Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Thematic (Sector/Industry)

<ul><li>Australia is in a sweet spot. We forecast the ASX200 to rise 9% to 6630pts underpinned by a 1pt increase in the PE multiple to 16.9pts and a modest increase in EPS (5%)</li></ul><ul><li>Stronger growth with the RBA on hold. Economic growth should get a little stronger next year as credit restrictions work to reduce housing risks.  The Inflation outlook seems benign enough to keep the RBA on the sidelines until Q3.  The yield curve should begin to flatten late in the year.</li></ul><ul><li>The risk is getting too bullish Value. A combination of earnings and interest rate risk has driven valuation dispersion to "distressed" levels.  This typically triggers Value out-performance, but not mean reversion.  The "cheap" end of the equity market is under pressure from unfavourable cyclical and structural growth pressures and political meddling.  This is a classic Value trap – cheap valuations, but no sustainable growth rebound.  Stick to Growth and quality.</li></ul><ul><li>Technological disruption is accelerating. Australia is in the early stages of a long, technology-driven disruption cycle that compresses pricing power and margins.  The attack on bricks and mortar retail will continue, potentially dragging down areas that have been untouched thus far.  It’s far too early to go back into this space.  We recommend no Retail or traditional Consumer Staples.</li></ul><ul><li>Stay Neutral Banks and Miners and apply weight where there is growth. Bank balance sheets are in good shape and will benefit from the delta provided by improving growth and yield curve steepening in H1 2018.  However, Government has the sector in its crosshairs leaving the regulatory risk premium elevated and limiting performance upside.  The announcement last week of a Financial Services Royal Commission isn’t the last bad news event to hit the banks.</li></ul><ul class=""><li>Miners will not break the correlation with earnings momentum. Miners are momentum stocks and are losing earnings support despite strong free cash flow generation.  Slowing Chinese growth is a downside risk for spot commodities prices with any upside surprises likely to be relatively short-lived.  Themes within commodities, such as Lithium demand, still have legs (<a href="https://www.smartkarma.com/entities/15103" target="_blank" data-smartkarma-citation="entities:15103">Mineral Resources Ltd (MIN AU)</a>.</li><li>Industrials offer both cyclical and structural upside. We are 15% overweight cyclicals.  Industrials are our preferred way to gain exposure to both cyclical and structural onshore and offshore growth.  The domestic infrastructure and capex thematic has longevity (<a href="https://www.smartkarma.com/entities/20166" target="_blank" data-smartkarma-citation="entities:20166">Adelaide Brighton Ltd (ABC AU)</a>, <a href="https://www.smartkarma.com/entities/12350" target="_blank" data-smartkarma-citation="entities:12350">Downer EDI Ltd (DOW AU)</a>.  We like the US home building cycle (<a href="https://www.smartkarma.com/entities/1487" target="_blank" data-smartkarma-citation="entities:1487">Boral Ltd (BLD AU)</a>, <a href="https://www.smartkarma.com/entities/10937" target="_blank" data-smartkarma-citation="entities:10937">James Hardie Industries Cdi (JHX AU)</a> and exposure to broad upside in industrial activity via soft commodities (IPL).  A period of $A weakness has the potential to add a substantial tailwind to stocks with offshore revenue in H1.</li></ul><ul><li>The surprise will be Australian relative outperformance: US equities are valuation constrained and positioned late in the earnings cycle.  The Fed is intent on keeping asset prices elevated, but relative performance is the end game.  Expect US equities to provide the directional lead and beta for Australia, but not the alpha.</li></ul><ul><li>We detail our key themes for the Aussie market. Our top picks are ALL, BLD, CCL, COH, DOW, JHX, SEK, TWE, and WOR.</li></ul>

Australia is in a sweet spot. We forecast the ASX200 to rise 9% to 6630pts underpinned by a 1pt increase in the PE multiple to 16.9pts and a modest increase in EPS (5%)Stronger growth with the RBA on hold. Economic growth should get a little stronger next year as credit restrictions work to reduce housing risks.  The Inflation outlook seems benign enough to keep the RBA on the sidelines until Q3.  The yield curve should begin to flatten late in the year.The risk is getting too bullish Value. A combination of earnings and interest rate risk has driven valuation dispersion to "distressed" levels.  This typically triggers Value out-performance, but not mean reversion.  The "cheap" end of the equity market is under pressure from unfavourable cyclical and structural growth pressures and political meddling.  This is a classic Value trap – cheap valuations, but no sustainable growth rebound.  Stick to Growth and quality.Technological disruption is accelerating. Australia is in the early stages of a long, technology-driven disruption cycle that compresses pricing power and margins.  The attack on bricks and mortar retail will continue, potentially dragging down areas that have been untouched thus far.  It’s far too early to go back into this space.  We recommend no Retail or traditional Consumer Staples.Stay Neutral Banks and Miners and apply weight where there is growth. Bank balance sheets are in good shape and will benefit from the delta provided by improving growth and yield curve steepening in H1 2018.  However, Government has the sector in its crosshairs leaving the regulatory risk premium elevated and limiting performance upside.  The announcement last week of a Financial Services Royal Commission isn’t the last bad news event to hit the banks.Miners will not break the correlation with earnings momentum. Miners are momentum stocks and are losing earnings support despite strong free cash flow generation.  Slowing Chinese growth is a downside risk for spot commodities prices with any upside surprises likely to be relatively short-lived.  Themes within commodities, such as Lithium demand, still have legs (Mineral Resources Ltd (MIN AU).Industrials offer both cyclical and structural upside. We are 15% overweight cyclicals.  Industrials are our preferred way to gain exposure to both cyclical and structural onshore and offshore growth.  The domestic infrastructure and capex thematic has longevity (Adelaide Brighton Ltd (ABC AU), Downer EDI Ltd (DOW AU).  We like the US home building cycle (Boral Ltd (BLD AU), James Hardie Industries Cdi (JHX AU) and exposure to broad upside in industrial activity via soft commodities (IPL).  A period of $A weakness has the potential to add a substantial tailwind to stocks with offshore revenue in H1.The surprise will be Australian relative outperformance: US equities are valuation constrained and positioned late in the earnings cycle.  The Fed is intent on keeping asset prices elevated, but relative performance is the end game.  Expect US equities to provide the directional lead and beta for Australia, but not the alpha.We detail our key themes for the Aussie market. Our top picks are ALL, BLD, CCL, COH, DOW, JHX, SEK, TWE, and WOR.

Aussie Equities 2018: In a Sweetspot