Standby for upgrades

The Australian stockmarket could rise up to 16% more before the end of the year, according to a growing number of bullish brokers.

PORTFOLIO POINT: Brokers suggest it’s time for investors to return to equities, but to do so selectively.

Battled-scarred by the GFC and 2012’s crushing minus 15% returns on the ASX, Australian stockbrokers have been a little less voluble in their projections for the year ahead: But the remarkable feature of recent broker reports has barely been noticed by the wider public'¦ brokers are rapidly upgrading their projections for 2012.

What’s changed? A better atmosphere in the US, a softer-than-expected landing in China, an Australian corporate results season that passed without negative shocks all combine to a tentative confidence in the broking community that has yet to translate to price action '¦ but it may do very soon.

The graph above fully illustrates the wrenching ride taken by Australian equity investors over the past five years. But key brokers believe the worm has turned and with it the outlook for the ASX index. Macquarie Private Wealth’s head of research, Riccardo Briganti, says the problems in all three regions: the US, China and the EU are more deeply understood now.

“What’s different in 2012 is that we can remove two of those big fears – the US and China – from the equation,” he says, because Chinese growth is up and strengthening US economic data is encouraging consumers, and consequently investors.

“But that still leaves Europe, and the European issues are not resolved. The difference is that whereas before the European Central Bank (ECB) was happy to stay out of the debate, it is now part of the solution.”

The latest deal struck (on February 21) between Greece, the ECB, the IMF and the country’s public and private creditors to stave off default is an example of this new atmosphere in the markets.

As a result, the Australian market is set to benefit from an improvement in risk tolerance, Briganti says, though he is quick to point out that this does not mean an end to volatility in the markets.

Deutsche Bank strategist Tim Baker says in a recent note that Australian company earnings grew last year but the index failed to follow, meaning price/earnings (P/E) multiples have fallen sharply over the past two years.

We are now more than halfway through results and the broad consensus for earnings per share growth is expected to be strong for cyclical stocks, particularly for domestic- and market-focused companies, such as Challenger, AMP and Perpetual, but overall the view is for moderate, single-digit increases.

“Markets have tended to perform very well in the year following a sizeable de-rating,” he says, adding that in the year after nine similar periods in the past, markets have risen by an average of 7%.

Both Goldman Sachs and UBS say the ASX 200 P/E of 11.5 is cheap compared to the 10-year average P/E of 14.3. Goldman said in a note that the sharply better macro-economic changes means that it’s now expecting much better price to earnings ratios over the coming 12 months.

Although overall earnings growth is expected not to be as high as last year, the mere fact that the market hasn’t caught up with the past two years of growth should push it higher.

Goldman thinks there is, “considerable upside for equity markets if P/E multiples revert faster than our current expectations; for example, a prospective P/E multiple of 13 times by December 2012 would generate a target of 4880.”

Some of the upgrades have been significant and the most recent have been Deutsche Bank, which is predicting the ASX 200 to hit 4700 by the end of the year; and Goldman Sachs, which lifted its forecast from 4400 to 4500.

They join Macquarie, Citibank, AMP and UBS, which are also predicting year-end targets of 4560, 4750, 4800, and 4956 respectively. At worst that’s a 6.26% gain from the close on Tuesday and at best a 15.49% gain – and that’s on top of the 5% the market has grown since the start of the year.

So, in light of Eureka Report’s critical reviews of banks and iron ore miners in the past few weeks, let’s look at the potential stock hotspots for 2012: It’s an eclectic range of cyclicals, industrials, energy, financials, banks and A-REITs.

UBS’s head of investment strategy, George Boubouras, says while a portfolio of income stocks such as Telstra (TLS), Tabcorp (TAB), Duet (DUE) and Spark Infrastructure (SKI), or of fixed rate bonds, outperformed the market last year, that was the defensive 2011 story.

“In 2012 they’re still going to deliver your dividend-plus strategy before franking or growth, but we take the view that this is a year to take a look at cyclical exposures,” he says.

“The underperformers of 2011 should start ranking higher in 2012. We know that BHP, Rio and Woodside were unforgivingly negative last year and they were large detractors to the overall performance of index, so we’re looking for them not to do that in 2012, and by year-end to have that recovery.”

China’s release of its choke-hold on liquidity will be good for resources stocks as the central bank, the People’s Bank of China, said yesterday (February 21) that it will cut banks’ reserve cash holdings by 0.5% by Friday and thereby release about 400 billion yuan into the economy. Lower unemployment figures and better manufacturing data in the US will benefit for the US-aligned industrials.

Boubouras says stocks with global earnings are also on his radar, such as Brambles (BXB) and News Corp (NWS); and in the latest UBS investment note he picks Asciano (AIO), casino-operator Echo Entertainment (EGP), Incitec Pivot (IPL), WA-based mining services company NRW Holdings (NHW) and Rio Tinto (RIO).

Macquarie’s Briganti says although equities tend to perform well in this kind of environment, not all sectors are going to benefit to the same extent because the twin pressures of the strong Australian dollar and relatively high interest rates will keep consumers here on the sidelines for a little longer.

“When we look at the sectors where our outlook is beneficial for those sectors, it is the energy and materials sectors and probably telecommunications because it’s the last of the defensive sectors, and property trusts would be another one: they’ve regained their status as being defensive,” he says.

Consumer staples would normally be in the mix, but the price war between Woolworths (WOW) and Wesfarmers (WES) is cutting into their defensiveness. Coca-Cola Amatil (CCL), is one company in the consumer staple sector that Briganti expects to do well this year.

And in an opposite view to Michael Feller (click here), Briganti’s outlook for the banks is actually improving, as the biggest problem for them is wholesale funding costs.

“If they can better control that funding side then they retain part of their defensive attributes as well. To some extent the improvements in Europe help that, and the delinking of mortgage rates from the reserve banks also helps that to some extent.”

Indeed, there is scepticism that funding is such an issue after Societe Generale Asia’s head of interest rate strategy, Christian Carillo, said there’s no evidence that Australian banks are paying higher sums for their funding and it actually suggests that they’re paying less than they were six months ago (click here).

Citibank strategist Tony Brennan says earnings of industrial stocks may disappoint investors but slightly higher commodities prices and higher volumes will support resources stocks, while banks will probably grow a little. Industrial stocks such as Amcor (AMC) and Ansell (ANN) are on the money thanks to their US dollar revenue.

The brokers think it’s a year to dip your toes back into equities, but the “new normal” of volatile markets and nervous investors means that instead of simply dumping those huge cash holdings into the top miners or industrial stocks, you’re going to have to get a little more selective.

-How they've performed
Company ASX
Price 21/02
high ($)
low ($)
Amcor AMC
Ansell ANN
Brambles BXB
News Corp NWS
Asciano AIO
Echo Entertainment EGP
Incitec Pivot IPL
NRW Holdings NWH
Coca-Cola Amatil CCL
Rio Tinto RIO

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