Rumours of the Fed buying Facebook shares drove the mother of all short-covering rallies last night.
OK, I made that up, but the expectation of coordinated central bank action did drive aggressive short-covering in risk assets and profit taking in havens.
You get the feeling the entire fast money/momentum investing community has the same trade on now (short risk, long havens) and it only takes a WSJ article or two on QE3 (a third quantitative easing package) to spark sharp moves.
The market rallies
The Dow closed up 286 points, or 2.4%, at 12,414, the S&P500 gained 29 points, or 2.35%, at 1,315 and the NASDAQ rallied 66 points, or 2.4%, to 2844. The energy (3.2%), financials (3%) and materials (2.8%) sectors led Wall St as commodities and commodity currencies advanced.
The Australian Dollar is up at 99.20 US cents, yet the VIX, or fear index, is down 10% to 22, and the US 10-year bond yield is up sharply at 1.66%.
If the correlation between the AUD and Australian resource stocks holds today, which it will, it will be a violent day of short-covering in first and second-tier Australian resource stocks.
As part of my broader strategy of focusing on the bottom-up in a period of complete top-down pricing influence, I am trying to speak to as many leaders of corporate Australia as I can. The common theme in ALL my discussions is that current trading conditions are nowhere near as dire as share prices (or bond yields) would suggest. They all remind me, “continuous discloser ensures we would tell the market if things had deteriorated.”
Cover the fact
That same theme can be seen in the first quarter gross domestic product (GDP) data, which stunned all of us yesterday. Could it be that the Australian government bond yield curve, Australian Dollar and the Australian equity market are simply too bearish on Australia’s prospects?
I believe that the consensus top-down view of Australia, and what is priced into Australian asset classes, is now out of whack with the direct feedback I get from corporate Australia. It’s that simple and I am starting to wonder whether this is going to be a case of short the rumour, short cover the fact. I suspect it is going to be.
Suncorp (SUN) – Buy
A classic stock-specific large cap example of ‘short the rumour, short cover the fact’, in my opinion, will be Suncorp (SUN), which I mentioned in my note last week [1]. I have seen scare story after scare story doing the rounds on Suncorp, a stock that is in my high conviction buy list. Yesterday, I sat down with Suncorp’s CEO Patrick Snowball and went through ALL the perceived negatives.
This was a very, very useful meeting that cleared the air on numerous issues, but most importantly the Queensland assets in the so-called ‘bad bank’. It seems Suncorp’s share price is totally dominated by bad bank speculation, which is distracting from the strong earnings growth from the general insurance business and good bank. To put this in context, the bad bank has less than $700 million of Gold Coast property assets, while the good bank maintains a strong A+ rating and just got a $1.5 billion covered bond away, a first by any Australian regional bank.
I thought Snowball was excellent and eloquent yesterday. He showed good passion and answered difficult questions firmly. He also focused on the momentum in the broader business that goes unnoticed by most analysts. I came away from the meeting with even higher conviction on Suncorp, feeling over the next few years as the bad bank runs off that Suncorp will be re-rated to a general insurance plus regional bank multiple. That multiple is 50% higher than the current multiple of 8.8-times in fiscal 2013.
- Last closing price: $8.02 (up from $7.75 in my last note)
- Target (12 months): $9.60 (unchanged)
- Expected capital growth 22.9%
- Expected dividend yield 6.1%
- Total expected return 29.0%
Iluka Resources Ltd (ILU) – Buy
We have raised our rating on Iluka to Buy from Hold. Current prices provide an attractive re-entry point for Iluka, which has fallen by 15% since its production and sales downgrade announced on 8 May. While we are cognisant of the short-term weakness in the zircon market, our stress test scenarios suggest Iluka has been significantly oversold. There are signs of improved economic traction in the US and China, and European customers’ stock levels have almost completely been exhausted. Iluka is currently low-grading Jacinth-Ambrosia, in anticipation of an improved second half of this year.
- 12-month target price: $14.41 (previously $14.53)
- Last closing price: $11.88
- Capital growth: 21.4%
- Dividend yield: 7.1%
- Total expected return: 28.5%
Macquarie Group (MQG) – Sell
The inherent operating and market risks within Macquarie has led us to lower its rating to Reduce from Hold. We have lowered 2013 earnings by 12% and subsequent earnings by 6%. Macquarie’s current guidance is for an overall net profit contribution improvement on 2012 provided market conditions are not worse than those experienced in 2012. While our forecasts suggest this is possible, the headwinds continue to mount especially for the market facing businesses with top line growth remaining weak. While the bank has de-risked its balance sheet (e.g. largely fixed its funding and capital positions), the bulk of revenues are overseas sourced and will remain volatile for some time to come. Medium-term expectations for the core businesses are as follows:
- Macquarie Funds – AUM growth assumptions lowered by 2-3%;
- Corporate and Asset Finance – 2-3% weaker portfolio growth/NIM pressure;
- Banking and Financial Services – AUM growth assumptions lowered by 2-3%;
- Macquarie Securities – 2013 loss from lower trading income and brokerage;
- Macquarie Capital – Weak listings and deal pipeline.
Given global markets uncertainty and above headwinds, the return on equity (ROE) is expected to remain below the cost of equity until much later. We believe there is better value in the banking space with major banks such as ANZ, NAB and WBC, and even in general insurance, e.g. IAG and SUN with strong earnings growth and yield.
- 12-month target price: $26.10 (previously $27.80)
- Last closing price: $26.22
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.