As you know, I’ve been maximum bullish/fully risk on/’recklessly positive’ from early October when the ASX 200 was at 3,850. In that time it has risen by more than 10%. Since then, the RBA has cut domestic cash rates by 50 basis points from 4.75% to 4.25% – a drop of more than 10%. I don’t think it’s a coincidence that the ASX 200 has rallied almost exactly in line with cash rates in percentage terms.
I also believe December will not end in a market whimper. I believe the ASX 200 will take out the widely reported technical resistance level of 4,350 and head to our long held technical target of 4,477. That would represent the top end of the recent, well defined, lower, bear market trading range. When the market approaches 4,477, we at Bell Potter will reassess our short-term trading strategy.
My strategy
The way to play the next leg of this rally, in my view, is to buy the most shorted stocks and sectors. The next leg of this won’t be a ‘risk on’ rally as such; it will be a ‘short-covering’ rally of grand scale as macro shorters realise the top-down short-trade in high beta stocks (materials, discretionary retailers, financials and biotechs) is over. Remember, in reality, shorting is just ‘deferred buying’. (Short sellers aim to profit from a stock’s decline by selling shares they don’t technically own. Short covering is when short sellers buy the shorted stocks to close out their positions.)
While Australia’s ‘Big Four’ banks have already seen some short-covering and will not lead the next leg of this short-covering rally, they will still trade higher, led by National Australia Bank (NAB).
I believe the next leg of the rally will be led by highly-shorted stocks such as:
- JB Hi-Fi (JBH)
- Harvey Norman (HVN)
- Myer (MYR)
- Billabong (BBG)
- Seven West Media (SWM)
- Mesoblast (MSB)
- Bluescope (BSL)
- Macquarie Bank (MBL)
- Fortescue (FMG)
- Atlas Iron (AGO)
- Western Areas (WSA)
- Paladin (PDN)
- Woodside Petroleum (WPL)
- Rio Tinto (RIO)
- BHP Billiton (BHP)
In the heavyweight index sectors, resources will slightly outpace banks from here on short-covering. It is worth finishing today’s note with a fundamental and technical view on BHP Billiton, the largest ASX 200 index weight stock, accounting for 11.65% of the index.
BHP Billiton (BHP) – Buy
One of the highlights of my year was being criticised in the Melbourne tabloid press for recommending BHP shares. I mean seriously, I will happily accept any justified criticism of our views, but to be criticised for recommending buying BHP after they have corrected by falling 28% and they are trading on the lowest EV/EBITDA ratio in 30 years still amazes me. But that aside, we have clearly reached the point where the fundamentals and technicals are converging on BHP Billiton. While the stock price has fallen 28% since April, our earnings estimates are all but unchanged for fiscal 2012. The price to earnings ratio is just 8.9-times, EV/EBITDA 6.2-times, return on equity (ROE) is 33% and sustainable yield (progressive dividend policy) is 3%.
On the technical side, the downtrend from the April high is being tested, while $34 has proved a ‘triple bottom’. At Wednesday morning’s ADR conversion price of $37.33, BHP is bang on the downtrend line from the April high. Our view is that downtrend will break and the next shorter-term technical target is around $41.50. If you are looking for the single best risk adjusted, mega cap, east-facing (Asia), highly liquid way of playing a less risk averse world, BHP is it. Our medium-term price target remains $54.87.
- Price target: $54.87
- Wednesday’s close: $37.02
Kingsrose Mining (KRM) – Buy
We have remodelled Kingrose and reduced our exploration value to take account of the maiden resource at Talang Santo. We have increased our modelled mine life to 10 years. This is over and above the life of mine afforded by the current resource (six years); a result of confidence that Kingrose will prove up and discover more high-grade systems. Kingrose is undertaking aggressive exploration with 12 drill rigs and a $14 million exploration budget over the next 12 months.
- Price target: $2.00
- Wednesday’s close: $1.58
Sustainable yield stocks
Banks are the best pound-for-pound option.
Our sustainable yield screen analysis looks to rank a mix of size, risk, growth, yield and value factors to pick the sectors and stocks that are most likely to maintain yield on a cross sectional basis. The Top 5 (ex Property Trust and Utilities) in the sector screen are Consumer Durables & Apparel, Retailing, Banks, Diversified Financials and Materials. The sector to move up the most since last month is Consumer Durables & Apparel. Banks remain the best large cap, lower risk-yield option with the Big Four banks in the top ten large cap ideas.
The best stock ideas with a market cap above $350 million, after removing property, utilities and infrastructure stocks are listed below.
The large cap stocks in the sustainable top 150 screen with greater than 6% yield expectations are:
WBC, CBA, NAB, ANZ, MQG, IAG, TLS, ASX, SUN, QBE and AMP.
Best large cap stock ideas:
ILU, BHP, WBC, CBA, NAB, ANZ, MQG, LEI, IAG, RIO
Best mid cap stock ideas:
OST, MND, FXJ, DOW, BOQ, GFF, DJS, MYR, CGF, SGM
Best small cap stock ideas:
MGX, KCN, PBG, WTF, APN, TRY, PTM, CRZ, IRE, FLT
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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in the Switzer Super Report
- Peter Switzer: SMSFs are doing “pretty well”
- Ron Bewley: Portfolio building: sectoral allocation risk-reward
- Tony Negline: Will your allocated pension last the distance
- Andrew Bloore: Two tax benefits of SMSF
