Just holes

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It may have passed Craig James by, but a few brokers are starting to wake up to the obvious. That the Australian economy is being permanently altered by the mining boom and the impact of China. It will inevitably bias the stock market towards resources. No houses, just holes. A report by Southern Cross arrives at this rather self evident conclusion. As the chorus gets louder it raises an interesting investment question. If the conventional wisdom is to price in a two speed economy, is it time to bet against the conventional wisdom? Pick stocks that are being downgraded too far because they are in the wrong half of the two speed economy? It will require some care, but may turn out to be fruitful.

The Southern Cross report “discovers” the effect of the mining boom on the share market.

Why do I sense a period of wildly divergent stock performance starting?? Because what is good for raw materials producers and our record terms of trade on the flipside is actually negative for the vast bulk of the Australian industrial economy. We have written in these notes numerous times about the “one speed economy”, but I think we are actually in a “two speed economy”, with resources and those who service them moving forward, and now just about everyone else moving backwards or sideways.

The Australian industrial economy is simply not set up to handle a 105usc Australian Dollar. The AUD is causing genuine imbalances in an economy that is based off an average AUD cross rate of 75usc for the last two decades. There are entire business models that simply don’t work at 105usc, yet if I am right on the AUD we will see 110usc and perhaps even 120usc over the next few years. In my view we need to all get our heads around an AUD above parity for the foreseeable future and that has major ramifications for stock selection, particularly given most Australian companies gave up any form of currency hedging years ago.

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Yep. The mining boom is a double edged sword. Southern Cross has buys on Kagara and Fortescue. Looking for growth stocks in the mining sector is one way of playing the two speed economy. Big stocks like BHP and Rio are more likely to have the boom priced in, although Rio’s low forward earnings multiple suggests the stock probably still represents value. More interesting is its buy recommendation on AMP.

Market growth. Currently the Australian, New Zealand and global equity markets are up 3% to 5% since the start of the year, with around half of AUM in equities this will help to drive near-term growth. Further, we believe growth in equity markets will continue;

• We anticipate more normalised net-flows to return over the medium to long-term as discretionary personal and superannuation contributions improve; and

• The underlying fundamentals for individual insurance remain strong given Australia’s low level of cover in addition to the robust growth rates being experienced in the industry.

AMP does give exposure to the share market, which is by implication exposure to resources. That means it provides some downside protection on the right side of the two speed economy. And it has a dominant market share, so, although it will track the fate of the wrong side of the two speed economy to some extent, it does benefit from the super fund flows, and may be able to increase its market dominance if its competitors start to struggle. The main concern is the wider future of insurance and reinsurance, especially if global warming unfolds as predicted. Southern Cross has a 12 month target price of $6.80.

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Southern Cross – AMP