In 2014, investors should see global economic growth picking up, but with a slightly different focus to recent years, in that the developed-world economies will be leading the way. The International Monetary Fund (IMF) expects global economic growth to rise to 3.6% in 2014, from 2.9% in 2013, and to move to 4% plus in 2015.
While China remains an important bulwark of this growth, the big stories for 2014 are likely to be the greater contribution to global growth coming from the US, and the strengthening of the US dollar. On a macro-economic level, investors are hoping to see synchronised global economic growth – across the US, China, Japan and Europe – for the first time since 2010. This is certainly possible, but Europe remains the weak link in the argument.
The middle kingdom
Taking China first, the world’s second-largest economy is expected to post a final growth figure for 2013 of 7.6%, which would exceed Beijing’s target of 7.5%, but would represent a decline from 7.7% in 2012. As at the third quarter of 2013, China looked to be on track to beat 2012’s performance, with growth running at an annual rate of 7.8%, as government investment in rail and subway construction, as well as tax and other business incentives, boosted growth. But the Chinese economy lost momentum in the fourth quarter, with manufacturing growth slowing in December for the first time in six months.
While no economic target has been announced for 2014, many economists predict Beijing will set a similar growth rate of 7.6%. That is a long way from the double-digit growth rates that were the norm until recently, but is, in fact, consistent with how Beijing wants to transform its economy from an investment- and export-driven economy to a western-style services- and consumption-driven economy.
The year of the greenback
The bigger story on the economic growth front is the US, which surged into 2014 with plenty of momentum. For the second half of 2013, the American economy grew at an annual rate of 4.1% – much stronger than the previous reading of 3.6% – as consumer spending and business investment strengthened. US manufacturing is recovering, US consumers and companies have repaired their balance sheets, and the cheap energy revolution brought by shale oil and gas could potentially boost the recovery even further. The US is the wildcard for 2014: its performance could boost the global economic growth rate significantly higher than the 3.6% the IMF expects.
The improving US economy was the major reason the US Federal Reserve was able to announce last month the beginning of the “tapering” of its bond-buying program, from $US85 billion a month to US$75 billion a month. Tapering is not tightening: under its new head, Janet Yellen, the Fed is still applying plenty of stimulus, until the US economic recovery gains further traction, and US interest rates remain at record lows. However, the gradual unwinding of the Fed’s stimulus program has clearly begun, ushering in the “year of the greenback.”
AUD vs USD
Source: Yahoo
Expectations of this recovery have well and truly taken the wind from the sails of the A$. From a high of US$1.05 in January, the A$ ended 2013 at 89.36 cents. This has major implications for the companies whose earnings are boosted by a falling A$. The prime beneficiaries are those companies that actually report their financial results in US$, including BHP Billiton, Rio Tinto, Fortescue Metals Group, QBE Insurance, CSL, Woodside Petroleum, 21st Century Fox, News Corporation, Oil Search, Brambles, Computershare, James Hardie and ResMed. A weaker A$ helps boost their earnings.
Companies with significant percentages of their revenue coming from overseas also benefiting from a lower A$. (In this context, it is not only the US$ that matters: last week, for example, the British pound hit a more than four-year high against the A$ – up to $1.86, compared to $1.45 in April – on the back of an improving UK economy.) Companies in this boat include Amcor, CSR, Cochlear, Treasury Wine Estates, Sims Metal Management, Westfield Group, Sonic Healthcare, Henderson Group, Ansell, Adelaide Brighton, GWA, Navitas, Bega Cheese, Incitec Pivot and Orica.
Of course, the actual performance of the company will always matter more than the currency impact on the earnings. But absent any stock-specific disasters – for example, QBE’s massive earnings downgrade in December or Treasury Wine Estates’ $160 million in write-downs in 2013 on excess US wine inventory – a lower A$ is a factor that should help these companies.
Commodity comedown
For the resources companies, commodity prices are always more important than the exchange rate. For example, iron ore accounts for all of Fortescue Metals’ earnings, and 90% of Rio Tinto’s earnings at present. A favourable exchange rate does not mean much to Fortescue and Rio if a Chinese slowdown were to send iron ore falling below US$100 a tonne. That is where the Chinese economic growth story is so important to the big miners: iron ore is trading at $US134 a tonne, which is still elevated by many analysts’ reckoning. Lower growth in China would bring this price down: Goldman Sachs, for example, expects increased iron ore supply to cut the price to US$90 a tonne in 2014. Both BHP and Rio Tinto are still considered reasonably cheap – if the iron ore price holds up – but each has big negatives in aluminium and coal.
In oil and gas, Woodside, one of the world’s top LNG producers, looks increasingly likely to have the ‘overhang’ of Royal Dutch Shell’s 23.1% stake in the company removed. The near-quarter stake has weighed on Woodside’s share price for three years, but Shell is reported to be looking to sell up to $US30 billion ($34 billion) of non-core assets – of which the Woodside stake is definitely one.
The local picture
At home, Australian investors can expect reasonably strong economic growth in 2014, with the current consensus for economic growth, at about 2.5%, looking if anything likely to be revised upward. CommSec, for example, has lifted its forecast range to 2.75%–3.25%. Consumer and business confidence is on the rise, and the Reserve Bank of Australia (RBA) has room to cut rates further if it decides the economy needs further assistance.
The Australian stock market (the S&P/ASX 200 Index) was up 15.1% in 2013, but in reality, the big four banks and Telstra generated 80% of the rise in the market. And that is likely to continue in 2014.
The big four banks face some stiff headwinds in 2014, notably high valuations, imminent regulation, the government’s financial services inquiry (Murray Review) and concerns over potential rises in bad and doubtful debts. The Murray Review holds some concerns for the Big Four, as it is likely to look at the supposed advantage they have in the $1.3 trillion mortgage market, because they have to put less capital aside to back home loans than their competitors.
But the bottom line for local investors is that the Big Four posted a combined 9.5% lift in cash earnings in FY13, and none is expected to show a fall in profit this year, particularly as credit demand improves. The banks are still generating growth, and asset quality is improving. Despite the lofty bank valuations, earnings risk is low, unless you expect a slump in house prices, and the bank stocks still offer a 5.5% to 6% fully-franked yield – which investors will continue to support. More specifically, CBA has the best-in-class profit growth and lower risk profile that justifies a premium to its peers, while NAB has the potential upside from the sale of its UK operations.
The other main pillar of the Australian market, Telstra, has to re-negotiate its $11.2 billion deal with the NBN for the use of its copper network – but the market expects both the company’s profit and dividend to grow this year, and the grossed-up yield of 8.1% provides a case for buying the stock on its own.
Elsewhere, improving consumer confidence can be expected to flow into stronger consumer spending in Australia, which should benefit the consumer discretionary stocks: many of these stocks did very well in 2013, but companies such as Super Retail, Kathmandu, JB Hi-Fi and Specialty Fashion should all continue to benefit from an improving economy – as well as a nice kicker from the expected lower $A, which should lessen the attractiveness of shopping internationally online, in addition to boosting inbound tourism.
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.
Also in the Switzer Super Report:
- Peter Switzer: Stocks will rise in 2014 [1]
- Paul Rickard: Portfolios end year on a high! [2]
- Tony Featherstone: Opportunities in resource stocks in 2014 [3]