Stock buys for the new financial year

Chief Investment Officer and founder of Aitken Investment Management
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The 2012 financial year was a complete annus horribilis in terms of the Australian equity market, a year that is best forgotten. Let’s all hope FY2013 is brighter.

I have been thinking recently that we have reached the point where anyone who doesn’t want to own equities has already sold and moved on. Private investors have dumped equities in favour of the ‘safety’ of bonds (at all time high prices), pension funds have allocated in favour of fixed interest over equities, hedge funds are short equities and long fixed interest and central banks are massively long fixed interest and have no equity holdings.

Bond yields have bottomed

All roads have led to bonds and that is why they remain the mother of all bubbles, with yields artificially held down by the coordinated actions of central banks. Those still holding equities claim to be ‘defensively’ positioned, parked in the perceived safety of defensives (at record high premiums to cyclicals).

My view is that Australian 10 year Government bond yields bottomed for our lifetime at 2.70% in early June. Yields have risen recently and I see further yield increases coming, with a near-term technical target of 3.65%. Australian Government Bonds will prove to be ‘return-free risk’ over the medium-term.

It seems Australian large cap financials, particularly banks and general insurers, have an inverse correlation to domestic long bond prices. In fact, early this week it looked like asset allocation money was rotating from government bond yield to financial equity dividend yield – and Telstra (TLS). ANZ, AMP, NAB, WBC, SUN and TLS remain in my high conviction buy list. All performed well yesterday as domestic bond yields rose. I expect this to continue into the full-year dividend season.

Metals and Mining

Meanwhile, I may well be proved too simplistic, but I continue to believe the Australian Metals & Mining sector (XMM) is going to play performance catch up to the world’s commodity and risk sentiment barometer – the Australian Dollar. I believe many of the world’s biggest global macro hedge funds are short the Australian dollar and XMM, a nasty combination as beta rallies. It also seems domestic investors are underweight metals and mining, while private clients have given up on miners.

If the correlation between the Aussie and XMM holds firm, there is around another 10% move higher in Australian metals and mining stocks just to play catch up to the Aussie dollar move. I am firmly of the belief this correlation will hold, which is why I continue to beat the buy drum on BHP Billiton (BHP) and Fortescue (FMG). Remember, currencies lead and equities follow in this macro driven correlation world.

Fortescue (FMG) – Buy

I personally think Fortescue is going to rip the shorters to shreds this quarter.

Andrew Forrest bought 28 million shares last week and it seems most came from fresh shorters (investors who are essentially betting on making money from a price decline). Long-only money didn’t sell to him and the majority of his buying was left unsatisfied. The CEO of New Power also bought Fortescue shares personally in the last quarter.

Industry sources suggest Fortescue shipped close to 6.5 million tonnes (mt) in May based off railed volumes of near 6mt. If proved correct, that means Fortescue shipped at an annualised rate of 78mt in May and railed at an annualised rate of 72mt. The industry rumour is those run rates have been maintained in June with the new ship-loader commissioned.

My view is the June quarter production report will lead to consensus upgrades for this stock as NOBODY is using those annualised rates of Fortescue production.

I also believe there is a growing likelihood of a 2012 financial year earnings and DIVIDEND surprise at the full-year result in August.

But our view on Fortescue has always been based on FY2013 and beyond. We forecast 53% earnings per share (EPS) growth and a prospective 7% dividend yield, all for a price to earnings ratio of 5.4-times and EV/EBITDA of 3.7-times.

Fortescue should lead a risk rally. That’s all I know, with Andrew tightening an already tight register even further. Fortescue remains a high conviction buy with a $7.50 price target.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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