Key points:
- It may only be a matter of time before the Aussie dollar/US dollar cross rate re-correlates to GFC levels of around 68 US cents.
- Lower interest rates mean investors will look for growth from the equity market and it is not the time to take profits.
- Instead increase exposure to key dividend yield/dividend growth and US dollar earnings. ASX, Perpetual and IOOF are all added to the high-conviction list.
The Aussie dollar
Below is a chart of the Aussie dollar/US dollar cross rate (green), the Reserve Bank (RBA) cash rate (purple) and the Baltic Dry Index (white) over the last decade. Mind the gap.
[1]Both the Baltic Dry Index and RBA cash rate are below levels seen at the peak of the GFC. I now believe it’s only a matter of time before the Aussie dollar/US dollar cross rate re-correlates to GFC levels.
On that basis, this week I am DOWNGRADING my medium-term Aussie dollar/US dollar price target from 75 US cents to
68 US cents
Interest rates
Last week the RBA joined the global currency war. This is a very important development that requires a medium-term forecasting reaction.
We have now become the latest country to adopt competitive currency devaluation as a monetary tool. Welcome to the global currency wars.
Make no mistake, this was a big decision for the RBA. To suddenly change tack with the cash rate already below GFC crisis levels, and abandon “a period of stability” in favour of a new aggressive easing policy is a monetary event, which should not be taken lightly. Clearly, it surprised many economists and some institutional investors. However, against a global backdrop of deflationary forces and competitive currency devaluations, I think there is a very real possibility of the cash rate with a “1” handle at some stage over the next 12-18 months. I know that prospect is hard to imagine. But instead of asking “why?”, ask yourself “why not?”
As the “the once in a century” windfall from the mining boom becomes a distant memory, it doesn’t require a huge leap of faith to envisage our economy experiencing the same anaemic growth as the rest of the Western block in the aftermath of the GFC. As such, it is absolutely critical for the RBA to target a lower cash rate and a lower Aussie dollar. Unfortunately for savers and retirees, that means an extended period of very low (or even lower) cash rates and fixed interest returns.
ASX/S&P 200 target upgrade
The ramifications of the RBA’s clear policy shift are multi-faceted and cross-asset class. To my way of forecasting, this now ensures that the Australian dollar trades in a lower trading range, Australian fixed interest yields move into a lower trading range, Australian commercial property cap rates move into a lower trading range, Australian equity dividend yields move into a lower trading range, and inversely the ASX200 moves into a higher trading range and Australian residential/commercial property moves into a higher trading range. The playbook on all this is the USA three years ago.
Outside of downgrading my medium-term Aussie dollar/US dollar forecast today, I am also upgrading my forecast for median residential property price gains to 10% from 5% in 2015 and upgrading my ASX200 trading range forecast to from 5000 – 5550 to
5550 – 6000
It also means dips in equity dividend yield stocks and US dollar earners will be bought by the SMSF army who are being squeezed out of cash as an asset class with negative real returns.
DO NOT TAKE PROFITS
In recent days I have had many questions from advisors and investors about “profit taking” in dividend yield and US dollar earning stocks that have performed well in 2015 so far. My answer to those questions is DO NOT TAKE PROFITS.
The investing world has not yet adjusted to what I write above and I think there’s a very real chance we are all underestimating the amount of money that will attempt to move down a narrow street.
My advice is to use any trading dips or ex-dividend dips to INCREASE EXPOSURE to key dividend yield/dividend growth and US dollar earning ideas. Where these stocks have come from is not the issue: it is where they are going that matters.
You will read report after report from the so-called experts about how “expensive” these names have become. But “expensive” versus what? History? Their valuation model?
I must remind all readers that P/Es, and dividend yields for that matter, can be ANYTHING. If demand for the attribute outstrips supply, then the P/E can be ANYTHING. History is NOT a guide to future market valuations.
My theory remains that if the Australian bond market and fixed interest curves are proved right with their medium-term implied forecasts, then we are all underestimating the P/E that will be paid by investors for stocks with the right attributes for the times. That is why I am recommending NOT TAKING PROFITS in key dividend yield/dividend growth and US dollar earning equities. Any pullbacks will be shallow and it will prove too cute for most investors to attempt to trade short-term volatility in this theme.
Today I am going to reiterate my strongest sector and stock selections based on an extended period of ultra-low Australian interest rates and taking into account my new lower Aussie dollar/US dollar forecast/higher ASX200 forecast. I have made a couple of additions to this list, which are bolded. In next week’s note, I will have a bottom up look at one or two of our key ideas after they have reported first half earnings this week.
High-conviction list
Major banks
ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC)
Regional banks
Bank of Queensland (BOQ)
Non-bank dividend growth
AMP (AMP), APA Group (APA), ASX (ASX), Challenger (CGF), Goodman Group (GMG), GPT (GPT), IAG (IAG), IOOF (IFL), Medibank Private (MPL), Perpetual (PPT), Transurban (TCL), Suncorp (SUN), Tabcorp (TAH), Telstra (TLS) Wesfarmers (WES) and Spark New Zealand (SPK)
US dollar leverage
Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Mesoblast (MSB), Treasury Wine Estates (TWE), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). In the banks, ANZ (ANZ) generates the greatest proportion of US dollar earnings.
Inbound tourism
Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Qantas (QAN), Air New Zealand (AIR.NZ), Village Roadshow (VRL), Ardent Leisure Group (AAD) and Sealink Travel Group (SLK). For the highly risk-tolerant, Virgin Australia (VAH) is arguably worth a punt.
Developers
Lend Lease (LLC), Mirvac Group (MGR), Stockland Group (SGP) and at the small cap end AV Jennings (AVJ).
Home improvement/renovations
Harvey Norman (HVN), Brickworks (BKW), GWA (GWA) and Boral (BLD)
Media
REA Group (REA) and Fairfax (FXJ)
Tactical trade: discretionary retailers
JB Hi-Fi (JBH), Super Retail Group (SUL), RCG Corporation (RCG), Automotive Holdings (AHE)
With my new 68 US cents Aussie dollar/US dollar price target, I also reiterate my long-held view that Australian investors need to “lose the home bias” and increase asset allocation to proven, unhedged, Australian-based, offshore fund managers. On that basis, I am sitting down with one of Australia’s best in that field this afternoon and will have more to say on this in the weeks ahead.
Go Australia, Charlie
Important: 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. Consider the appropriateness of the information in regards to your circumstances.