It seems to me that Swan et al are trying to force the Reserve Bank of Australia (RBA) to use aggressive monetary policy via constrictive fiscal policy. This budget surplus nonsense isn’t about anything other than trying to force a deep rate cut cycle ahead of the next election then claim that the government somehow organised it. Isn’t the world of populist politics wonderful?

But Swan’s surplus and spending cuts in a slowing economic environment will ensure the RBA has no choice but to slash rates and that will see the Aussie dollar fall. I think that’s telling me to sell any stock reliant on government spending and switch to those exposed to consumer, rural and business spending. I am also getting more bullish on inbound tourism as the Aussie falls.

Dividend yields more attractive

Yields are being crunched in the government bond market, followed by yields in constant maturity treasuries (CMTs), floating rate hybrids and eventually term deposits, making fully franked equity dividend yields more attractive by the day.

All the grey nomads parked in fixed interest will be forced into equity yield as the year progresses. Sure, days like yesterday reminded retirees why they hate equities, but as incomes get squashed in the second-half of this year, those of you who are retired will likely find you’re being forced into high fully franked equity yield.

When you sit back and think about where investors will be forced to go in the second half of this year, it points you to high sustainable dividend yield stocks and east coast cyclicals. One thing I’m sure of is the second-half of this year and beyond will prove that many of these industrial cyclicals weren’t structurally challenged – it was just a giant cycle. This is all now about a little bit of short-term pain for long-term gain.

My strategy

My key strategy remains to short the Aussie dollar and long my high conviction large cap equities portfolio, where I have been increasing high fully franked yield and east coast exposure. Yes, some of that list took a hit yesterday, but that just increases their attractiveness in the short and medium-term.

AMP, ANZ (cum 66c), BHP, CWN, FMG, NAB, STO, SWM, TLS, WBC (cum 82c)

Telstra (TLS)

I got a lot of questions on Telstra yesterday after its stock price made another fresh three-year high driven by yield chasing. Most investors were asking me if it’s time to take some profits? Well, Telstra has been our best total idea return in years, with the Future Fund’s selling turning out to be a true gift from the Nation at what will prove to be the low forever.

The way I see this now is if you are a long-term investor, you should continue to hold Telstra as it heads towards $4, but if you are a short-term trader, Telstra’s outperformance of riskier industrial and resource stocks would suggest there are grounds for a trading rotation in the short-term from Telstra to other stocks.

The reason I remain fundamentally positive on Telstra, despite the huge rally (plus dividends), is because I think the company is in an earnings and dividend upgrade cycle, while I also believe, as I wrote a few weeks ago, that Telstra would be re-rated if it bought a little extra growth in the form of Consolidated Media Holdings (CMJ).

I think the market would applaud Telstra buying Consolidated Media and adding to its FOXTEL exposure, and I think you can see that is an accurate call as both stocks have rallied since rumours of a deal emerged. Telstra yields 7.8% fully franked, even at current prices, and it’s hard to see a yield like that underperforming in a falling cash rate environment.

Insurance Australia Group (IAG)

Another larger cap industrial I like is Insurance Australia Group. On our updated earnings estimates, IAG trades on 9.6-times full-year 2013, while offering 49% earnings per share (EPS) growth and a prospective 6.8% fully franked yield. Of course, this assumes a normalisation of the claims/natural disaster cycle, which is overdue for IAG. Either way, IAG is seeing premium rate rises that should drive insurance margins back up to 12.2%. We’ve lifted our 12-month target price on this stock to $3.90 from $3.60, and it’s currently trading at about $3.46.

Fortescue Metals Group (FMG)

And finally today, just a short note on Fortescue. We had operatives on the ground at Port Hedland earlier this week and feel the expansion is on track and on budget as guided, while the production for this quarter is playing catch-up after last quarter’s cyclone interruptions. The company continues to sell all the iron ore it can produce.

Fortescue has had a series of positive pieces of news in the last few days:

• No diesel fuel rebate cut in the budget (was rumoured to cost FMG $150m if changed).
• Moody’s upgrading FMG’s debt rating.
• Comments from Teck Cominco last night about “buying a producing iron ore company” (Teck own 3.9% of FMG)
• The Aussie falling to 1.00 US cent … FMG’s cost base is in Aussie dollars.
• WTI Oil falling to $96.50. Diesel is FMG’s biggest variable cost.
• The iron ore price continuing to hold above $140.00 per tonne.

So fingers crossed, the worst of this anti-Fortescue short-seller sentiment is behind us as fundamentals take over. Anywhere under $5.50, I see Fortescue as a trading and fundamental buy with the company simply priced for its 55mtpa (million tonnes per annum) current production.

Go Australia, Charlie.

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