Not A Question Of Banks, But Of Portfolio Composition

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In this week's Weekly Insights:

– Not A Question Of Banks, But Of Portfolio Composition
– US Interest Rates: Nothing's New
– Terms Of Trade Now A Problem, Deutsche Bank
– A Favourite Amongst Resources Stocks
– Stockbrokers' Top Ten
– Buy-Backs Rule
– Rudi On TV: The Week Ahead
– Rudi On Tour

Not A Question Of Banks, But Of Portfolio Composition

By Rudi Filapek-Vandyck, Editor FNArena

You never really know until that moment arrives. Central bankers in the US have started preparing global investors for a normalisation process in official interest rates and the effects have well and truly shown up on Australian shores.

The Australian dollar is trading below US90c and still looking vulnerable as every day passes by. The Australian share market is teaching those experts calling for the ASX200 at 6000 by year-end a painful lesson: Australia is closer to China these days than it is to the USA. Be careful what you wish for.

Now that we've all established that Australian banks have been among the major beneficiaries of a zero interest rate policy in the US, and elsewhere, the obvious question that comes to mind is: how low can bank share prices fall before buyers start moving back in?

Let me first point out that whoever is selling offshore is not motivated by any questions about value or direction for Australian bank shares. This is all about changing perceptions regarding US bonds and their impact on US and global asset prices. The US is still home for many of the world's largest professional investors and asset managers. Right now, these market participants are reshuffling portfolios and reviewing their options and market positioning.

If one takes the view that normalising interest rates must translate into higher yields for US bonds, which should push up the US dollar against currencies backed by weaker regions like the eurozone, Japan and, yes indeed, Australia, then it makes a lot of sense to repatriate funds. Enter: noticeable weakness for the Australian dollar and for local large cap yield stocks over the past ten days.

Nevertheless, the question remains: how low before we see a bottom?

History cannot help us in this case because, as explained earlier, most of the selling is non-bank related. And nobody knows how much is still out there, waiting to receive the green light to leave Australian shores. Viewed through the lens of broker consensus target prices, however, there are a few easy to make observations:

– most bank shares had stopped trading above targets in April/May this year, so a mild de-rating was already taking place
– recent sell-offs are pushing bank share prices well below targets, as low as we've witnessed in a long time

The chart below, showing ANZ Bank ((ANZ)) shares over the past twelve months in relationship to consensus target (grey background), shows the current gap between target and share price is as wide as it's been over the year. Earnings forecasts are pretty stable. Forward dividend yields for the Big Four have now risen to 5.5% for CommBank ((CBA)) and to 6% for National Bank ((NAB)) with ANZ and Westpac ((WBC)) sitting in between.

Last time the gap expanded as much as it has done these past two weeks, it didn't take long for ANZ Bank shares to put in a come-back to a new high, above target, near $35. Given the broader context is changing, I don't think a repeat is on the cards, yet I'd be hugely surprised if we don't see a bottoming soon, and a recovery next. Three of the Big Four are about to release full year financials plus pay out final dividends in a few weeks' time.

No doubt, traders playing the sector ahead of banks going ex-div will be increasing their expectations this time around.

But what about investors?

Consensus forecasts for the banks in Australia suggest the sector might well face de-rating as the pace of growth is anticipated to slow into mid-to-low single digits and there are plenty of suggestions the growth in dividends is likely going to be slower than the slowing growth in cash earnings. Then again, it is anyone's guess how exactly such de-rating is going to impact and, as said earlier, it can be argued this de-rating had already started back in April, plus that this month's weakness has fully taken care of it, plus some.

Here are forward expectations for CommBank which reported FY financials in August:

This, from an investment portfolio perspective, opens up a far more niggling question for Australian investors: doesn't your portfolio include (more than) enough bank shares already?

Anecdotal evidence suggests the average investment portfolio among "Smurfs" (SMSF trustees) and retail investors already is overweight local large cap yield stocks, in particular the Big Four Banks, and most investors simply never re-weight or adjust, regardless of the growing imbalance that follows after a prolonged period of sector outperformance.

Assuming (some of) these investors are currently looking into diversifying away from a too highly concentrated sector allocation, what are the best options available?

Reading through recent updates on portfolios and strategies by investment banks and stockbrokers, the following strategies/adjustments stand out:

– invest in industrial companies that derive growth from overseas markets
– invest in industrial cyclicals
– invest in industrials that combine yield with growth
– invest more internationally (everybody's favourite: US equities)

Here's a brief run through each of these options:

1. Growth overseas

The theme is not new, not by any stretch, and many of the popular stocks from the year past belong to this category, such as Ardent Leisure ((AAD)), Flight Centre ((FLT)), Brambles ((BXB)), Amcor ((AMC)), CSL ((CSL)), Ramsay Healthcare ((RHC)), Computershare ((CPU)) and Aristocrat Leisure ((ALL)).

None of these names looks particularly cheap on today's metrics but many seem poised for solid growth in the years ahead, and a weaker Aussie dollar -if that's the new trend- only adds more weight to the underlying attraction.

2. Industrial cyclicals

Citi likes managers of property assets, such as Charter Hall ((CHC)). CIMB likes building materials companies and property developers such as Boral ((BLD)), James Hardie ((JHX)) and Mirvac ((MGR)). Macquarie likes Lend Lease ((LLC)) and Mantra Group ((MTR)). The wholesale team at UBS has been highlighting Nine Entertainment ((NEC)).

3. Yield and Growth

Remember my story from 2012 about David Jones beating Rio Tinto by more than 100% in return since 2003 despite the latter being a beneficiary of the Commodities Super Cycle? It's the magic that happens when one combines dividends with growth and there's an ever growing number of market researchers arriving at similar conclusions. Problem this time around is yield stocks are much higher-valued than they were in years past (but many are becoming more interesting as portfolio reshuffling leads to share price weakness).

Investors do not need to take on board excessive risk, such as trying to predict the bottom for mining services providers, many of which pay a nice dividend at current levels. Ardent Leisure, still one of my favourite stocks in the yield space despite its newfound popularity, looks poised for double digit growth in the years ahead. This means the current sub-5% yield on offer could well surpass 6% in three years' time.

4. More international exposure

On Monday, stockbroker Morgans updated its Asset Allocation benchmarks, recommending international exposure should range between 15-40% of Total Assets depending on risk profile (Conservative 15% and aggressive 40%).

The motivation behind the above is pretty straightforward: "International equities can offer investors access to superior value, growth and/or currency tailwinds relative to domestic. A portfolio of purely domestic equities not only limits opportunities, but also concentrates risks toward the Australian and regional economies."

Of course, seeking international leverage does not by definition mean investors have to embark on full time research of global equity markets. This can be done through global funds and/or exchange traded funds (ETFs).

In response to specific questions about portfolios and portfolio adjustments, I intend to compile an overview of various portfolios and recommendations released recently. This overview shall be added as an attachment when this Weekly Insights will be published in the form of a news story on the FNArena website on Wednesday. Alternatively, paid subscribers can always send an email to info@fnarena.com to request a copy.

[Note from Editor on Wednesday: the file has been attached (excel) and subscribers should note it contains nine different portfolios, all with their own tab in the attached document]

See also "The Retain A Quality Of Life Investment Portfolio", published on 21 July, 2014.

US Interest Rates: Nothing's New

Headlines come and headlines go. Asset prices move around every day. The market's current obsession with Fed communiques and "dots" set by FOMC decision makers will soon be forgotten too, argues Glushkin Sheff's chief economist and global strategist, Dave Rosenberg. He adds: Two things that cannot be replaced in this business are experience and a good memory.

To those with a bad memory: nothing keeping investors' minds spinning at night these days is genuinely "new". Go back a decade and the Fed introduced "considerable time" in its press release on 12 August, 2003. The pledge was kept until late January 2004. In June that same year, five months after removing "considerable time", the Fed started hiking in 25bp increments.

Has anyone seen anything "new"? Rosenberg argues Janet Yellen has merely dusted off the old Greenspan playbook.

Admittedly, he recalls, equities did have a rough ride immediately after the Fed removed "considerable time" from its press release, but it wasn't until 3.5 years later that everything fell apart due to subprime lending to an over-exuberant US housing market.

The lesson here, says Rosenberg, is to treat everything that happens between now and mid-next year as "noise". Equity markets may be overdue a correction, or a pull back, or a pause, but the trend line is still pointing north, just as it was back in 2004.

Terms Of Trade Now A Problem, Deutsche Bank

With just about everyone focused on the exact outlook for US interest rates and, on secondary level, when unemployment in Australia moves back below 6% so that the RBA can change its policy mindset too, it is worth paying attention as to why some economists locally stick with an alternative view. Deutsche Bank, for example, reiterated its view on Friday the RBA will NOT raise the cash rate until well into 2016. This is a whole lot later than what most peers are talking about when asked the question.

Deutsche Bank's motivation is the falling terms of trade. When terms of trade are in decline, real GDP growth no longer offers a true connection with the jobs market, argue the economists. The idea is that large LNG projects, that commence exporting next year, will keep Australia's GDP numbers relatively buoyant, but unemployment is more likely to continue rising nevertheless. Deutsche Bank does not see a peak in local unemployment before late 2015, at the earliest, and by then the number will be circa 6.75%.

Under different circumstances, this might entice the RBA to consider further cutting the cash rate, but this time around Glenn Stevens and Co are worried about a housing bubble. Which is why Deutsche Bank thinks there will be no move from the RBA for a long time coming. Mid-2016, at the earliest, predict the economists.

Could be a recipe for a much steeper fall in AUD/USD than is currently prognosticated.

A Favourite Amongst Resources Stocks

At first glance, the outlook table for Hillgrove Resources ((HGO)) in WilsonHTM's latest update on the company provides a near perfect illustration of the ongoing tough outlook for small miners whose products to sell consist of copper, gold and silver. There's virtually no growth between FY14 and FY16 and by FY17, suggest the numbers in the table, net profits are likely to halve.

So what is it exactly that makes Hillgrove Resources WilsonHTM's favourite resources stock right now?

Well, there's intrinsic valuation sitting around 94c while the share price hovers around 60c. There's also the prospect of the resumption of fully franked dividends. The report suggests investors should expect to see 1.5c being announced in February with a further rise to 3c from FY15 onwards.

The company should be in a net cash position by year-end. WilsonHTM observes Hillgrove has established a sequence of consecutive quarters of strong performance, with the Kanmantoo mine now performing at levels which had been long aspired to. Earlier this month, shareholders passed a resolution to approve an 8:1 share consolidation.

If current projections prove correct, Hillgrove will be swimming in cash in the years ahead. Regardless, WilsonHTM doesn't believe dividends will be raised beyond 3c. Mind you, at current share price this translates into 5% fully franked. The company last paid out a dividend in 2009.

Stockbrokers' Top Ten

FNArena has published the newest edition of the Australian Super Stock Report. Subscribers: head to the website for your copy.

Below is the Top Ten taken from the report. Nine stocks with only Buy ratings, plus Flight Centre ((FLT)) with a nearly perfect score card. What all these stocks have in common is that today's share prices are considered too low. At least according to the analysts covering these stocks.

Experience shows sometimes this apparent weakness is there for a good reason, which is why Energy Developments ((ENE)), to name but one, is not necessarily a screaming buy. But what about Rio Tinto ((RIO)) if iron ore prices do not fall below US$80/tonne?

Nine Entertainment ((NEC)) and Pact Group ((PGH)) are part of this year's share market newbies which probably translates into little interest from retail investors just yet. Flexigroup ((FXL)) has been out of favour for almost a year now. Flight Centre ((FLT)) is currently trading near its lows for the past twelve months (earnings estimates have been falling too).

Equally interesting is that many of the stocks that feature regularly in my market analyses find themselves just outside the Top Ten: Carsales.com ((CRZ)), ResMed ((RMD)), Transurban ((TCL)), Ardent Leisure ((AAD)), G8 Education ((GEM)), etc. For more info and insights: download the report from the website.

Buy-Backs Rule

I've labeled it the Americanisation of the Australian share market. Economic momentum might be patchy, and the Aussie dollar still very much too high. No real help can be expected from Canberra and top line growth is still a demanding target. But none of this stops boards rewarding shareholders, just like their corporate peers have done on Wall Street in years past. International research suggests a strong causation between companies who buy in their own capital and share price outperformance. At the very least, share buy-backs provide support to the downside in case of a defensive policy.

Here at FNArena, we've put together a list of companies that have announced buy backs:

Ansell ((ANN))
CSL ((CSL))
Donaco International ((DNA))
Helloworld ((HLO))
Karoon Gas ((KAR))
Telstra ((TLS))

Companies believed to potentially announce buy backs in the not too distant future:

Aurizon ((AZJ))
BHP Billiton ((BHP))
GWA Group ((GWA))
Rio Tinto ((RIO))

If you know of any more companies, do tell us and we'll investigate and add them to the list. Our address, as per usual, is info@fnarena.com

Rudi On TV: The Week Ahead

On request from readers and subscribers, from now onwards this Weekly Insights story will carry my scheduled TV appearances for the seven days ahead:

– Wednesday – Sky Business, Market Moves – 5.30-6pm
– Thursday – Sky Business, Lunch Money – noon-12.45pm
– Friday, Sky Business – YMYC, Fixed Interest, 7-8pm

Rudi On Tour

I have accepted an invitation to present to the Sydney chapter of the ATAA, in Sydney, on November 17th.

(This story was written on Monday, 22 September 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of August available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms