Earnings – Looking for Growth in 2012 ?
At the time of writing this report the month of November saw the ASX 200 drop 200pts or - 4.7%. The rollercoaster between black and red continues however we have been using the red to buy quality at compelling yields of 7% plus 3.5% franking credits in all of the big 4 banks. Whilst the European crisis is being played out we have seen that buying around the low 4100 point level has rewarded long term investors. We have seen on at least four occasions in the last 5 months the ASX 200 continuing to find support base around the 4100 level. So whilst we may be looking for growth we have focused on what income we can earn from investments.
How will a European recession affect Australia?
The European debt crisis threatens Australia’s outlook in three ways. First, it can crush confidence, second it may undermine the ability of the banking system to fund growth in the Australian economy, especially resource projects. And third, it could indirectly affect the economy if Asian exports to Europe collapse as a result of plunging demand.
The direct impact is marginal as shown in the following graph, with just over 4% of Australian exports going to the Eurozone and less than 1% to the PIIGS (Portugal, Ireland, Italy, Greece and Spain). As such, according to Morgan Stanley, their research says that Eurozone policy has no direct bearing on Australian policy, however with global economic weakness should encourage the Reserve Bank to deliver further rate cuts. We recently had an economic briefing with Mr Bill Evans Chief Economist of Westpac and he felt that another 3 interest rate cuts of 25 basis points each (0.75%) should be made by the RBA over the next 6 months.
Figure 1: The Eurozone Takes Just 4% of Australian
Exports
Source: ABS, MSSB Research
Despite the negative there are some Positives…….
Cash coming into our Market
Despite slower global growth, Morgan Stanley Smith Barney (MSSB) argues that Australia’s GDP is highly likely to accelerate in 2012. This is because last year we were affected by Queensland floods and Cyclone Yasi which adversely impacted coal production, agricultural production and tourism all being adversely affected, whilst higher food prices squeezed consumer spending. As such, MSSB research predicts the Australian economy to accelerate from 1.9% to 3.25% for the full year, other things being equal, and real GDP growth contributes to profit growth for solid companies. Another point that MSSB makes in the same report is that US money market mutual funds are increasing exposure to Australian banks at the expense of European banks.
On 1st July 2012, employers will increase compulsory superannuation to their employees from 9% to 12% which ultimately means a huge influx of cash will have to find its way into the Australian share market, especially when the “employment rate” is sitting around 94%. However, this may affect wages growth over the next 12 months which ultimately affects consumer spending, but if further interest rate cuts occur as suggested above this may provide some relief to the consumer, the householder and the retail sector.
In the month of December there is a significant amount of capital being paid to stock market participants in the form of dividends and cash takeovers. It is estimated that nearly $16 bn has the potential of flowing back into the market from ANZ’s dividend ($1.4b payable), NAB’s dividend ($1.36bn payable) WBC’s dividend ($2bn payable) and the takeover of Macarthur Coal ($4.8bn) and Foster’s ($6.3bn).
Interest rate cuts
All eyes will be on the RBA and their monetary policy as they have a long way to catch up if we look at how recently the trading for Commonwealth Government bonds have been sold down. (A coupon rate of 4.75% and maturity date of 15th Nov 2012 and the yield is 3.28%). This illustrates a “flight to safety” as investors and institutions invest in fixed interest in volatile times however these rates are considerably less than the current RBA cash rate of 4.5%. Bell Potter’s research agrees with Mr Bill Evans suggesting that this is a sign that further rate cuts should occur in the short term.
A Lower Australian Dollar
The Aussie Dollar has retreated over the last quarter, easing a headwind that has adversely impacted the profits of Australian multinationals and exporters alike. So if the Aussie dollar retreats and stabilizes beneath parity to the US dollar, it should be positive for the Australian economy and Australian equities.
To conclude, in tough times the words of a great contrarian investor Sir John Templeton said “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell”. So as we look to see whether our market closes above 4300 points for the 5th time this year, we watch with interest to see how the European crisis unfolds and any uncertainty can be seen as an opportunity to invest in solid businesses paying healthy dividends with sustainable business models.
Good investing
Kirk Jarrott
