PORTFOLIO POINT: Investors in the yield hunt will continue to focus on equities in 2013, but the focus could switch from banks into other sectors including resources, property trusts and industrials.
The festive season is a time for celebration, reflection, resolution and, after a little too much festivity, for all those simmering tensions to boil over and create one hell of an argument.
Within the investment banking and stockbroking fraternity, it has forever been thus. In the past, the barney has always been about where the opportunities lie and how far the market will rise.
This year, though, there seems to be a broad and rather uncharacteristic agreement about the future. The year ahead is shaping up as, if not a complete stinker, then certainly tough.
Perhaps it’s personal fear, delivered en-masse. In a market that is over-serviced and under-utilised, with enough excess capacity to handle at least twice the share trading volumes currently experienced and with virtually no takeover activity, little wonder an air of despondency has settled across those employed in the financial services sector.
For if things don’t pick up within the first half of 2013, the long-awaited shakeout within investment banking circles will begin in earnest.
Ever since the great 2008 meltdown, our stockbrokers and analysts have been calling the recovery – the emergence of the next great bull market. Initially it was to be V-shaped, and in 2009, as optimism overruled logic, it was difficult to argue the contrary. But the V gradually became a U, and has since turned into a W that, in Australia, is still 30% shy of its 2007 peak.
Just as they overcooked the enthusiasm in previous years, it is possible they have applied a little too much pessimism to the mix this time around.
While there has been general cause for celebration at the 13% rise in calendar 2012, it is hard to ignore the simple truth that for the past three years, our market has gone nowhere. It has bounced between 4,000 and 5,000, and fittingly has ended 2012 neatly perched between the two barriers. Although on a nice year-end rally, it has pushed to 17-month highs despite a relatively poor earnings performance.
Throughout this period, however, some investors have made good returns. It has required patience, diligence and a watchful eye on emerging trends, and 2013 promises much the same. The days when you could simply dive in and rise with the incoming tide are gone, at least for the foreseeable future.
The view from the satellite
Financial crises don’t last forever, and neither do resources booms. Australia, uniquely caught between these two diametrically opposing forces, has seen its economy violently stretched in ways that have been difficult to fathom and almost impossible to predict.
Both phases are in the early stages of receding. The boom will have a much longer-lasting effect on our economy as the new mines and expanded older operations deliver increased export earnings into the next decade.
But the crisis is having a much more immediate impact, primarily via a persistently strong Australian dollar that has brushed aside the naïve but once fashionable theory amongst economists that Australia had “decoupled” from America.
The first stage of the resources boom – the investment phase that has seen cash flooding the economy – is nearing an end. It will peak in 2013 at lower levels, and earlier than originally anticipated.
Ordinarily that should have seen the Australian dollar drop, especially in October when commodity prices hit the skids, paving the way for a smooth transition to greater reliance on non-mining industries. But as one of the few ‘AAA-rated’ economies and one that has interest rates north of zero, investment cash in search of a safe haven continues to prop up the currency.
That phenomenon is likely to continue into the New Year, particularly given Federal Reserve chairman Ben Bernanke’s determination to keep the smoke pouring out of those printing presses as he floods the globe with greenbacks.
That will create problems for the economy as the industrial and service sectors continue to groan under the oppressive weight of the currency. But it will also create opportunities for investors.
Where a once incredibly nimble Aussie dollar did all the heavy lifting – remember how it plunged to US60c in 2008 – the Reserve Bank now will be forced to pick up the slack, particularly if the federal government maintains its resolve to deliver a budget surplus. It is now almost certain that interest rates will be cut in the New Year, with some pundits predicting cash rates of 2.5% and even lower.
Right now, we have a situation where business is in a deep psychological funk, fretting about its ability to compete on the global stage as the dollar prices Australia out of the market. Consumers on the other hand, despite a negative reading a few weeks back, are considerably more chirpy. At some stage that will translate into higher consumption levels, particularly if rates fall further, improving revenue streams to business in a lower-cost environment.
For the past four years, a disproportionate amount of global capital has flocked to government bonds and treasuries, to the point where yields on US instruments have been negative in real terms. Many now believe a bubble is forming and that treasuries, rather than being a safe haven, could in fact be the opposite. It is likely then that cash will flow out of debt instruments and into equities during the coming year. The wildcard in that scenario is whether Europe can maintain its unity.
Another positive for 2013 is China. With the leadership change out of the way, and with the new Congress to be implemented in March, the world’s economic growth engine, which misfired terribly in 2012, should begin to hum a little more after Chinese New Year.
The view from the Jumbo
After a horror stretch in the latter half of 2012, resources are back in favour. The bounce-back in commodity prices has been a major factor, but that is only part of the story.
When iron ore prices plunged below US$90 a tonne in October, it forced a radical rethink among our resource houses, big and small.
A raft of major projects were shelved, cost-cutting regimes were implemented and asset sales were undertaken to cut debt and restore balance sheets. The mood suddenly shifted from expansion and investing for future growth to maximising immediate returns and delivering yield.
While iron ore and metallurgical coal prices are unlikely to return to the stratospheric levels of 2011, they have bounced back strongly in recent months. Iron ore has risen comfortably above US$120 a tonne and, with China now resuming growth, are likely to remain above that level.
Just months after the resources boom was read its last rites, most brokers are bullish on the miners.
But those shelved expansion plans will come at the expense of the contractors involved in providing mining services, particularly construction. It stands to reason that as expansion plans are shelved, and as in the investment boom peaks, the contractors will find their services less in demand.
The hunt for yield, the dominant factor in 2012, is likely to continue into the New Year as interest rates continue to fall. But it will become ever more elusive. The banks, which have been at the forefront in the past year, are likely to struggle to maintain momentum.
There is general agreement among local analysts that in a lower interest rate environment – and hence lower margins and a new attitude among Australians to save more and borrow less – our banks, while remaining hugely profitable, will not experience the growth of recent years.
That said, it would be an unwise investor to abandon the sector. Even if dividend momentum stalls or even falls, they remain among the highest-yielding stocks on the market and are worthy investments on any market dips.
For dividend growth prospects, Australian Real Estate Investment Trusts remain the pick. One of the few sectors to fund dividend growth with improved earnings, rather than through higher payout ratios, the sector has been given a little extra spice in recent weeks with the tantalising prospect of takeover activity.
Another theme among the broking fraternity for 2013 is the potential switch from defensives to cyclical industrial stocks, particularly those paying decent yields. These companies have the most to gain from a lower interest rate environment and the Reserve Bank clearly is mindful of generating earnings and employment growth in this sector to pick up the slack as mining investment slows.
That the growth in the Australian market has outpaced earnings is evidenced by the overall lift in the price earnings multiple. It began the year at 10.6 and ended at 13. As UBS analysts note however, that’s well below its 20-year average of 14.4. So there still is some room for growth.
The view from the crop duster
Banks out, miners in. At least that’s the view for now. Yet another negative review of the banking sector hit my desk this morning, this one by Credit Suisse. It raises a host of problems for the majors, including the prospect of higher bad debts, an over-reliance on mortgage lending, easing property prices, and dividend unsustainability due to higher payout ratios.
But choosing which is the best of the bunch is difficult. NAB is paying the highest yield but has the most problems, particularly with its UK business. On the dividend front, Macquarie deems NAB and Commonwealth to be “stretched to the limit”, while ANZ is in the weakest position. Westpac comes out in front on dividend sustainability. JP Morgan prefers NAB and ANZ, arguing the other two are overvalued.
Among the miners, the brokers are divided over whether BHP or Rio is the better buy. Both have offloaded assets in recent months. Both are engaged in cost control. Rio wins the nod from several broking houses for its plans to strip out more costs than BHP. But the ‘Big Australian’ has a more diversified portfolio, which many others prefer.
Fortescue is also in asset sale and debt reduction mode, with plans to sell a portion of its rail link. If it succeeds it will certainly alter the financial dynamics of the business, given it is more vulnerable to iron ore price falls, although the infrastructure is considered a money spinner. Mount Gibson also rates among many brokers.
Listed property trusts are back in the spotlight after GPT’s $3 billion offer to buy Australand’s office and industrial portfolio. The offer was rejected but GPT hasn’t given up and now Mirvac apparently is running the numbers. As a sector, it pays good dividends with earnings growth potential. Dexus, Investa and Cromwell all get a broker Guernsey.
Telstra may have blitzed the field in 2012, but in the telco department iinet is considered worth a look by Citi and RBS.
In a low interest rate environment, Citi analysts reckon small and mid-caps with decent yields are the go in the coming year. Flight Centre, salary packaging group McMillan Shakespeare and Myclic Express Offshore, which supplies support vessels to the offshore oil industry, are also rated as buys. Even Southern Cross Media is favourably considered.
No-one picked the trends for 2012 this time last year. And 2013 is likely to be a moveable feast as well. Let’s hope there’s enough in the oven for the main course.