to 6.5% in the next 12mths. We do not see any government policy or global macro changes that can create jobs in the short term to limit this damage. The infrastructure job creation will only start in 2016 and will only deliver jobs that will pay much less than the jobs being lost over the past few years.
Taxation Outlook: Due to the current fiscal policy of the government, we expect overall taxation to increase in the next few years to cater for falling overall tax revenue on federal and state levels. We expect GST to be raised once the state elections and asset sales are out of the way. The structural decline in the budget has not been addressed as it is a revenue problem. The current policy solutions are no more than nipping at the edges with minor spending cuts.
Currency Outlook: We maintain our view that AUDUSD will settle around 94 cents (i.e. remain in 87-94 cents band) in the short term and then track down to mid 80s. We need to see substantial US or China growth risk for currency to break the recent trading pattern…now 94.4 cents.
Interest Rate Outlook: We maintain our view that our rates will remain unchanged at the current low level atleast till 2015Q2. We have to see substantial collapse of consumer sentiment from current low levels to force RBA to change lower. RBA can’t afford
to support any more asset bubble inflation with lower rates despite global Central Banks keeping rates at historical low levels. More and more brokers are now moving back their rate rise expectations well into 2015.
POINTS OF INTEREST IN S&P 300 STOCKS BY SECTOR:
• Energy stocks were mainly negative. We see the energy sector as fully valued and prefer to wait for pullback in the big caps to get back in. Big moves> DOWN: BRU (-4%), RFE (-3%), PDN (-3%)
• Material (Ex Mining) stocks were mainly negative. We maintain our preference to packaging stocks such as AMC and ORA while chemical stocks IPL, ORI and NUF beginning to look good with recovering China and the long term food thematic. ABC and DLX are worth long term picks on the housing cycle. Big moves> None
• Mining (Ex Gold) stocks were mainly negative. We maintain our preference in the big miners BHP (-1.43%) and RIO (-1.25%) for Iron Ore exposure and have added ILU for Mineral Sands and NCM for Gold exposure. ILU bid for Kenmare Resources (UK listed) was rejected. But we continue to expect more industry consolidation in this sector. Big moves> DOWN: LYC (-7%), ARI (-5%), FMG (-4%), MGX (-4%), IMD (-3%), ORE (-3%)
• Gold stocks were mainly negative with spot gold holding around $1315. There could be a big move towards $1350 coming any day soon with seasonal gold buying in India and China in play. We maintain our preference to NCM while other low cost producers like BDR and SAR remain in the picture. Big moves> DOWN: PRU (-7%), RSG (-5%), SBM (-4%), IAU (-4%), MML (-3%), KCN (-3%)
• Industrial stocks were mainly negative. We maintain our preference in CCP and SEK. We continue to see high risk in mining service companies due to China risk, commodity price volatility and resource sector capex decline from 2015. Big moves> UP: AAX (+3%); DOWN: QAN (-6%), EHL (-5%), MAH (-5%), VED (-3%)
• Consumer stocks were slightly negative. We maintain our preference in ALL, FLT, AGI, SWM, SXL and PRT while remain a fan of other media stocks like TEN back at 25 cents despite the problems and FXJ and APN on M&A. We also like CTD on any pullback below $6…it’s a FLT in the making. We see big risk to discretionary retail stocks like DJS, HVN, JBH, MYR, NCK and TRS in falling consumer sentiment. Despite the downgrade FLT looks good value long term for global tourism exposure with recent pullback below $45. Despite the downgrades we like PBG around $0.50 due to the brand value. KMD (despite recent downgrade) and PMV are other retailers with good global brands in tough markets. Despite the recent downgrade SUL is a quality stock that offers consumer experience that will see it recover with consumer sentiment. Big moves> UP: RCG (+8%), ORL (+6%), WEB (+4%), TEN (+4%), FWD (+3%)
• Staple stocks were mainly negative. We maintain our preference in WES and WOW. SHV is beginning to look interesting close to $5 with Asian low fat protein demand despite recent crop issues. We continue to like GNC after it was sold down below $8 after the bid was blocked by ACCC. We feel such a unique asset will get taken over with government unable to put up the cost of infrastructure upgrades needed for the industry. Big moves> DOWN: RIC (-4%)
• Healthcare stocks were mainly negative. We maintain our preference in ANN and our pet favourite GXL. RHC is a buy on any pullback with population ageing and government cutting healthcare budgets…may see selling as funding vehicle for Healthscope IPO…like it close to $40. GXL announcement of cap raising and acquisition makes it an even better growth story. ANN is getting a lot of airplay with number of brokers upgrading after the event. BNO has finally delivered the big deal and expect this to continue to recover back to recent highs around 70-80 cent range (Disclaimer – I own BNO shares). We continue to like PRY and lesser extent SHL with changes in co-payment will see these stocks rebound. Big moves> DOWN: SIP (-5%), BNO (-4%), GXL (-3%) > Change in director interest
• Banks stocks were negative but less than the market. We maintain our preference in ANZ and NAB as they offer best global exposure out of the big four. Big moves> None
• Diversified Financial stocks were mainly flat. We maintain our preference in MQG for the global exposure while HGG and BTT are worth a look on any pullback. Big moves> DOWN: CVO (-4%) > Becoming a substantial holder
• REIT stocks were mainly flat. We maintain our preference in SGP and LLC to get housing and construction exposure while MGR, ALZ and DVN look interesting with housing exposure. DVN (Outside S&P 300) has run from below $0.80 to $1 since we have been pushing the story after its first upgrade…going to $1.15 and take over potential may see it as high as $1.50. Big moves> None
• IT stocks were mainly positive. We maintain our preference in CPU and CRZ while remain big fan of ALU and IPP in the long term. IPP has bounced from below $2.30 to $3 recently…more to come. Big moves> UP: SLX (+5%) > Major strategy review, CSV (+3%)
• Telco stocks were mainly negative. We maintain our preference in TLS and TEL while remain big fan of IIN in the long term. Booming NZ economy should put more attention into recovering TEL. Big moves> DOWN: NWT (-8%) > Director resigns
• Utility stocks were mainly negative. Big moves> DOWN: IFN (-4%)
• Overall negative day on decent volume to finish the financial year
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