Equity Strategy: Time For A Retracement?

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This story features TREASURY WINE ESTATES LIMITED, and other companies.
For more info SHARE ANALYSIS: TWE
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

– Commodity rebound questionable
– Growth hard to find
– Yield well priced
– A$ leverage well priced

By Greg Peel

World View

Deutsche Bank expects global economic growth to slow to 3.0% in 2016. This would represent the slowest pace since the GFC, but is only marginally below the 2015 rate. While not a particularly inspiring forecast, it is not as bad, Deutsche suggests, as previously feared. Global growth will mostly be weighed down by the US and Japan, the economies of which are slowing “materially”.

The analysts expect US growth to slow to 1.2% in 2016 from 2.4% in 2015. The main issues are a build-up in inventories, weak external demand due to the stronger greenback and weak domestic investment (in energy in particular). Preventing an even greater deceleration are strength in employment, housing, and the consumer. As the inventory problem fades in the second half, growth should pick up, Deutsche suggests. Meanwhile, inflation is not likely to be an issue.

Europe continues to chug along with its resilient but slow recovery. Downside risk spiked earlier in the year when banks came under a lot of pressure from exposure to both the energy sector and emerging markets (eg China, Russia), but subsequent shock & awe policy easing from the European Central Bank has mitigated this risk, Deutsche suggests. The analysts are forecasting 1.4% growth for the eurozone in 2016, roughly in line with 2015.

We are probably now into the fifth year in which a major market concern has centred on fears of a hard landing for China. So far China has not landed hard. The country is not going to see the 10% per annum average growth rate achieved in 1990s and 2000s again, Deutsche suggests, and Beijing’s target growth rate out to 2020 of 6.5-7.0% is the lowest since the 1970s. But macro data do not point to anything “hard” around the corner. (See also: China: Where Is It Headed?)

The export and investment-led growth model that led to 10%-plus growth rates has reached its limit. Deutsche Bank sees further monetary policy easing in China this year and possibly further fiscal easing.

In other emerging markets, the situation does remain bleak. While the recession in Russia is proving to be milder than first feared, low commodity prices and weaker demand for exports from US and Europe continue to weigh. Asian economies have been particularly hit by the China slowdown. Things can only get worse if the Fed starts raising, Deutsche notes, but the good news is emerging market countries are in a much better position than they were ahead of the crisis suffered in the late 1990s in terms of foreign reserves, debt and trade balances.

The real fear is emerging market corporates, which still have a long deleveraging path to travel down. The period 2017-18 will see a wall of debt maturities for emerging market companies, Deutsche warns, at a time when the Fed raising cycle may well be in full swing.

Wall Street

On Tuesday night the S&P500 and Dow Jones Industrial Average closed at their highest levels in 2016. Last week every one of the thirty Dow component stocks moved above their respective 10-, 20- and 50-day moving averages, Canaccord Genuity notes. The last time this occurred was in October 2011, after which the Dow promptly fell 8%.

The good news is that back in 2011 the Dow fell only to its previous low before commencing an 18% rally over four months.

Canaccord moved to a Neutral view on the US stock market two weeks ago, given a number of “tactical concerns” regarding the sharp rebound off the February 11 low. The analysts foresee a period of consolidation for Wall Street before the next leg higher. This may well be driven by another heightening in terrorism fears, anti-immigration murmurings as the US Republican nominee selection approaches, and the “Brexit” vote in June.

Canaccord’s end-2016 target for the S&P500 remains at 2175, calculated on net US$121 per share earnings for the 500 S&P companies on a price/earnings (PE) multiple of 18 times.

The Australian Market

Morgan Stanley’s global analysts are not as positive as those of Canaccord Genuity but they do retain a preference for US stocks, with their least preferred regions being Europe and emerging markets.

Risk assets have rallied off their February lows due to a bounce in commodity prices, a rolling over of US dollar strength and data out of both the US and China that have not been quite as bad as feared, Morgan Stanley notes. The analysts view these developments as being somewhat transient. The challenges that dominated earlier in 2016 still remain.

Morgan Stanley forecasts a stalling of global growth in 2016, increasingly limited effectiveness of easier monetary policy, a likely return to strength for the US dollar and risks surrounding China’s currency and debt levels. These all lead to a cautious stance and a positioning of the analysts’ model portfolio towards an expected retracement.

Morgan Stanley’s Australian analysts note the ASX200 rallied 9% off its February low to its peak last week. Taking heed of their US colleagues’ view, the local analysts retain a target of 4800 for the index and expect a 7% retracement from current levels. Valuation looks rich on a 15.7x 12-month forward PE when forecast earnings growth for industrials ex-banks sits at only 0.9% for FY16, the analysts suggest.

How does a local investor thus position a stock portfolio? Morgan Stanley remains Underweight the banks and has no desire to chase the rally in resources. The analysts prefer foreign earners, and to that end have added Treasury Wine Estate ((TWE)), Aconex ((ACX)) and Orora ((ORA)) to their model portfolio, consistent with a preference for stocks satisfying twin themes of “global expansion” and “new exports”.

Of concern to UBS’ equity strategists is a PE dispersion (range from lowest to highest PE in the ASX200) that remains well above average, despite having retraced somewhat in recent weeks. Over the past 15 years, dispersion has shown a reliable tendency to mean-revert. This would suggest some caution is required with regard the high PE end of the market.

To that end, the strategists advise investors should look for value among mid to low PE stocks while still holding a small number of preferred high PE names.

High PE names UBS stills finds attractive include Sirtex Medical ((SRX)), ResMed ((RMD)) and Aristocrat Leisure ((ALL)). Low PE stocks the strategists favour include Qantas ((QAN)), Lend Lease ((LLC)), Incitec Pivot ((IPL)) and QBE Insurance ((QBE)). Attractive mid-range PE stocks include Boral ((BLD)), Perpetual ((PPT)), Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), AMP ((AMP)), Orora and Primary Health Care ((PRY)).

Macquarie’s analysts do not agree with those of Morgan Stanley. Morgan Stanley is Underweight banks and will not chase resource stocks. Macquarie prefers exposure to banks and energy. Macquarie does agree with Morgan Stanley in having a preference for offshore healthcare, nonetheless.

Macquarie also favours paper & packaging, utilities and online/outdoor media, while being less predisposed towards consumer staples, general insurance, consumer cyclicals and domestic healthcare. Mind you, the analysts acknowledge that in the current market, investment is more about what one doesn’t want rather than what one wants.

Earnings growth, yield and leverage to the Aussie dollar remain as investment thematics for Macquarie, but even these have become less clear as selection criteria and price drivers. Cheap growth is no longer available, thus one has to settle for limited growth (which is where the banks come in). Yield is now well valued into stock prices, thus offering no further upside unless interest rates fall or volatility rises even further than it has (flight to safety).

Even the Aussie leverage story is becoming an asymmetric trade, Macquarie believes, given it, too, is now well priced in. If the Aussie does fall from here, that’s already priced into expectations. If it doesn’t, or rises, downgrades are in order. Only were the Aussie to fall further than the market anticipates would this cohort of stocks re-rate once more.

Macquarie has become more positive on the energy sector compared to the start of the year but like Morgan Stanley, will not “chase” the miners. The analysts believe Chinese policy is now limiting further cyclical downside risks but improvement in earnings for miners remains a long way off and mining stocks have rebounded hard. A preference for energy sees the additions of Caltex ((CTX)) and Santos ((STO)) alongside Oil Search ((OSH)) in Macquarie’s model portfolio.

A positive stance on the banks now means National Australia Bank ((NAB)) is added to join Commonwealth Bank ((CBA)) and Westpac ((WBC)). Macquarie believes concerns around bad loan impairments and capital are overdone and that the banks retain pricing power (repricing their variable rate mortgage books) when domestic cyclicals don’t, as price increases would be at the expense of the consumer.

Only consumer stocks with a structural growth angle are attractive to the analysts. Thus Star Entertainment Group ((SGR)) is added to join Carsales.com ((CAR)), Baby Bunting Group ((BBN)), Mantra Group ((MTR)) and oOh!media ((OML)).

In terms of yield stocks, Macquarie adds AGL Energy ((AGL)) and Contact Energy ((CEN)) to Telstra ((TLS)).

Macquarie may not be prepared to “chase” the miners but one of the largest Overweights in the model portfolio is Rio Tinto ((RIO)). The other large Overweights are AGL Energy, Commonwealth Bank and Westpac.

Macquarie does not hold gold.
 

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