Australia | Jul 14 2014
By Mathan Somasundaram, Baillieu Holst Quant Strategy
Summary: Aussie market remained in positive territory with global sentiment on a really low turnover day. Let’s hope the fund managers coming back from their holidays have new plans to boost their quarterly performance or brokers are going to run out of youtube videos. Aussie market was up 0.45% with turnover was just below $3.1b. We don’t see consumer confidence bouncing back while the current macro outlook continues. I am confused with all the political tussle on carbon tax – all we are doing is taking one tax out and putting another carbon tax on. Unless money grows on trees, the multi-billion dollar direct action plan is being paid out of tax revenue (i.e. another carbon tax). We continue to feel that corporate earnings will be close to expectations (i.e. not great but no “Valley of Death” either) while interest rates are unlikely to move in the next 12mth. Central banks are going to keep rates low and force the cash sitting on the sidelines to flow back into the equity market. Brokers are now pushing rate cut potential…not in that boat yet…it needs to get pretty messy for RBA to cut. We have much higher unemployment outlook than most and we don’t think there is a need for another rate cut. Pick of the day…Telecom NZ (TEL) was sold down to $1.90 about 12mths ago when we went positive…now with booming NZ economy, post divestment and NZ data super cycle, TEL is trading $2.58 and going above $3.00 with analyst consensus still negative.
FIFA WORLD CUP WINNER: Since my original pick Brazil lost to Germany, I backed my substantial family connection to Deutschland…and on threat of family violence…backed the Germans to beat my other original final pick Argentina. I expected it to be close and it was. Germans were clinical in defence and were able to restrict Messi to a sideshow. World Cups are all about personalities and this one has been quite boring….no hair, not head butt, no drugs and no sex scandal. As much as I love watching Messi play, he could not take the title away from the Germans. German victory should not be a real surprise as Bundesliga is one of the premier competitions in Europe…if not the best when you look through the Champion League performances predominantly using home talent. Brazil on the other hand should take the defence used by everyone in finance to explain their shocking mess in the Dutch game…yes…it was because of rogue players ?
NRL: Sydney Roosters – Still can’t see anyone else holding a steady pace…maybe Manly. I can’t see my Tigers even sneaking into the top eight this year. Bennett leaving Knights has to put a few coaches on the chopping block. Hope Daley stays away from doing any short term coaching at club level…Sharkies have been a coach career killer in recent years.
AFL: Sydney Swans – Hawks, Cats and Port lead the challenge, but the Swanies still look good…even if the Clive Palmer of AFL is whinging about them. Bombers unlikely to win the flag with their issues, but will hurt someone’s chances in the back end of the season.
Rugby: NSW Waratahs – They have delivered up to now, but the question remains can they take the title. Time will tell, but atleast they are playing attractive footy.
Macro Events: Tonight – German consumer price index report.
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.
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.
Similar to US, the jobs we are losing are high paid high skilled full time jobs while majority of the jobs being created are low paid low skilled part time jobs.
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. In case anyone hasn’t realised, Carbon tax is not going away as we have a multi-billion dollar direct action plan that is being paid by tax payers (i.e. another carbon tax).
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 94.0 cents.
Interest Rate Outlook: We maintain our view that our rates will remain unchanged at the current low level atleast till 2015Q3. 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.
Reporting Season Outlook: We expect the market to be positively surprised compared to the current “Valley of Death” outlook. We expect current cyclical low valuations, falling currency and M&A will help improve sentiment while sectors with high risk to earnings have already come to the market and declared their sins.
POINTS OF INTEREST IN S&P 300 STOCKS BY SECTOR:
• Energy stocks were slightly positive. 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 (-9%) > Operations Update, SEH (-9%)
• Material (Ex Mining) stocks were slightly positive. 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. ORI is our only large cap GARY pick and it has bounced from the lows when it was picked in GARY. ABC and DLX are worth long term picks on the housing cycle. Big moves> None
• Mining (Ex Gold) stocks were mainly positive. We maintain our preference in the big miners BHP (+0.75%) and RIO (+0.32%) for Iron Ore exposure and have added ILU for Mineral Sands. We continue to expect more industry consolidation in the overall resources sector. Big moves> UP: IRN (+5%), IMD (+5%), LYC (+4%); DOWN: SYR (-11%), ARI (-5%), PNA (-4%), SIR (-4%) > Quarterly report, WDR (-4%), MGX (-4%), AGO (-3%), CDU (-3%)
• Gold stocks were mainly negative with spot gold moving below $1320. As we said on Friday to take profit as the spot gold profit taking was likely today. We maintain our preference to NCM while other low cost producers like BDR and SAR remain in the picture. Big moves> UP: NST (+3%); DOWN: SLR (-6%), MML (-6%), PRU (-5%), RRL (-4%), EVN (-4%), RSG (-4%), KCN (-3%), BDR (-3%)
• Industrial stocks were mainly positive. 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: NWH (+6%), RCR (+3%); DOWN: BLY (-9%) > Change in substantial, PRG (-4%), MLD (-4%) > Change in BYL holding, AAX (-4%)
• Consumer stocks were mainly positive. 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: KMD (+5%), BBG (+4%); DOWN: APN (-4%), RCG (-4%)
• Staple stocks were mainly positive. We maintain our preference in WES and WOW. SHV is beginning to look interesting below $5 with Asian low fat protein demand despite recent crop issues…buyer around $4.80. 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. Given recent ADM acquisition, GNC may be running out of dancing partners with cash. Big moves> None
• Healthcare stocks were slightly positive. 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 in the low $40’s. GXL announcement of cap raising and acquisition makes it an even better growth story. ANN remains a good global growth exposure despite the restructure plans announced recently. BNO has 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. ACR is tearing its way back up after certain broker scare story shot it down below 80 cents. RMD is worth buying on any pullback…going to $5.60 again. Big moves> None
• Banks stocks were positive and carried the market higher. 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 slightly positive. We maintain our preference in MQG for the global exposure while HGG and BTT are worth a look on any pullback. Big moves> None
• REIT stocks were slightly positive. 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> DOWN: APZ (-3%)
• IT stocks were slightly negative. 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 $3.40…more to come. CRZ is the sleeper in the online space that we see delivering 30-40% in the next 12mths. Big moves> DOWN: CSV (-3%)
• Telco stocks were mainly positive. We maintain our preference in TLS and TEL while remain big fan of IIN in the long term. Booming NZ economy should help TEL. Big moves> UP: AMM (+4%), NWT (+4%); DOWN: VOC (-7%)
• Utility stocks were mainly positive. Big moves> None
• Overall positive day on low volume….as exciting as watching Brazilian defence
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