By Greg Peel
Global Double Trouble
Russell Investments echoes the views of several market analysts in assuming global financial markets are currently at risk of volatility from two macro uncertainties – the timing of the first Fed rate hike and whatever becomes of Greece – but that any pullback in markets will provide investment opportunities.
On the Greek front, Standard & Poor's now puts the odds of a Greek exit of the eurozone at 50-50. One might be inclined to dismiss such a view as a disingenuous coin toss, but the truth is S&P had a Grexit at lower odds prior to last weekend.
The pervading view amongst global analysts looking on is that Greece will more likely remain in euro, some way, somehow. But there are plenty who are beginning to assume a Grexit is inevitable. The bottom line, nonetheless, is simply that no one knows. Were Sunday's Greek referendum to return a "yes" vote, implying acceptance of a bailout package's requisite reforms, but implicit of a vote to stay in the euro, then one assumes a deal could indeed be reached with a new Greek negotiating team. A "no" vote would simply be inconclusive, but would probably lift S&P's odds of a Grexit to beyond even money.
Russell Investments was backing Greece to remain in the eurozone when it published a third quarter outlook last week. The analysts also expect the Fed will move in September, but acknowledge a deal of uncertainty surrounding both calls. Uncertainty is the enemy of markets, and thus a source of volatility.
From a global economic perspective, Russell is still assuming the September quarter will see moderate growth for the US, the recovery in Europe becoming more entrenched, and improvement from Japan. Emerging market economies will nevertheless remain under pressure, and Russell sees the Chinese slowdown as having further to run.
While 2.5-3.0% growth is expected for the US in the second half of 2015, supported by robust single-digit corporate earnings growth, the expensive US stock market and low bond yields mean investors need to be cautious heading into the Fed rate rise. Greece may upset Europe's recovery path, but Russell would look to any pullback as a buying opportunity.
In the Asian region, Russell notes the Chinese, Australian and New Zealand economies continue to slow, but that policy accommodation makes deep downturns unlikely. Japan remains the pick of the region.
Deutsche Bank, too, is expecting the Fed to move in September. Deutsche's economists see the global economy posting slightly lower growth in 2015 than the already below-trend pace of 2014, before rising slightly to above trend in 2016 at 3.8%. The US appears to have overcome its weak first quarter and Deutsche believes growth in most major regions will pick up significantly, with the exception of Asia ex-Japan.
The analysts suggest the risk of another 50-100 basis point jump in longer term US bond yields once the Fed has made its first move is manageable, given implicit forward momentum in the US economy and resultant support of risk assets. However the analysts won't rule out a sudden panic jump in rates due to current low liquidity in bond markets, and a subsequent spill-over into risk asset volatility. This would only occur if the Fed were forced to keep raising faster than it would like due to inflationary pressures, and is unlikely in Deutsche's view.
China tends to be relatively less sensitive to developments in US financial markets and here Deutsche sees monetary and fiscal easing, and emerging signs of stability in China's property market, as supporting modest growth in the second half.
Were the referendum in Greece to prove the catalyst for heightened uncertainty and nervousness, Citi would expect a rush into US, German and UK bonds and strength for the US dollar, pound and probably yen. Gold might find support and equities could pull back further. But a survey conducted by Citi has found most equity investors are not that worried about Greece and the potential for global disruption.
Most would see further pullbacks as a buying opportunity.
Australia
The rally experienced on the ASX in the March quarter thanks to a falling Aussie and the global demand for yield now seems but a distant memory, admits Morgan Stanley. Since the broker asked the question back in April whether the old "Sell in May" adage might play out in 2015, the ASX200 has fallen over 8%.
"Sell in May" might be dismissed by some as mere folklore but Morgan Stanley's analysis back to 1937 for the All Ordinaries does confirm June as the second worst month on average after September, with December being the best (thanks Santa).
Morgan Stanley believes Australia's macro outlook remains challenging as the domestic economy struggles with its transition due to lower commodity prices and labour cost pressure. The growth outlook for developed markets in general has been improving but a patient Fed has kept the Aussie dollar higher than warranted, constraining domestic growth and earnings. The analysts expect Greece and a slowing China will weigh on consumer and business sentiment in the short term, supporting Morgan Stanley's below-consensus forecasts for growth and employment.
The ASX200 is currently trading on a one-year forward PE of 15.2x compared to the long run average of 14.1x, suggesting the index offers 7% further downside to around 5000. Earnings upgrades are required to support such a PE and they rely heavily on cyclical improvement, hence Morgan Stanley believes the Australian market remains more vulnerable than those of developed market counterparts.
Morgan Stanley would not be surprised if 5000 is tested, before a recovery towards the broker's 5650 target for mid-2016.
On the subject of corporate earnings, Macquarie notes the last few weeks (known as the "confession session" ahead of year-end books close) have seen a number of high profile downgrades, with the likes of Woolworths ((WOW)), Seek ((SEK)), Flight Centre ((FLT)), Qube Holdings ((QUB)), Nine Entertainment ((NEC)) and Virtus Health ((VRT)) all cutting FY15 and/or FY16 guidance. The broker believes, nonetheless, that while conditions remain challenging generally these downgrades are more company specific and/or structural than implicit of macro issues.
The broker also notes forecast earnings growth for the market ex resources remains relatively unchanged, with 6.5% expected for FY15 (FY14 saw 5.2%) and 7.8% expected for FY16. After the February result season, these numbers were 6.3% and 8.0%.
The ratio of earnings upgrades to downgrades was showing positive momentum in April-May and has pulled back somewhat in June, but the ratio remains above the lows of twelve months ago, Macquarie points out. The broker has identified a group of stocks for which revision ratios have been positive yet stock prices have underperformed. The group includes Oil Search ((OSH)), Mirvac Group ((MGR)), CSR ((CSR)), Fairfax Media ((FXJ)), Navitas ((NVT)), Fletcher Building ((FBU)) and Transfield Services ((TSE)).
Conversely, the group that has seen negative revisions yet share price outperformance includes ALS ((ALQ)), Tabcorp ((TAH)), Orica ((ORI)), Austal ((ASB)), Ainsworth Gaming ((AGI)), Steadfast ((SDF)), Mantra Group ((MTR)) and SAI Global ((SAI)).
UBS notes the sell-off on the ASX in the June quarter was led by the banks and consumer staples, while rallies for consumer discretionary and REITs provided some offset. The ASX200 PE has fallen back year to date, but this principally due to resources.
UBS expects global interest rates to push higher in the second half of 2015 but does not expect a panic sell-off in bonds. Global and Australian stock markets should be able to cope with a moderate rise in yields over the next six to twelve months and the Aussie still has downside potential, UBS believes, which should offer earnings support for corporates.
UBS' ASX200 target for end-2015 has been pulled back to 5800 from 5900 due to risks surrounding bank capital requirements and risk for the iron ore price. The broker still sees mid-single digit earnings growth in FY16, in line with consensus forecasts.
UBS is underweight mining, REITs, telcos, consumer staples and general insurance, and overweight US dollar earners, housing construction plays and energy. The broker is neutral on the banks.
UBS' favoured stocks include Asciano ((AIO)), Challenger ((CGF)), CSL ((CSL)), Harvey Norman ((HVN)), Incitec Pivot ((IPL)), Origin Energy ((ORG)), Qantas ((QAN)), QBE Insurance ((QBE)) and Sonic Health Care ((SHL)).
Housing
Credit Suisse agrees with UBS on the housing construction front. The broker notes Australian house prices rose at a 7% annual pace in the March quarter, down from 11% in the December quarter but still strong given a weakening economic backdrop and anaemic income growth.
While tight supply and low mortgage rates have been obvious drivers, so too has demand from Chinese buyers, Credit Suisse notes. In FY14, Chinese buying grew by 60% on FY13, the broker estimates, and Chinese demand represents 15% of national housing supply. City preference is split from Sydney (23%) to less than 6% in Perth, Adelaide and Hobart.
Sydney has not been signalled out for Chinese attention globally, with Melbourne, Auckland, Hong Kong, Singapore, London, San Francisco and Vancouver all proving popular, making these cities some of the most expensive in the world.
Australia sits at the doorstop of the greatest wealth creation in history, Credit Suisse notes, which is why Chinese demand for Aussie housing is unlikely to abate. The broker suggests a number of local companies should continue to benefit from this longer term theme, including developers, building material producers and property websites, and has now added Boral ((BLD)) to its preferred portfolio.
Commodities
When will it be time to risk investment in commodities once more? Deutsche Bank believes lows in commodity prices should be hit during the second half before tightening fundamentals and higher prices begin to emerge in some markets in 2016.
Chinese monetary and fiscal measures are set to improve the outlook for industrial metals going forward, Deutsche suggests. The broker has a preference for nickel, zinc and palladium. Producer cuts will nevertheless be required to reduce oversupply of iron ore and coal.
The outlook for gold is not so rosy, in the face of expected Fed rate increases and subsequent rises in US yields and the greenback. There is no evidence investors are positioned in gold in case of a negative outcome for Greece, the broker notes.
Nor does Deutsche expect the sharp decline in US shale drilling activity to promote any tightening in energy markets. Not only are productivity increases offsetting the impact, production looks to be accelerating into the second half. Assuming OPEC continues to dismiss the notion of production cuts, the global oil balance should tilt to oversupply in 2016, the broker suggests.
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