2013: Not Such A Bad Proposition

No surprise thus, BlackRock's head of Alpha Strategies for Asia Pacific, Marc Desmidt, used the video connection between Singapore and Sydney on Monday afternoon to advise investors better get used to dealing with the same old issues as these headwinds might transform in shape and/or intensity throughout calendar year 2013, but there's little chance any of the known demons might actually be resolved or simply "go away".

And so it is that we can embrace a year ahead in which Chinese growth is likely to pick up some strength (in moderation) while the US should see some better growth numbers too (also in moderation), with ongoing struggles in Europe and Japan. Yields on bond markets might move a little lower, still, as inflation is also expected to remain subdued and central bank policies will remain accommodative.

The good news about all this is that 2012 has been actually looking worse for most of the year and overall returns haven't been that bad, including in Australia, point out the experts at BlackRock.

Because of macro forces currently in play, including Quantitative Easing by the four major central banks of the world, Australians better also get used to having an overvalued currency (probably fluctuating between US$1.05 and US$0.98). The good news on this front is that the currency will likely force the RBA's cash rate lower than would have otherwise been the case. BlackRock agrees with current market projections of an RBA cash rate of 2.50% sometime in 2013, though Fixed Income specialist, MD Steve Miller, believes the cash rate might even end up lower.

It should be clear to everyone the Australian economy's support from the boom in mining capex is going to end sooner and at lower levels than previously projected, Miller re-affirmed. Hence rebalancing of the Australian economy has now become top priority at the RBA to guide the economy back to trend growth. One way to achieve this will be with renewed focus on exports (though the currency may have something to say about this), another point of the RBA's focus will be reinvigorating the local construction sector, Miller predicts. Even if this process were to unfold at a slower than desired pace, Miller suggests investors can at least draw comfort from the fact the sector now enjoys firm support from the RBA.

One key element in support of BlackRock's view is that, globally, investment portfolios are still tilted towards defensives and safety, and at extreme levels.This makes "risk" cheaply priced and attractive if projections for a mild uptick in growth eventuate alongside an improvement in earnings forecasts. It is BlackRock's view that after the devastating downward correction in corporate profits expectations throughout the Asian Pacific this year, a mild improvement in the economic picture should now see more upgrades to forecasts coming through. This will make a lot of the beaten down cyclical equities look a lot more attractive.

At the same time, the view remains that the global search for yield is here to stay. BlackRock suggests investors should not necessarily abandon those yield investments that have served them so well over the past four years, but adding more growth/risk for the year ahead seems but the reasonable thing to do.

All in all, the views expressed by BlackRock experts on Monday afternoon were pretty much a carbon copy of the projections and views shared at the inaugural IHS Global Investors Forum in Washington DC, which I attended two weeks ago. Current optimism on the nascent US recovery is based upon a turnaround for US housing in combination with projected improvement in business capex and consumer spending, alongside a surprising new boom for the local energy sector (shale gas and tight oil). Both IHS and BlackRock share the view that all of this will probably turn out more of a 2014 story, but the risks for next year are now for a potential positive surprise.

One key difference was that IHS offered more consideration to the fact that tensions related to the nuclear program under development in Iran might come to a head by mid next year, a potential threat taken very seriously in Washington DC as it has the power to negate all the positives that currently lay on the table for investors and for the global economy. When questioned about the issue, BlackRock's Chief Investment Officer in Australia, Mike McCorry, readily admitted this is probably the biggest threat hanging over global financial markets right now.

The problem, as he sees it, is there's nothing investors can do about it. As has been the case in years past, tensions in the Middle East can easily flare up again, but they might just as easily subside without causing great troubles such as a spike in the oil price a la 2008. In which case investors will be better off focusing on the positives elsewhere.

What's going to happen then with the much publicised "fiscal cliff" in the US? BlackRock shares the widely held view that Congress, Senate and the US President will eventually work out an agreement. Exactly how and when this will happen remains anyone's best guess.

One conclusion stands out from the Asia-Pac's research team's findings: there are no two ways about it, over the longer term equity investments in quality companies with quality balance sheets and with robust business models and management teams offer superior returns, but right now, "risk" looks very attractive. Or as one of the experts (accidentally I assume) stated during the video linkage: "junk" might well outperform next year.

Given the yield-focus among investors is unlikely to abate anytime soon, investors in Australia may want to pay attention to recent research conducted by analysts at Macquarie. According to this research, overall payout ratios among Australian companies (ex-resources) have lifted sharply this year. In fact, states Macquarie, 2012 marks "the most rapid increase in over six years". This suggests higher risks to those dividends because it implies that company boards, in the absence of sufficient growth, decided to lift payout ratios. Were growth to remain absent for longer or payout ratios again reigned in, this may lead to dividend disappointments, of course.

According to Macquarie, the average payout ratio in Australia has now risen to 65% vis-a-vis the long term average of 60%. Regardless, offer the analysts, actual dividend deliveries remained below expectations this year, while growth proved weaker than in previous years with one notable exception: Listed Property Trusts (otherwise known as REITs) where a clear positive trend prevailed. Remarkable is also that dividend growth forecasts for FY13 are once again higher than projected growth in earnings. For how long can this remain a viable assumption?

At the very least, Macquarie suggests further growth in dividends for these companies is likely to be more closely tied to growth (or lack thereof) in profits from now onwards.

Stocks with trending higher payout ratios include Bank of Queensland ((BOQ)), AMP ((AMP)), Suncorp ((SUN)), Mirvac ((MGR)), CommBank ((CBA)), Westpac ((WBC)), Bendigo and Adelaide Bank ((BEN)), Aristocrat ((ALL)), Computershare ((CPU)), Harvey Norman ((HVN)), Fairfax Media ((FXJ)), Toll Holdings ((TOL)), QBE Insurance ((QBE)), Primary Health Care ((PRY)) and Boral ((BLD)) as well as small caps Acrux ((ACR)), GUD Holdings ((GUD)), Qube Logistics ((QUB)), GWA Holdings ((GWA)), Charter Hall ((CHC)), Iress ((IRE)), JB Hi-Fi ((JBH)), Sigma Pharmaceuticals ((SIP)), Southern Cross Media ((SXL)), FlexiGroup ((FXL)), Emeco ((EHL)) and Transfield Services ((TSE)).

Not helping the cause for these companies is that consensus forecasts for earnings per share are still in decline in Australia. Currently, market consensus as measured by FNArena is projecting 5% growth in EPS this year. Some top-down forecasters such as UBS think this is likely to end up closer to zero by June next year.

On the other hand, stocks with above average dividend yield (in excess of 5%) and yet still trending lower payout ratios include Telstra ((TLS)), SP Ausnet ((SPN)), Spark Infrastructure ((SKI)), Sydney Airport ((SYD)), Amcor ((AMC)), Commonwealth Property Office ((CPA)), Westfield ((WDC)), Challenger ((CGF)), Tabcorp ((TAB)), as well as small caps Fleetwood ((FWD)) and Premier Investments ((PMV)).

With regards to that second list of companies, it has to be noted market consensus now anticipates a rather marked fall in dividends to be received from Fleetwood this year (-8.3%). If accurate, this would be the first time since 1995 (as far I have data available) that dividends won't be increased on the previous year. For what's likely in store post FY13, see Stock Analysis on the FNArena website.

Rudi Filapek-Vandyck
Editor FNArena