|Summary: Economists have revised down their growth forecasts on China, the world’s biggest importer of iron ore, gold, and coal. The China slowdown effect has pushed mining shares lower, and that is making them good value at current levels.|
|Key take-out: The big mining stocks might not be sexy investments, but they could serve the dual purpose of generating income and realising upside on the back of spurred Chinese demand.|
|Key beneficiaries: General investors. Category: Shares.|
Benjamin Pedley and Jose Rasco, HSBC Private Bank’s investment strategists for Asia and US/Latin America, recently returned from their client roadshow with a few insights and a number of concerns.
Top of mind for their clients: how best to redistribute portions of the portfolio that are looking increasingly frothy, like high-yield bonds? Pedley and Rasco make a case for a back-to-basics approach, buying large cap value stocks over growth, with a preference toward dividend growers.
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The HSBC duo rattles off a number of increasingly risky asset classes. From Pedley’s perspective, based in Hong Kong, he watched last year as the Australian dollar and gold all came under pressure. Investors got complacent, thinking they were camped in historically safe assets. Asian high yield, delivering stellar returns for years, has also become wobbly. For such reasons, Pedley and Rasco are advising their clients to rotate out of headier markets like US and Japanese equities, where deals are hard to come by and valuations are stretched.
So where do they divert all this money? The bank is overweight European equities because the economy appears to have bottomed. Plus, ECB President Mario Draghi’s commitment to do “whatever it takes” to save the Eurozone seems to have put a floor on the downside, they say. This is fairly consensus thinking in the wealth management world.
But perhaps more interesting, last week, HSBC Private Bank upgraded China from underweight to overweight. Economists have recently suggested that the Chinese economy could slow to 7% from 7.7% last year. That’s a far cry from 10-plus per cent growth of just six years ago and Pedley certainly acknowledges the weakness, specifically in the all-important manufacturing sector. But he points to mini-stimulus efforts, including spending on railways, low-income households and tax relief. The duo thinks such discussions prove the government is committed to its 7.5% growth target.
With inflation at a historically low 2.5%, the government could choose to loosen the money supply. “There are a number of policy levers available and there are few economies in the world that are in a better position to do what China can do,” he says. The thinking is similar to their European play – the Chinese politburo is prepared to take extreme measures if growth slows.
How to play their bullish China call? As in the past, out of favour global mining companies are the best way to take advantage of China’s bottoming economy, Pedley and Roscoe argue. China is the world’s biggest importer of iron ore, gold, and coal. The slowdown in China has pushed mining shares lower making them both historically cheap, valued at 10.8 times this year’s earnings, and their dividend yields increasingly attractive, between 3% and 5%.
But there is another upside on the miners beyond China. Cost-cutting measures and digesting the mergers and acquisitions of a few years ago are making diversified, global miners more efficient, Pedley and Roscoe say. They expect some of this excess cash getting generated will be returned to shareholders in the form of buybacks and dividend hikes.
Barron’s Asian Trader columnist Assif Shameen likes BHP Billiton (ticker: BHP) and Rio Tinto (RIO), easily the largest players in the space, with market caps of $180 billion and $85 billion respectively. Shameen notes that both the companies have new CEOs, are slashing capital expenditures, and sport above market dividend yields, both near 3.5%. BHP trades for 12.1 times this year’s earnings and RIO at 9.9 times, versus the S&P’s 15.5.
As an aside: a recent HSBC research note on the big UK-based miners has an overweight rating on Anglo American (AAL.U.K.), Glencore Xstrata (GLEN.U.K.), and Rio Tinto. Price targets show between 20% and 35% upside, with Glencore Xstrata being the bank’s top pick. BHP is rated neutral.
The big mining stocks might not be sexy investments, say Pedley and Rasco, but they could serve the dual purpose of generating income and realising upside on the back of spurred Chinese demand. In a maturing bull market, what more could clients ask for?
This article was first published in Barron's, and is reproduced with permission.