ASX in 2018: Running with the bulls or fleeing from the bears?


January 02, 2018 16:14:40

Having lagged the rest of the world markets in 2017, Australia’s investors and superannuants will be hoping for something far more upbeat in the next 12 months.

Key points:

  • Big broker forecasts range from the ASX gaining 8pc to dropping 3pc
  • Only healthcare and mining sectors enjoy widespread support as outperformers in 2018
  • Telcos and real estate trusts are the least preferred

But they are likely to be disappointed. Opinions vary across the big broking houses, but general feeling is the market should enjoy solid, but not spectacular gains.

At the bullish end of the spectrum sit Goldman Sachs and Macquarie, forecasting the ASX 200 will finish 2018 at 6,500, a gain of a bit more than 8 per cent from current levels — or 13 per cent if you throw in dividends.

Morgan Stanley maintains its position as “bear-in-residence” tipping a 3 per cent slide to 5,800.


ASX 200 forecast

(End of 2018)

Percentage change

(from 6,000 level)

Total shareholder return

(4.5pc dividend yield)

Macquarie 6,500 +8.3pc +12.8pc
Goldman Sachs 6,500 +8.3pc +12.8pc
Citi 6,400 +6.6pc +11.1pc
Bank of America Merrill Lynch 6,300 +5pc +9.5pc
JP Morgan 6,300 +5pc +9.5pc
UBS 6,200 +5pc +9.5pc
Morgan Stanley 5,800 -3.3pc +2.2pc

What happened in 2017

Up until October things were pretty bleak on the ASX. It had muddled its way into the red, when a sudden surge in commodity prices triggered a flood of buy orders in the resource stocks.

The so-called “Trump trade” — with its promise of tax cuts and infrastructure spending — also added to the appetite for risky assets.

The benefit of Australia’s big dividend payout combined with the ASX 200’s climb towards a decade high gave investors a double-digit total return.

However, compared to a 20 per cent gain across developed economy bourses, or more than 30 per cent in Asia, it looked pretty insipid.

Then again, the exponential trajectory of bitcoin values obliterates everything else over the year. And it doesn’t get much riskier than bitcoin.

With commodity price inflation looking like easing again and US tax cuts priced in, the question for investors is what is left in the tank to keep the momentum of the past few months going.

A view from the “bull ring”

For the bullish Macquarie team, 2018 will be a solid year for the ASX, but there is a caveat.

It could be a “bumpy road” with a “combustible combination” of modest earnings growth and not exactly cheap price-to-earnings (PE) multiples.

“We think Australia is in a sweet spot and similar to where the US market was 18-to-24 months ago,” Macquarie’s strategy team of Jason Todd, Justin Fabo and Phineas Glover told clients.

“That is, before the Fed began to raise policy rates, before there was any hint around rising wage costs and when the full benefits of a weaker currency were flowing through to corporate earnings.”

However, that sweet spot could dry up in time.

“We see greater risks for the market emerging in 2019 rather than over the coming 12 months,” Macquarie warned.

The big surprise in 2018, according to the Macquarie team, will be the ASX’s relative outperformance compared to Wall Street.

… meanwhile in the bear cave

Across the road at Morgan Stanley, the risks are already here and any sweet spot is more like a “honey trap” for unwary investors.

Morgan Stanley’s Chris Nichol and Daniel Blake see the ASX continuing to lag in the global equity stakes, weighed down by weak economic growth, lacklustre earnings growth and a weaker Australian dollar.

“Australia has lagged the global recovery, and we see this continuing in 2018 as a tightening credit cycle for housing and negative real income growth see consumer weakness overwhelm a pickup in capex,” the pair wrote.

It should be noted Morgan Stanley has the bleakest view of 2018 GDP growth in the market, coming in at 1.5 per cent — about half the consensus figure.

For Mr Nichol, the fourth quarter surge this year was nothing more than a catch-up rally to global and regional peers without much substance.

“Whilst the key sentiment index level of 6,000 was breached, we feel it has been far from conquered,” Mr Nichol said.

“Heavy lifting will be done by state-based fiscal spending and sequential strength in infrastructure, but the domestic earnings cycle is hamstrung by both slowing housing signals and fatigued consumers.”

As Minack Advisors founder Gerard Minack recently noted, the upshot of weak wage growth plus rising effective tax rates [via bracket creep] — versus declining effective tax rates through the boom — is that real household disposable income is flat-lining, while real per capita incomes are falling sharply.

And that is hardly a “buy” signal for the market.

Banks’ year of living uncomfortably

None of the big broking houses are very positive on the banks. At best they are neutral.

The consensus view is that earnings will grow at a fairly pedestrian 3 per cent, or a tad lower.

Morgan Stanley’s Chris Nichol said it is hard to get excited about the banks.

“Top line [revenue] looks weak as volume growth slows and the benefits of repricing and cost-out seem to get lost in the translation of higher regulatory and compliance costs, and potentially weaker credit quality,” he observed.

“Return on equity trends look weak and valuations increasingly supported by dividends [which in turn are] supported by high payout ratios.”

The big four have fixed up their capital buffers, so that is not so much a risk and, while the housing market is cooling, their mortgage-dominated balance sheets are still sound.

Global inflation has probably bottomed out, so they should benefit from rising interest rates.

A kick-up in the economy would help too, but if it goes the other way and unemployment starts rising the historically low bad debt rates the banks currently enjoy will be imperilled.

However, the biggest problem is political risk. The bank levy is in place and a royal commission is not far behind.

What they do have is an oligopoly and pretty much a large, captive customer base, so a neutral call is reasonable despite a very awkward year ahead.

Retail hit by weak spending and disruption

Many of the strictly economic issues pressing down on the banks also flow into the retail sector.

Wages are flat, disposable household income is falling and pessimism largely outweighed optimism in consumer-land, despite a reasonably positive final confidence reading for the year.

On top of that, there is a price war going on in the supermarket aisles and with the arrival of the Amazon “death-star” into the Australian retail orbit it is hard to be too chipper about the sector’s prospects.

Morgan Stanley’s Chris Nichol is blunt in his view.

“It’s crunch time. We expect the key Christmas selling period will fall short and ongoing weakness could ultimately drag down broader parts of the economy,” he said.

Macquarie has a more positive view on discretionary retail from a stock-picking perspective but is negative on consumer staples, such as the supermarkets.

“Technology, not Amazon, is the disrupter,” Macquarie noted.

It is a disruption that is accelerating and will only make things tougher, even for businesses working hard to catch up.

“Australia is in the early stages of a long, technology-driven disruption cycle that compresses pricing power and margins,” Macquarie said.

“The attack on bricks-and-mortar retail will continue, potentially dragging down areas deemed almost untouchable to date, such as hardware.

“It is too early to go back into this space. We recommend no retail or food staples.”

Will China’s Year of the Dog deliver for miners?

The miners did most of the heavy lifting on the ASX in 2017.

Earnings growth across the entire market came in at close 17 per cent. Take the miners out and it falls to under 4 per cent.

Citi’s Tony Brennan said resources will again need to have another solid year to hit his target for the ASX 200 winding up at 6,400.

“After moderating over recent months, possibly in anticipation of the winter production shutdowns across heavy industry in China, bulk prices, particularly for iron-ore, have bounced again lately, and could mean significantly higher resource earnings this year,” Mr Brennan said.

“With the resource sector close to a fifth of the market by size, a jump in earnings can contribute meaningfully to market earnings growth and, though the resource sector is already expected to be a major source of earnings growth, it could add more.”

Morgan Stanley’s Chris Nichol said stabilising prices and the benefits of years of cost cutting should deliver strong cash flows.

“The near term offers some outsize potential for the receipt of strong free-cash-flows in our view, while the sector’s lack of discipline is still too recent a bad memory to re-emerge as a risk to such returns,” Mr Nichol said.

Macquarie argues the risks in mining are evenly balanced, despite valuations not being stretched.

“The risk for the commodity stocks is that we begin to see lower spot prices translate into earnings downgrades,” Macquarie said.

“We think this could happen sometime later into 2018 but at this stage think there is enough macro [growth sentiment] and micro [cash flow] tailwinds to support performance.”

One thing most brokers agree on is the demand for minerals associated with the growth in renewable energy and electric cars still has legs well into 2018.

Gold may regain some lustre

Gold has bounced around over the year, but not really gone that far.

The last past couple of months have taken off much of the glitter of gains earlier in the year.

“The most recent weakness was not just seasonal, but also driven at least partially by a continued rally in equities, the Fed rate hike, and weaker than normal physical demand in key regions like India,” RBC’s commodity team wrote in an end of year note to clients.

RBC has pencilled in an average price of $US1,303 per ounce for 2018, which is only $US50 an ounce up on the realised average in 2017.

That is still higher than the consensus view, with RBC seeing supply as stable but demand picking up for jewellery, as well as bars and coins.

Oil and gas remain volatile

Trying to forecast oil and gas prices is a fraught process.

The deal between OPEC producers and Russia to limit production is holding and keeps being extended and has supported the price for most of the year.

Predicably, though, the higher prices have encouraged US oil producers to pump more, prompting the International Energy Agency (IEA) to forecast the global oil glut is now likely to be drained much later than earlier anticipated.

These forecasts bounce around, but the IEA argued non-OPEC supply will rise by 1.6 million barrels a day (mbd), overwhelming the expected 1.3 mbd increase in global demand.

The main reason the price didn’t slump on the IEA forecast was simultaneous news a key oil pipe in the North Sea had ruptured, keeping a lid on immediate production.

And therein lies the problem with second-guessing energy prices — so many market-moving surprises keep bubbling up.

Venezuela teeters closer to collapse, Iranian backed Houthis fire missiles at Saudi civilian targets, IS regroups in Libya, the US moves to impose trade sanctions on Iran again, OPEC and Russia could dissolve their deal — it seems risk lurks behind every barrel.

RBC’s Helima Croft — who keeps a keen eye on geopolitical ructions in the sector — said, overall, the oil price should edge up in 2018.

“Despite several premature price rallies over recent years, the drastically improved fundamental backdrop makes the recent recovery more sustainable than the previous myriad of stutter steps,” Ms Croft said.

However she cautioned, “Subtle shifts in sentiment can have an outsized impact on price.”

“The lesson learned over recent years is that the herd mentality is strong and tourist traders cycling in and out of positions can make for violent swings even if prices are largely embedded in a $US50-to-65 a barrel range.”

LNG producers have benefited from not only stronger oil-linked price rises, but greater demand from China.

The push for cleaner energy (and skies) has driven Chinese LNG demand up almost 50 per cent this year.

The clamp-down on burning coal during the so-called “heating season” over winter can be seen in the recent spike in spot LNG prices into north Asia over recent months.

While the consensus view is the LNG market is facing oversupply well into 2022, Deutsche Bank’s respected energy analyst John Hirjee noted recent events pointed to 2018 pivoting from a buyers’ to a sellers’ market.

If that is the case, then local LNG exporters could see a significant upgrading of their immediate prospects.

Industrials to join global growth race?

The industrial sector on the ASX is a fairly broad church but they have one in thing in common — the need for an uptick in both domestic and global economies.

Citi’s Tony Brennan argues both global and domestic conditions seem to be progressively more supportive for the market.

“The strengthening in the global economy is now widely recognised, in particular its breadth both by country and industry, and though growth at or above trend seems to have been occurring for 18 months, still low inflation and interest rates should extend it,” Mr Brennan said.

“Improvement has been more gradual in Australia but nonetheless seems genuine, with those predicting an inevitable downturn so far disappointed again, and this should support domestic company earnings, along with very low labour cost rises.”

The bullish Macquarie has pencilled industrials as one of its key overweight calls of the year.

Macquarie’s argued recovering infrastructure and capex programs locally have a feeling of longevity about them, while a broader global pickup in industrial activity will help.

Morgan Stanley agrees the building materials and construction businesses should be among the stronger performers over the year.

A weaker dollar would also be handy for offshore earners as well, which would give the sector a substantial lift, given around 20 per cent of ASX 200 companies are leveraged to a depreciation.

Bank of America Merrill Lynch head of research Sameer Chopra points to technological disruption coming to the aid of the industrial sector with digitisation offsetting cost inflation.

“Around 20 per cent of companies in the ASX 100 are in the early/mid-stages of their targeted cost out programmes,” Mr Chopra said.

“But there may be benefits leakage, as 25 per cent of companies providing updates since September have highlighted inflationary pressures, particularly wages and electricity.”

‘Defensives’ are cheaper but are they ‘value’?

Many of the big dividend paying stocks — the real estate investment trusts, or REITs, and telcos — were a significant drag on the ASX in 2017.

On Macquarie’s analysis, “REIT’s have gone from a 17 per cent premium to now trade back in line with the broader market while telco’s — despite being caught up in a structural earnings slowdown — are back to where they traded during the GFC.”

But by becoming cheaper are they good value? Not necessarily according to Macquarie’s strategy team.

“The ‘cheap’ end of the equity market is under pressure from cyclical and structural growth risks as well as political meddling,” Macquarie noted.

“This is classic value trap territory without a sustainable growth rebound.”

Broker sentiment

If there is any consensus to be found among the brokers it is to avoid telcos and real estate trusts, especially those geared to retail.

As for where to put your money, it is a lottery with perhaps healthcare and mining being less negative than most.

Of course this is not financial advice, merely an observation.

To quote the world’s most famous investor, Warren Buffet, “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

Sector Bank of America Merrill Lynch Morgan Stanley Macquarie
Banks Neutral Negative Neutral
Energy Negative Positive Positive
Healthcare Neutral Positive Positive
Industrials Positive Negative Positive
Infrastructure/utilities Neutral Negative Negative
Insurance Positive Positive Negative
Mining Positive Neutral Neutral
REITs Negative Negative Negative
Retail (discretionary) Negative Positive Positive
Retail (staples) Positive Neutral Negative
Telcos Negative Negative Negative












First posted

January 02, 2018 07:00:00

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