Brokers have caught on. They must be reading MacroBusines. Much of the Australian economy is not in good health, Dutch disease is fast becoming Australian disease, and earnings forecasts in many sectors may be pretty dodgy. As more bearish sentiment starts to grip the market, the question it raises is: is it time to buy on bad news? Probably not. But it is always worth remembering that the best bargains occur when the market thinks that things look bad. And that sentiment is getting stronger. The case for diversifying offshore is looking stronger with the $A high. For the same reason that Australia should establish a sovereign wealth fund, to hedge against the mining boom skewing the entire economy, so investors should think about diversification internationally. There is also another looming question. Should investors just assume that Dutch Disease is semi-permanent, and concentrate on picking value in mining, food and, especially, energy?
Macquarie has a report out that expresses the mood:
The Australian economy has entered an extended period of stress where the ongoing resources boom is crowding out much of the rest.
- The resulting strong AUD and higher interest rates, together with government policies, which are squeezing the consumer via higher taxes and costs have put substantial downside pressure on industrials earnings. FY11 will see this grouping record negative EPSg for the fourth year in a row, in other words they have missed the cycle entirely.
- Further substantial earnings downgrades, especially for FY12 beckon as EBITDA margins are continuing to erode. We have this month removed the final domestic cyclical from the portfolio in JBH as that stock is now coming to the end of its buy back period.
The emphasis is going on to defensive stocks:
The ongoing domestic Australian exposures are limited to defensive stocks with earnings certainty a major input.
- With this in mind, we have added RHC, Australia’s largest private hospital operator, which is generating very strong (15% to 20%) EPSg rates. The stock has recorded consistently strong top line growth over many years with an ROE hovering in the mid teens. Useful starts have been made to building similar exposures in the UK and France.
- The portfolio remains heavily overweight cyclical exposures to the global economic recovery.
- Resources, resource services and international manufacturing are all over- represented. This month we have added further to this bias via the addition of MIN, an emerging resource services and iron ore producing company in an extremely strong earnings growth phase with EPSg forecast at 85% in FY11 and 33% in FY12. The company has shown a consistent ability to deliver new projects on time and on budget. The balance sheet is net cash whilst the ROE is over 25% and accelerating to the upside. The valuation is still only modest with prospective PERs at a discount to the market.
Southern Cross is predicting that a lot of the earnings forecasts are looking dubious and has this to say:
I always think the rotation to defensives is the final movement before a broader correction starts. Remember, the only true defensive is cash.”
Very true. Southern Cross is uusally pretty bullish, but it is getting worried:
Let me make one thing VERY clear; I place zero faith in any company guidance for FY12. Interestingly, it seems some people are putting faith in “FY11 guidance being maintained” by certain companies, yet the debate should be FY12 not FY11 with only 1.5 months left to run in FY11.
One of the key reasons I changed our strategy to “take some profits, raise cash, reduce risk” 2 weeks ago was because I am uncertain what comes next economically. I think visibility in the year ahead is the lowest in quite some time, yet many companies carry on giving guidance about the year ahead. They must have a crystall ball that I don’t.”
UBS is making bearish observations about investors getting worried about earnings forecasts:
Conclusions – Demand Still The Key Uncertainty Our analysis suggests that weak demand has been the biggest problem for Australian corporates over the past 12 months and in the absence of a pick-up in key areas (e.g. retail spending, US housing, capital markets activity) it remains the key risk to monitor. The currency has also dragged on earnings but apart from domestic steel stocks it does not appear to represent significant problem for earnings, providing it does not move significantly higher. Cost pressures have been a relatively minor problem in terms of driving industrial downgrades but wages developments bear watching. Our catch-all one-offs category also bears watching given the capacity of areas like mispriced contracts to hit more than once.”
The portfolio now has zero exposure to domestic steel, building materials, airline, logistics, media and discretionary retail. Value traps now abound in these sectors. We have also trimmed the exposure to the consumer staple stock WOW, which should feel some headwinds from further interest rate rises.”