Via the excellent Damien Boey at Credit Suisse:
1. We have a modest ASX 200 target of 7000. At an aggregate level, income, rather than capital growth will likely be the driver of returns.
2. We see earnings recovery, but multiple compression. IBES Consensus numbers point to roughly 6% earnings per share (EPS) growth over the next year, with the market currently trading on a forward price-to-earnings (PE) multiple of 17.3x. We think that the earnings growth forecast is quite easily achievable on cyclical recovery in Australia and abroad. But we also think that the market is expensive, trading on a through-the-cycle multiple of 28x. At this level of valuation, equities are priced for 4% annualized returns over the next 10 years, and slightly negative returns over the next 5 years. In contrast, bonds are offering 1% annualized returns over the next 10 years, and 0.7% annualized returns over the next 5 years. On a 5-year horizon, the equity risk premium is effectively negative, consistent with upcoming multiple compression.
3. We are quite comfortable with 2020 earnings recovery. Our market (real) EPS model, based on credit growth, commodity prices and currency, points to above Consensus growth in 2020. We note that every 1% acceleration in system (private and public sector) credit growth historically adds almost 5% to real EPS, with inflation on top. Also, every 10% increase in AUD-denominated commodity prices adds roughly 7% to real EPS, also with inflation on top. Leading indicators tell us that both Australian credit growth, and world industrial production (IP) growth are likely to accelerate in the year ahead, supporting real EPS recovery. And the rebound in Australia could potentially be quite sharp, given the very low (and arguably negative) starting point of growth in absolute terms, and relative to the rest of the world.
On domestic credit growth, we note that recently, house prices have been rising strongly, and loan approvals have started to rise. But credit growth has slowed, because foreigners rather than locals have been driving house prices higher, and locals have been in de-leveraging mode. Also, developers have not responded to the positive signal in rising house prices. These dynamics could very easily turn around, given the easiness of credit conditions. But the risk factor is that global liquidity dries up sooner than locals can take the baton of growth from foreigners.
On world IP growth, we note that the US consumer has been remarkably resilient to recent uncertainty, and is now in the process of re-leveraging. Yet world IP growth has effectively slowed to 0% recently on trade war uncertainty. Should uncertainty peak, we would expect world IP to converge upwards to retail sales growth, as firms entertain re-stocking and re-investment in response to the robust final demand outlook. But how strong this recovery will be is debatable. Also, there risk factors to consider because uncertainty may rise again on US-China trade tensions, and financial market volatility could prove quite hard to contain going forward given negative risk premia.
4. We are not optimistic about 2021 growth prospects. There is no “real economy” based leading indicator that will give us a 2-year outlook on growth. The best approach to longer-term forecasting is to recognize that financial markets drive the real economy, and to forecast what might happen to financial markets. In this context, we worry about the passive investing bubble unravelling in illiquid conditions, with potentially non-linear and negative implications for the cycle. Specifically, we note that bonds are expensive, and alternatives to bonds are trading on negative risk premia to bonds across various horizons. Also, we think that volatility is far too low for the outlook, even accounting for the Fed put. Passive, and levered passive funds are likely to struggle on a 1-3 year outlook given these pre-conditions. And history tells us that passive performance is a very powerful coincident, if not leading indicator of the growth cycle, because asset prices influence credit conditions.
5. In terms of factor exposures, we are roughly 30% weight momentum, 30% weight on value, and 40% weight on quality. Momentum is slightly favouring defensives over cyclicals, and is capturing the risks of near-term undershooting in the EPS cycle. Value favours cyclicals, and captures 2020 recovery prospects. Quality favours stocks with bond-like properties, strong growth or strong profitability, and offers a powerful hedge against 2021 correction risks.
6. 20 longs, and 20 shorts for 2020. Within the ASX 100, top twenty long ideas include: MGR, BPT, SGP, A2M, CHC, JHX, ORG, NCM, GPT, DXS, LLC, DOW, AZJ, VCX, SCG, BSL, CSL, GMG, RMD and BHP. Top twenty short ideas include: TPM, CIM, CPU, CGF, LNK, IAG, SYD, BXB, SEK, QBE, CCL, DMP, BOQ, OSH, ANZ, CBA, SUN, QAN, ALX and MQG. At a high level, our model portfolio is overweight more cyclical A-REITs, some pure cyclicals, some high growth industrials, and selected resources stocks over crowded defensive names, and financials. Importantly, these long and short ideas are broadly consistent with Credit Suisse analyst ratings.
FYI. I disagree with most of this and expect Australian eranings to be flat at best and probably fall in 2020 as the bulk commosity correction continues on supply side recoveries and ongoing glide slope slowing in China.
That said, if there is no external shock, Australian equities will more likely rise than not on (less than elswhere) on multiple expansion despite weak earnings as the cash rate is cut to 25bps and the RBA launches QE.
Agree on 2021 though!
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.