Australia’s stock market to find fortune as ‘lucky country’ enters ‘lost decade’

Credit Suisse analysts tip 16.5 per cent rise in benchmark equities index

PUBLISHED : Tuesday, 08 December, 2015, 1:51pm
UPDATED : Tuesday, 08 December, 2015, 1:51pm

The ‘lucky country’, a popular residence and investment choice for Hongkongers and mainland Chinese, is not looking so fortunate these days.

Australia has entered a “lost decade” argues a new report by Credit Suisse analysts; a structural slowdown that’s spread from the mining industry, hit by a collapse in commodity prices, to the housing market. The benchmark ASX 200 equities index rose just 1 per cent last year and is down 5 per cent this year, with a weakening Australian dollar a major negative for overseas investors. And yet some economic retrenchment might paradoxically be good news for stocks, the same analysts suggest.

“Lost decades have often followed periods of excessive investment and Australia seems to have already started its own,” Credit Suisse analysts Hasan Tevfik and Damien Boey wrote. “With a subdued backdrop we believe the future direction of stock indices should largely depend on how companies respond to the current sustained period of weak growth. We anticipate that Australia Inc will continue to cut costs, conserve capital and consider (mergers and acquisitions) to generate returns for its shareholders.”

The future direction of stock indices should largely depend on how companies respond to the current sustained period of weak growth
Hasan Tevfik and Damien Boey, Credit Suisse

Targeting a 2016 year-end level of 6,000 points for the ASX 200 – a 16.5 per cent up side from Friday’s close – the two analysts also expect Australian firms to use cheap debt to finance share buybacks and are recommending long positions on miners Rio Tinto and BHP Billiton, blue-chip banks Westpac and Macquarie, and energy players including AGL Energy.

On the downside, the Swiss bank suggests shorting Melco Crown casino shareholder Crown Resorts given the struggling Macau economy, as well as retailer Woolworths for having “little strategic direction”, among others.

It’s an ambitious growth target for the ASX index and assumes a benign growth outlook that jars with recent economic data.

A 9.2 per cent plunge in third-quarter private capital expenditure was much worst than a 2.5 per cent consensus estimate and “the absence of any real signs of a transition from mining investment to non-mining investment is a big worry” wrote Paul Dales at research group Capital Economics.

Third-quarter household spending was up, as were exports, but Davies says central bank gross domestic product targets for next year are too ambitious. The poor data, however, increases the chance of an equities-friendly interest rate cut, with Capital Economics expecting rates to fall from 2 per cent to 1.5 per cent.

Credit Suisse bases its analysis in part on historical trading valuations. The market looked cheap on a free-cash-flow basis, “perhaps the most helpful valuation measure during low-inflation periods”, Tevfik and Boey wrote, while dividend yields for June 2016 would likely hit 5.1 per cent, more than double the yield on cash and government bonds, meaning more money would flow into stocks as investors chased returns in a low-growth economy.

The biggest risk to their projections, they wrote, would be a surprise increase in global inflation. “High-dividend-yielding markets like Australia look attractive when there is little inflation, but will undoubtedly struggle if inflation accelerates. We imagine such a scenario would result in higher risk-free rates and a much steeper tightening cycle by the (US Federal Reserve).”