Wait for the buying opportunities – part 2

Chief Investment Officer and founder of Aitken Investment Management
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Last week I told you how I am taking my own advice and selling in May and going away. I’m hoping that when I come back, in a couple of weeks, Australian equities will offer better bottom-up value and we can start buying.

In the meantime there are a couple of headwinds that might put pressure on the markets. See my article last week for the macro factors.

Negative FY15 earnings revisions are an increasing headwind for Australian equities. It’s unlikely Australian equities can advance when FY15 earnings forecasts are being revised down by analysts.

The Australian Dollar also remains too high and it’s worth noting that yield spreads between US two-year bonds and Australian three-year bonds are narrowing sharply. As the Australian dollar’s yield advantage narrows, firstly via bond yields and secondly via cash rate differentials (FED will raise cash rates before the RBA and via larger percentages from a zero interest rate policy base), the Australian dollar will lose carry trade (yield buyer) support. In fact the carry traders will most likely be carried out. My medium-term AUD/USD target remains 85 US cents.

Below is the five-year chart of the US/AGB two to three year yield spread narrowing in the US’s favour.

Vulnerable stocks

Similarly, I reiterate my list of Australian stocks vulnerable to a valuation correction and suggest many Australian investors are a little too sanguine about what is happening globally in momentum/GAAP stocks. The vast bulk of this list have fallen in price, some very sharply since I first published it in April, but as we sit here today, consensus analyst views see everyone of these stocks as a “buy”. I don’t agree, I think they all look expensive, growth forecasts are too ambitious, registers are crowded with momentum investors and momentum is reversing. The “vulnerable MO” list remains:

REA Group (REA), Seek ltd (SEK), Domino Pizza Enterprises (DMP), CarSales.Com (CRZ), Xero Ltd (XRO), Vocus Comms ltd (VOC), TPG Telecom Ltd (TPM), iiNet ltd (IIN), CSL ltd (CSL), ResMed Inc (RMD), Ramsay Healthcare (RHC), Sirtex Medical (SRX), 21ST Century Fox (FOX), Navitas (NVT), G8 Education (GEM), OzFoxex (OFX),Vocation (VET), Donaco (DNA), James Hardie (JHX), Magellan Financial Group (MFG), BT Investment Management (BTT), Platinum Asset Management (PTM), Henderson Group (HGG),Credit Corp Group (CCP), Veda Group (VED), ASX Ltd (ASX), Macquarie Group (MQG), Brambles (BXB), Amcor (AMC), Fletcher Building (FBU), IOOF (IFL), Sydney Airport (SYD) and Transurban Group (TCL).

The banks

And finally that brings us to the Australian banks, which could prove to be the last domino to fall in this trading correction.

I’d be highly, highly surprised if Australian banks remained immune to a broader equity market trading correction. It is almost impossible for that to remain the case, particularly if that correction is triggered by changing investor expectations of the timing of global cash rate rises.

Australian banks are ex dividend and vulnerable to profit taking pressure. Ask yourself who is going to be the new marginal buyer of Australian bank equities at these levels? It certainly won’t be foreign investors who can’t value franking credits.

Australian banks have been major beneficiaries of short US dollar yield carry trades, but as the Fed’s balance sheet peaks, that clearly has the potential to reverse.

Below is a five-year chart of the ASX 200 Banks Index overlaid with the Federal Reserve’s total asset base (green line).

Australian banks have never been as widely held by Australians or been a higher percentage of domestic equity portfolios as they are now. They have never been more widely held by global income seekers. That, in itself, makes the sector vulnerable to profit taking.

I realise nobody listened and/or nobody wanted to hear it when I downgraded the bank sector to “hold” a few weeks ago (after two and half years of rampant bullishness), but the more I sit here, the more I believe there is more downside than upside in near-term in Australian banks. My advice is sell a bank – you don’t need to own all of them – that advice is relevant to both retail and institutional investors.

All in all I believe the three Vs, that is value, volatility and volume, will return to Australian equities and potentially quicker than anyone currently believes.

As this all evolves, remember the words of successful US hedge fund manager Dan Loeb (Third Point) who wrote in his Q1 letter to shareholders: “Four months into 2014 it now seems evident that investment performance will require a combination of good stock selection, patience and deft trading”.

That advice is proving 100% correct.

A better buying opportunity awaits us. Be Patient. I believe patience will be rewarded.

100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation.

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.

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