By Chris Shaw
A survey of nearly 700 institutional clients by Barclays Capital has shown global investor confidence has risen significantly over the past three months. The lift reflects the expectation prospects for the US economy are likely to continue improving as well as the fact asset valuations are not a major concern at current levels.
While confidence has improved, Barclays notes clients are not overly bullish, which is acknowledgement many risks remain such as the sovereign debt crisis in Europe. The survey showed 38% of respondents expect at least one country will leave the euro zone this year. Barclays views this number, down from 50% in the same survey last year, as still uncomfortably high given the potential significance of such an outcome.
Among its clients, Barclays notes 37% view equities as likely to be the strongest performing asset class, followed by credit at 18%. This compares to December survey results that showed 34% viewed bonds as the likely best performer compared to 19% for equities.
For clients that are equity market investors, the survey showed 71% expect equity prices will increase by 5% or more by the end of this year. This measure is up from 25% last December. Only 10% of such clients expect a fall of at least 5%.
Confidence has also improved in other asset classes, with Barclays noting 39.5% of investors in credit markets expect US high yield securities to be the best performer. Foreign exchange investors see best results coming from G10 currencies, followed by emerging market commodity currencies.
While investors were also fairly confident about the coming year in the first quarter survey last year, Barclays suggests conditions are somewhat different now, as while concerns over the euro zone crisis remain they have diminished somewhat.
A positive is both within and outside the US, monetary policy is expected to remain loose, which should prove to be supportive of economic growth.
BA Merrill Lynch has conducted a similar survey, finding while global equities have risen 28% from their lows of last October, sentiment is far from overly bullish. Cash levels remain high, while March allocations to equities, Europe and Banks rose only modestly from the previous month.
From a macro perspective, BA-ML notes its survey shows investors are now pricing out fresh central bank liquidity measures, as 47% now say there will be no QE3 in the US, which is up from 36% in the previous survey. It is a similar story in Europe as 43% expect no new European Central Bank QE, up from 23% previously.
In terms of asset allocations, BA-ML notes investors remain overweight equities and commodities and are underweight bonds and cash. Among equity markets, emerging market positions remain very overweight, long US equities remains popular and underweight European equities is still the case for most investors. Allocations to Japan rose strongly from the previous month.
In the view of BA-ML, the reluctance of investors to trim emerging market allocations may partly reflect an improving macro outlook, as a net 28% of investors see the global economy strengthening over the next 12 months. This is up from 13% last month.
Among Asia Pacific investors, BA-ML notes while overweight China remains a dominant position allocations fell to a five-month low of plus 26%. Hong Kong is the next most favoured market at plus 18%. Australia remains the least loved market in the region at a minus 13% position.
With respect to the Australian market, Deutsche Bank suggests conditions for a recovery in deposit margins for the major banks are emerging, which could deliver significant upside surprise to profits going forward.
This can be explained by the correlation between falling wholesale funding costs and improving deposit spreads of 0.8x, so the recent 70-80 basis point reduction in wholesale funding costs should see deposit rates reduce, so boosting industry margins.
For every 20-basis point improvement in spreads there is a 5-7 basis point improvement in group margins, which Deutsche suggests would translate to a 3-4% upgrade in earnings per share. The broker suggests ANZ Banking Group ((ANZ)), Commonwealth Bank ((CBA)) and Westpac ((WBC)) should benefit by around the same amount from this theme, while National Australia Bank ((NAB)) would lag given its UK operations.
Among the major banks Deutsche rates ANZ and NAB as Buy, while ascribing Hold ratings to CBA and Westpac.
UBS has looked more closely at the impact of department stores on Australian REITs, especially those involved in leasing retail space. This market is significant given department stores contribute around 5% of total rent, occupy about 20% of gross lettable area and pay rent of around $200-$250 per square metre.
At present, UBS notes the two major department stores in Australia are at opposite ends of the spectrum. Myer ((MYR)) is focused on trying to optimise its store network and returning space to landlords when possible, while David Jones ((DJS)) has a relatively small current footprint but is committed to growing its store network.
By income, UBS estimates CFS Retail Property ((CFX)) has 7.5% exposure to department stores, Westfield Retail ((WRT)) 6.0%, GPT ((GPT)) 4.0% and Centro Retail ((CRF)) 2.1%. The importance of these exposure levels, in the view of UBS, is concerns from retailers on rents are unlikely to go away anytime soon.
This suggests to UBS a cautious stance on those stocks where there is no capital management or capital recycling to prove up net asset value is appropriate. Among the REITs the broker's order of preference remains Westfield Group ((WDC)) and Charter Hall Retail ((CQR)) as the top picks, following by mid-weightings on CFS Retail, GPT, Centro Retail and Westfield Retail. UBS continues to prefer CS Retail to Westfield Retail.
Still in relation to retail in Australia, BA-ML notes earnings growth for food and beverage producers and retailers has been in decline for the past two to three years, this rate of decline picking up sharply over the last six to 12 months.
While the retailers have attributed weaker earnings to cyclical factors such as adverse weather and weak consumer spending, BA-ML sees the issue as more structural. These include over-investment in an already crowded market, a large proportion of investment being on property developments and renovations and the effective entry of a new major competitor given the resurgence in Coles over the past couple of years.
BA-ML argues the consumer sector is currently experiencing margin pressure from price deflation and increasing costs, with these stemming more from over-investment than from cyclical factors. This implies a lengthy period of margin pressure for the Australian food and beverage sector.
On BA-ML's numbers, the three main food retailers in Australia need to lift earnings before interest and tax (EBIT) by around $1.3 billion over the next three years to make an acceptable rate of return. A concern in achieving this is retailers are likely to step up what are already intense efforts to boost earnings via measures such as price cuts, which could cause a worsening outlook for both consumer products and the retailers.
Given price deflation is expected to stay for at least some time, BA-ML suggests Australian consumer companies are likely to realise, at best, low single digit earnings growth over the next two to three years.
For BA-ML a key will be owners and managers adjusting growth expectations to reflect the new market reality. This means not acting in an overly ambitious manner by investing to sustain abnormal growth rates, as such action could generate material dilution to returns on investment.
BA-ML notes the leading consumer stocks in Australia – Woolworths ((WOW)), Wesfarmers ((WES)) and Coca-Cola Amatil ((CCL)) are all trading on earnings multiples of 14-15 times at present, while dividends are better than 4.5%.
A company offering 3% growth with a cost of equity of 10% and a dividend yield of around 5% should have a price to growth multiple of around 1.2 times on BA-ML's numbers. This equates to an earnings multiple of around 10 times, well below current multiples for the sector leaders. This highlights BA-ML's caution in terms of investing in the sector at current levels.
JP Morgan has reviewed its coverage of emerging companies, noting since the start of 2012 the Small Industrials accumulation index has risen 15%. This is outperformance relative to an 8% increase in the Small Resources index and the 4% and 5% gains for S&P/ASX100 Industrials and Resources indices.
In JP Morgan's view the primary reason for the recent outperformance has been earnings multiple expansion, as the Small Industrials are now trading at a premium of around 10% relative to the S&P/ASX100 Industrials on a 12-month forward basis.
Among the emerging cap stocks under coverage, JP Morgan rates Asciano ((AIX)), Aristocrat ((ALL)), Ausdrill ((ASL)), Blackmores ((BKL)), Bradken ((BKN)), Credit Corp ((CCP)), Dulux ((DLX)), Fantastic Holdings ((FAN)), Flight Centre ((FLT)), Henderson Group ((HGG)), iiNet ((IIN)), Jetset Travelworld ((JET)), Miclyn Express ((MIO)), Norfolk ((NFK)), NIB Holdings ((NHF)), Programmed Maintenance ((PRG)), QRxPharma ((QRX)), REA Group ((REA)), SAI Global ((SAI)), Silex Systems ((SLX)), Seven Group ((SVW)), Transfield Services ((TSE)), Thinksmart ((TSM)) and Wotif.com ((WTF)) as Overweight.
Among the REITs, JP Morgan has Overweight ratings on Astro Japan ((AJA)), Carindale Property Trust ((CDP)), Charter Hall Group ((CHC)) and FKP Properties ((FKP)), while for the resource plays Overweight ratings are ascribed to Australian Worldwide ((AWE)), Aston Resources ((AZT)), Grange Resources ((GRR)), Hillgrove Resources ((HGO)), PMI Gold ((PVM)), Roc Oil ((ROC)), Silver Lake ((SLR)), Venture Minerals ((VMS)) and YTC Resources ((YTC)).
Among JP Morgan's Underweight recommendations are REIT plays Bunnings Warehouse Property ((BWP)) and Charter Hall Retail and resource plays Aurora Oil & Gas ((AUT)) and Sandfire Resources ((SFR)).
Among the emerging industrials, JP Morgan is Underweight on Austar ((AUN)), Billabong ((BBG)), Envestra ((ENV)), Gunns ((GNS)), Hastie ((HST)), Matrix Composites ((MCE)), Nufarm ((NUF)) and PaperlinX ((PPX)).
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