The market correction that wasn’t

Equities have held up against expectations of a decline, but even if there is a pullback, several large-cap yield stocks remain attractive.

Over the last month or two, we’ve written about the likelihood of a pullback in global markets. The “sell in May and go away” seasonal phenomenon has worked every year for the past five, but this year it hasn’t eventuated as many had expected. 

It certainly wasn’t for a lack of headwinds. Domestically we’ve had the uncertainty ahead of the Federal Budget to grapple with, while offshore there have been the ongoing issues in the Ukraine, concerns over slowing growth in China and the sharp selloff in high momentum growth stocks. And to top it off, these headwinds occurred against a backdrop of fully valued equity markets.

We certainly weren’t alone in our thinking. In fact, most of the market was expecting some sort of pullback in equities. Now for the question everyone is asking: Is the pullback still coming or are we not going to see another one this year?

Speaking to other industry participants, everyone seems a little perplexed about what to do in the short-term. People are struggling for ideas.

On a medium to long-term basis, we continue to believe equities will benefit from major global economies maintaining low interest rates for longer as growth struggles. However, in our view the risk of a short-term pullback remains as valuations are stretched and local and global risks persist.

Against this backdrop, we believe discipline and patience will be rewarded. We continue to favour sustainable yield stocks as Australia’s relatively high dividend yield attracts global interest, especially with forecasts for the Australian dollar to fall over the medium-term. However, we would recommend adding on weakness rather than chasing prices higher at this point.

At Baillieu, our top picks among large-cap yield stocks include Commonwealth Bank of Australia (CBA), Westpac Banking Corp. (WBC), National Australia Bank (NAB), ANZ (ANZ), Macquarie Group (MQG) and ASX (ASX).

Perhaps one sector of the market that is beginning to represent long-term value is the mining sector.

Expectations have become quite bearish, as evidenced by the recent price weakness in iron ore and associated stocks. In fact, it looks like expectations have become too negative. For example, iron ore was last traded at US$99.00/t. If we valued Rio Tinto (RIO) and Fortescue Metals Group (FMG) using a US$80.00/t iron ore price we get $$65.00 and $5.00 per share respectively. These prices are roughly 10% higher than where these two stocks are currently trading.

This tells us that the market is currently pricing in an average iron ore price of below US$80/t. While the iron ore price is volatile and could spike lower, it’s highly unlikely it would average below US$80/t for the year.

Elsewhere, another example demonstrating the long-term value on offer in the sector was the recent takeover bid for mid-cap copper and gold miner PanAust (PNA), which was at a 45 per cent premium to the last traded price.

Given considerable concerns still remain, especially those focused on China, we prefer the larger cap names at this point in the cycle, especially the diversified miners Rio Tinto (RIO) and BHP Billiton (BHP).

Ben Potter is retail editor at Baillieu Holst