Carr's Call: Pinpointing market hotspots

I’m sincerely stunned at the extent to which the economic debate has become inwardly focussed.

Regardless of your politics, I think the Opposition Treasurer, Joe Hockey, summed it up well when he said it appeared that Australia was going backwards. It does seem that way when the rest of the globe is improving, becoming more confident, but here it’s just getting worse. I suggested late last year that the entrenched nature of this pessimism would see to it that the Aussie market underperformed this year, and that has certainly been the case. US stocks are up about 22% so far this year, while Australian stocks are up almost 9%. Only a month or so ago, the Australian result was closer to 0%.

I’m still bullish on the Australian economy medium term, but that bullishness is being trumped by the near-term confidence crisis this country has – one that I think is policy induced, not structural or due to the end of the mining boom.

Against that backdrop it’s become increasingly difficult to take a near-term tactical view with regard to a domestic sector allocation – eg there doesn’t appear to be a clear defensives vs cyclical, or even a yield theme dominating as such (see chart 1).

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That's not to say the market does not have its hotspots. Indeed, there are both hotspots and blackspots across this market. It's just that it's a little complicated. To me, these are the dominant themes.

The impact of a weaker Australian dollar

Now the supposed upside to the Australian economy’s downside was that a weaker Australian dollar was meant to lift the All Ordinaries. Recall that this was blamed by many economists for the All Ords’ underperformance in the global equity bull market. No bull market here.

As a general observation, there doesn’t appear to have been any benefit to the lower dollar on our market, and the All Ords is still range trading, albeit at the top of that range. Now, to some extent, there has been support. Companies like Brambles and CSL are often touted as the key beneficiaries of a weaker $A and they have actually performed well. Yet this year’s momentum appears more a continuation of last year’s (when the $A was so much higher), not so much anything to do with the lower Aussie dollar. Moreover, the impact hasn’t been uniform and other touted beneficiaries – James Hardie, Cochlear, Treasury Wine Estates – don’t really appear to have obtained any discernible benefit from the exchange-rate moves. And we know our miners haven’t. Which leads me to the next theme.

China’s landing – hard, soft, none?

Materials, led by miners, have been the worst performers to date. Hit by China slowdown fears these stocks are the great underperformers. Down 10% thus far this year on fears of an iron ore price collapse; instead, what we’ve found is that iron ore is up to around $US130 per tonne. More to the point, iron ore shipments to China are still surging and the latest figures from Port Hedland show shipments to China up 36% from last year. But sometimes it is better to play the fool in a fool’s world. The key theme I’m seeing developing in the market though is a bit of resistance to this China slowing narrative. It’s probably because iron ore prices remain high – so Rio is up 20% and BHP is up 15% from their lows. For long-term buyers, now is great time to buy, but this sector is and will likely remain volatile. For those with a shorter-term horizon, or who don’t want the volatility or stress, I would stay clear while the market is obsessed with a China slowing.

All the way with the USA

While China fears weigh, the US star is shining bright – and so too are Aussie stocks with a heavy exposure to the US. That is sales on the ground, not just a US dollar exposure. Of the big listed stocks, Brambles (with over 50% of revenues US sourced) and Computershare (with around 40% of revenues US based) have done very well, and if you look at the IT sector (chart 1 again), CPU’s performance (60% of the index) is a key reason info tech has outperformed (the other of course being the success story that is carsales.com.au, which is 24% of the index).  

With the US expansion comparatively recent, and few if any headwinds to growth, this thematic is likely to be around for some time.

The housing market is showing signs of life – mainly lending, not so much construction

I suggested in my piece of May 8 The trouble with the bubble call that you couldn’t call a bubble in the banking sectors with credit growth at the trough. Now the banks did fall from that point – CBA was down 8-9%, yet what we find now is that the fall was an aberration. CBA is hitting new records and other banks have bounced back as well. Why? Because you can’t call a bubble at the bottom. Since I wrote that piece, auction clearance rates are hitting boom-time highs, house prices are rising sharply, especially in Sydney, and new home lending is on the rise. All of this will ensure that banks remain an attractive part of any portfolio, and with the housing market picking up there is little risk of a bank bubble here – and this thematic is in its early stages.

Now while the price and lending indicators are picking up, and this is providing a measure of support to banks, one area that remains comparatively unloved are our construction materials stocks like Boral and Adelaide Brighton. There is tentative support there, given the tentative lift in approvals and housing construction indicators – but this is a key emerging thematic and one to watch very closely.

Consumers are scared

The other more worrying theme that has emerged is the sudden and rapid decline in consumer spending compared to 2012. It’s ironic because this has been a trumped-up theme for many years and consumer stocks suffered as a result – all the while spending data defied the talk. It was a false premise, for so many years. That is until recently, when for no apparent reason, spending started to slump and, as we found out this week, remains soft. Now consumer fundamentals are very good and spending will pick up. Moreover, I realise that consumer stocks were perhaps oversold and that’s why we got that bounce back. But it appears overdone, still, and there are no signs as yet that is about to change.

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The transition from the mining investment boom to the production boom

Mining service stocks like Boart Longyear and Orca have been absolutely trashed this year, but the upside to this thematic is best captured by the 22% year-to-date gain in Aurizon, less so Asciano’s 12% gain although, let’s face it, 12% isn’t bad either. The thing is we haven’t really even begun to see the boom in this space – production and getting product to port. This too is an emerging thematic that will likely prove to linger for some time.

Conclusion

To conclude then, the main global theme buoying our market at the moment is the US recovery, and stocks with on-the-ground exposure to that economy. The China story, up till now, has been a downside influence but now it is merely one of confusion. The concern is still there, but there is growing resistance to the hard landing idea – volatility is the likely result.

Moreover, and despite the hype, the lower Australian dollar doesn’t appear to be providing a clear or consistent benefit to our market. Otherwise the housing recovery themes has a long way to run, as does the production phase of the mining boom. Consumer spending is the key worry.