Equity Strategies For FY15

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This story features MYER HOLDINGS LIMITED, and other companies.
For more info SHARE ANALYSIS: MYR
The company is included in ASX300 and ALL-ORDS

By Greg Peel

Volatility, or lack thereof, is a big talking point across global financial markets of late. The VIX volatility index on the US stock market, for example, is at lows not seen since before the GFC. This implies market complacency, and complacency worries many observers. A lack of concern leads to a lack of preparedness were something negative to appear out of left field, and a sharper sense of panic if it does.

Citi’s global equity strategists note volatility levels in the foreign exchange and oil markets are even lower than those in stock markets.

Central banks are the key driver, Citi suggests. The global search for yield in the face of historically low cash rates has driven credit spreads on fixed income inexorably lower, and historically, low credit spreads are associated with lower equity volatility. But it’s not just about cheap money – Citi notes global earnings per share volatility has fallen in recent years, and this also encourages lower share price volatility.

So should we also start panicking now and avoid the rush?

No, says Citi. Despite market unease, there is little relationship between market volatility and future equity returns over any time horizon, the strategists declare. Hence current low levels “should not be seen as a clear sign of investor complacency and an imminent market correction”.

Citi does worry, nevertheless, that a lack of real liquidity in markets at present would enhance a correction, were one to eventuate. The strategists are bullish global equities over the next twelve months based on accelerating earnings growth and well-behaved inflation. Risks are clearly present, however, in the form of rising US bond yields, higher oil prices (geopolitical shock) and growth issues in China and other emerging markets.

Closer to home, JP Morgan’s equity strategists believe FY15 will be a year in which three years of leadership of the Australian stock market by yield stocks and “low surprise” stocks will come to an end. Not suddenly – just gradually. The “grind higher” equity rally is intact, says JPM, but in its late stages. Valuations for low-growth-but-predictable companies have become challenging and micro factors are beginning to weigh more heavily.

The strategists expect bond yields to rise in FY15. This will act as a brake on “bond proxy” local sectors such as the banks, telcos and REITs. There’ll be no sudden or sharp correction but rather valuation support will “run out of road”. Otherwise, rising yields will imply a weaker Aussie dollar and improving economic growth in the developed world will support the local equity market in general.

JP Morgan maintains an end-December target for the ASX 200 of 5700 and likes companies with offshore earnings streams, including in the energy sector. The strategists believe the mining sector is not in a downtrend but in the low end of its trading range.

The UBS strategists are of a similar mind. They are currently Underweight yield stocks and Overweight US dollar earnings. Overweight extends to beneficiaries of the domestic housing construction cycle while resources attract a “modest” Overweight, with a preference for energy.

UBS also believes bond yields will rise in FY15, both in the US and Australia, on solid US economic growth. The Aussie will thus fall as the greenback rises, and UBS targets US85c by end-FY15. The impact will be positive for Australian corporate earnings and thus for the stock market, although there may be a bit of a global stock market correction when US yields first rise. That said, UBS has also set an end-December target of 5700 for the ASX 200.

Citi’s local strategists have set a year-end target of 5850.

Citi nevertheless notes growing nervousness in the local market as we approach the August result season with regard to the budget blues, lower iron ore prices and a spate of retail sector profit warnings. But as far as “confessions sessions” go, this year’s has been relatively quiet, the strategists note. We’ve had six to nine months of generally better business conditions and an improving GDP although there is the risk, Citi admits, “confessions” may come a bit later this time given more recent deterioration.

Certainly the past couple of months have been weaker, due to the abovementioned local factors and also to a realisation of just how weak the first quarter was in both the US and Europe, which has pushed the Aussie higher. Earnings expectations have been trimmed, and Citi analysts see a risk of disappointment for quite of few stocks, particularly across the retailing, media, engineering and mining sectors, as well as for some companies operating offshore.

The risk is to FY15 earnings, Citi notes, which are forecast to rebound solidly in FY15 for industrials (ex banks). Reporting season may reveal some scaling back of company guidance and thus earnings forecasts, but likely only back to trend on a net basis given conditions remain relatively reasonable. Mining earnings could be hit further but there is a chance of bank earnings upgrades.

Something that should be supportive for the Australian stock market in FY15 is what Credit Suisse calls “de-equitisation”, which occurs when the “retiral” of equity is greater than the issuance of equity. “Retiral” occurs as a result of share buybacks and mergers & acquisitions, while issuance results from capital raisings and IPOs.

De-equitisation has been a big theme in the US and Europe of late as companies take advantage of low interest rates to borrow money and buy back shares or to take over another corporate using debt financing. The result is that the number of shares on issue in the US is roughly unchanged since 2006. Australia has gone the other way, increasing the equity base of the ASX 200 by 3.9% per annum over that period.

That equates to $47bn of new equity per year the stock market has absorbed on average since 2006. Last year’s total was $24bn. While access to capital is what stock markets are there for, and new issuance is indicative of a healthy capital market system, the reality is fund managers must raise the money to buy new shares by selling existing share holdings. This has a negative share price influence on incumbent stocks.

But not in FY15, Credit Suisse predicts. Given a rise in M&A activity and a preference for debt rather than equity financing in the low interest rate environment (as well as the delisting of 21^st Century Fox), this new financial year should see de-equitisation for the first time in a long time, which is supportive of share prices.

This de-equitisation call is not immaterial, as it sees Credit Suisse raise its end-December target for the ASX 200 to 6000 from a previous 5600.

For the record, those stocks CS sees as potential takeover targets include Myer ((MYR)) and Beach Energy ((BPT)) while those in a good position to enhance value through acquisition include Carsales.com ((CRZ)) and TPG Telecom ((TPM)). CSL ((CSL)) is seen as offering value through accretive share buybacks.

The BA-Merrill Lynch quant boffins can back up the argument of de-equitisation being positive for stock prices with research that suggests that over the last twelve months, those stocks globally which have reduced their share counts the most have outperformed the global index by an average 9.7%.

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