My friends, across just about all Australian east coast industrial cyclical sectors, it is the bottom of the cycle right now. How can I make such a bold prediction? Because the Reserve Bank of Australia (RBA) has finally fallen on its monetary policy sword and relief of households and businesses is starting in the form of lower borrowing costs and a lower Australian dollar.

I believe Australian cash rates will be 50 to 75 basis points lower by Christmas. That should equate to around 80 basis points of mortgage rate relief to the average Australian. Yes, the first of the rate reductions will be saved by households to pay higher household living costs, yet the further ones this year will translate to activity and confidence. In a share market sense, that means you have to start buying a few Australian industrial cyclicals that are priced as structurals.

Where I’d put my money

The first place I’d be putting industrial money to work is in equity-market linked earners. Rumours of the equity market’s death are greatly exaggerated. As cash rates come down further in the second half of this year, partly in response to reduced government spending, you will see all the grey nomads who have their SMSFs parked in cash realise those unfranked falling cash returns won’t pay for their retirement lifestyle expectations. The fear of not enough income (FONI) will become widespread.

SMSFs will be forced into fully franked equity yield for those who want real returns greater than inflation. It’s that simple in my view. You can see the US equity markets are trading at four-year highs, not because the US economy is going fantastically well, but because the Fed’s zero-interest-rate policy has forced any American who relies on investment income to buy equities if they want a real return higher than inflation. In the US, the alternative to equities is a 10-year Treasury bond yielding 1.95% or cash account yielding zero. Some banks even charge you to place a deposit with them!

In Australia cash still remains an alternative to equities, but Australian 10-year government bonds with a yield at a 60-year low of 3.55% certainly don’t. Cash management trust rates of around 3.75% unfranked are also starting to look pretty unattractive, while even yields on hybrid securities have fallen with the bank bill swap rate (BBSW).

The difference in Australia remains that the banks and their never-ending fund issue continue to offer reasonable term deposit rates. However, under the cash rate scenario, I believe even those term deposit rates will drop below the low 4% unfranked mark later this year and that will be the trigger for broader retail investor yield chasing in domestic equities.

I don’t believe the current trend of SMFSs favouring cash and fixed interest over equities will prove to be structural. It’s a fad, driven by emotion (fear of losing your capital) over economic common sense. Yes, there is less volatility outside of equities, but there are also increasingly lower returns to be found. Return is a function of risk, but you are being paid to take the risk, for example, when National Australia Bank shares yield 7.6% fully franked versus a one year NAB term-deposit yielding 5.5% unfranked.

All the fixed interest gurus will be into me saying I’m a biased equity guy. Yeah whatever, the same biased equity guy who recommended buying Telstra (TLS) with your ears pinned back from the Future Fund at the bottom as they switched to fixed interest.

Equities vs fixed interest

I may well have drunk too much good water in Melbourne yesterday but I’m genuinely bullish about the prospects for Australian equities in the second half of this year. The Aussie-dollar headwind is easing, the RBA headwind is easing, global growth is recovering, China is on track and it’s now only a matter of time before we get a change of Federal Government. A huge percentage of Australian listed companies are priced on price to earnings ratios (P/Es) and dividend yields that suggest they’ll suffer no growth forever. Just about everything is priced as a ‘growthless oligopoly utility’, a situation that will prove way too pessimistic.

What we are all underestimating is how quickly confidence can improve. Confidence drives sentiment and sentiment drives asset prices.

If I am proved right on the second half 2012 call, you need to start positioning now. Many cyclical stocks currently discounted as ‘structural’ will gap higher even off the whiff of the cycle turning.

Shorts will cover, new money will come in from the sidelines, and there won’t be a willing supplier of stock. You could see major gaps higher when the consensus view belatedly agrees that the worst is behind us later this year.

Over the next few weeks I will work with our industrial analysts to find a few bottom-up stock ideas that fit the theme, but I am sure one of the first places to look is in equity market-linked earners. As I write above, rumours of the death of equities have been greatly exaggerated.

Go Australia…Charlie.

Ausenco (AAX): Buy 

We continue to rate Ausenco as a Buy. We expect the company to demonstrate that the positive earnings momentum delivered during the second half of 2011 is likely to continue. This improvement is expected to be driven by double-digit revenue growth in contrast to the second half of 2011, which was primarily driven by a reduction in the company’s fixed cost base.

• 12-month target price: $5.03
• Wednesday’s close: $4.48

Virgin Australia (VAH): Buy

Virgin is beginning to see the early results of a major change in strategy announced by incoming CEO John Borghetti in late 2010. This strategy revolves around improving the yield of the domestic business by focussing on increasing market share in the corporate and government and, to a lesser extent, the regional airline segments. In our view, the strategic repositioning has the potential to significantly change the company given it has been predicted on minimal incremental capital expenditure. On the assumption the company can deliver sustained earnings improvement; we consider a medium-term re-rating likely.

• 12-month price target: $0.50
• Wednesday’s close: $0.385

Woodside Petroleum (WPL): Buy

Woodside has surprised the market with an excellent deal on the Browse LNG project. The company has finally delivered some good news about the company’s future. The last couple of years have been dominated by delays and cost blow-outs on Pluto, uncertainty over growth projects like Browse, Sunrise and Pluto expansions as well as selling by the company’s major shareholder Shell. New MD Peter Coleman has also re-based expectations for growth in his first 12 months in the job. We view the announcement as a turning point and reiterate our Buy recommendation.

• 12-month target price: $47.30
• Wednesday’s close: $36.66

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, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.

Also in the Switzer Super Report:

• Peter Switzer: It’s May! Should we sell or stay?
• Alistair Bailey: The Archibald Prize: is it a jackpot for art investors?
• JP Goldman: Is it time to jump back into Chinese stocks?
• Andrew Bloore: The three most common SMSF trustee breaches