By Greg Peel
Amidst the current gloom of global economic uncertainty, stock brokers are mostly still forecasting stock indices to be higher than they are now by year-end. Such forecasts nevertheless come with 'bear case” caveats such as “unless Europe blows up,” and so forth. At present the majority attitude seems to be that the crisis in Europe will be resolved just before it is too late, that the Fed will ensure the US does not slide away, and that China is in a more immune position from developed world weakness in 2011 than it was in 2008. Even if it isn't, China still has plenty of gunpowder left in the stimulus capacity keg, analysts note.
Goldman Sachs analysts, for one, are forecasting a year-end target for the ASX 200 of 4460 and an end-2012 target of 5000, assuming the “bear case” does not come into play. That end-2012 target looks pretty good from here if you're a trader – it represents a 22% return (or 17.5% pa). But if you're a longer term investor still riding the stockmarket rollercoaster, you'll note that the ASX 200 first breached 5000 in 2006, fell back through in 2008, and has since rebounded to be at or near 5000 no less than five times.
Stock analysts are prone to being perennially positive, given they would be sacked from their brokerages for business-destroying negativity, but assuming one needs or wants to hold an equity component in one's investment portfolio then a look at the various sectors is helpful. Here follows some thoughts from analysts.
I noted above a belief that China is more immune to developed world weakness in 2011 than it was in 2008. Many thought China was immune in 2008, but at that time China's domestic economy was almost non-existent by comparison to its export economy. Today China's export economy still stands to suffer from weakened demand from Europe and the US but its domestic economy is now the world's leading economic growth engine. The ongoing “industrialisation and urbanisation” theme in China goes a long way to explaining why in 2011, unlike 2008, the prices of key commodities have not been crunched as stock prices have. In the case of iron ore and coal, for example, prices are steady to higher.
On that basis, RBS Australia posits that the local mining services sector is the new “defensive”. This seems odd given mining is traditionally a cyclical business unlike the traditional defensives of utilities, telcos and consumer staples, for example, but then China and its emerging market friends have rather turned the tables. RBS believes mining services is one of the few Australian sectors with a positive outlook for FY12, given both aforementioned commodity price robustness and the unaltered capacity expansion plans of the major Australian miners.
Among the “small” stocks in the sector, RBS believes Bradken ((BKN)) remains a standout investment while the analysts are also positive on Ausdrill ((ASL)), Emeco ((EHL)) and Imdex ((IMD)).
Nor does RBS believe a positive outlook is limited to mining, given energy is also in the frame. RBS analysts note a research paper released by the Reserve Bank of Australia last week which indicates the central bank agrees with those in the market very positive on the longer term outlook for LNG. The RBA suggests Australia could see “LNG exports approach coal and iron ore in terms of their contribution to total export earnings over the coming decade”.
Were that to occur, RBS points out that the result could ultimately be an Australian current account in surplus rather than just a trade balance in surplus. (The current account is the sum of the trade balance and the capital account. The capital account is determined by payments to offshore entities representing interest on loans, dividends on investment, royalties on licences and so forth.) However the swing factor will be the level of imports of capital equipment required for resource sector engineering and construction works, RBS suggests.
“We see these imports forming part of a boom in engineering construction,” say the analysts, “with Australian domestic final demand likely to surge, but with the net GDP impact depending on the imported share of the construction bill and the dynamics for household consumption”.
The LNG element also plays into RBS' positive view on the mining and energy services sector. Once we move away from mining and energy, things start to look a bit different.
RBS has surveyed 40 of the top 100 home builders in Australia in order to asses current conditions in the building materials sector. Assessments of current sales conditions were generally poor (42%) or average (also 42%) with only 16% seeing conditions as good. Of the respondents, 64% indicated a deterioration of sales levels in the past six months, suggesting further downside, RBA notes. Key issues were a lack of buyer confidence, affordability and finance constraints and the continued absence of first home buyers in the market.
Aside from sales levels, respondents further noted the level of inquiries had also declined in the past six months, which RBS sees as a clear leading indicator.
The analysts believe conditions will continue to turn down in Victoria, Queensland and Western Australia for the rest of 2011 with conditions in New South Wales remaining flat at best. They see a “material” decline in national housing starts through to mid-2012 to a level representing a “traditional deep cycle bottom”.
As for investment in building material stocks, RBS believes Adelaide Brighton ((ABC)) and James Hardie ((JHX)) are relatively immune to the weak domestic cycle while CSR ((CSR)) is a Buy on valuation grounds. The analysts retain Hold ratings on Boral ((BLD)) and Fletcher Building ((FBU)).
Ongoing stock market volatility is playing into the hands of Challenger Financial's ((CGF)) annuity sales business, leading Citi analysts to rate Challenger as their top pick in the diversified financials sector. Annuities guarantee an investor a fixed return over a preset long term period. Such returns are never particularly exciting but they do take one off the stock market rollercoaster.
Ongoing volatility is also benefitting the Australian Securities Exchange ((ASX)) through increased trading volumes, mostly in derivative products. This has helped to offset market concern about the entry of competition into the stock exchange space, while Citi suggests strong positions in clearing, settlement, market data and technical services along with new product development support ASX revenues.
For other non-defensive components of the diversified financials sector, Citi suggests market leverage is the key. In selecting their sector pecking order the analysts have included those stocks most leveraged to a market rebound. In so doing, they note, they are assuming that the Citi equity strategists' call for a market recovery ahead is accurate.
Citi's descending order of preference in the sector is Challenger Financial, ASX, Henderson Group ((HGG)) and Macquarie Group ((MCG)) all with Buy ratings, followed by ING Financial ((IFL)), Computershare ((CPU)) and Perpetual ((PPT)) with Hold ratings.
Weak business confidence is an issue for Australia's IT services sector. On that basis, BA-Merrill Lynch has made cuts to its earnings forecasts for its stocks under coverage, with average reductions of 2-8% taking Merrills' FY12-13 forecasts to below consensus.
Merrills notes that valuations for stocks in the sector currently appear cheap and mid-term fundamentals remain solid, but near term the analysts warn of a value trap. The analysts favour stocks with recurring revenues, strong cash generation and exposure to the latest structural driver, “cloud” computing. On that basis Technology One ((TNE)) and Reckon ((RKN)) are the analysts' favoured plays.
Merrills also has Buys on CSG Ltd ((CSV)) and SMS Management & Technology ((SMX)) but only on valuation grounds, meaning investors must be wary of that “valuation trap”. The analysts have downgraded Oakton ((OKN)) to Neutral and have Underperform ratings on ASG Group ((ASZ)) and DWS Advanced Business Solutions ((DWS)).
