'Bondcanos' to 'animal spirits': 5 key themes to watch for Australian stocks in 2018

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As 2017 draws to a close, market analysts turn their minds to the key themes and market predictions for the new year ahead.

Hasan Tevfik and Peter Liu — the Australian equities team at Credit Suisse — have prepared a note summarising five key themes to watch on the Australian stock market this year.

The duo’s outlook is quite positive. Taking both opportunities and threats into account, they forecast the ASX200 to reach 6,500 by December 2018, which will give a total return (both capital gains and dividends) of around 13% from current levels.

Here are the analysts’ five key themes that Australian equity investors should be on the lookout for next year:

1. Bondcano

Tevfik and Lue returned to their Bondcano research from earlier this year, highlighting the stocks most at risk from a pending rise in global bond yields.

Credit Suisse’s forecast of a 2017 rise in bond yields didn’t come to fruition, as inflation failed to rise and global central banks remained net-buyers of US treasuries.

However, the bank’s US-based bond analyst forecasts benchmark US 10-year bond yields will climb to 2.9% by December 2018 — from the current rate of 2.37% — amid declining demand for government bonds as central banks reduce the size of their balance sheets.

Tevfik and Liu said stocks with high leverage and high dividend payout ratios are most at risk from a Bondcano.

Within that framework, they said to watch the following stocks which also have low earnings-per-share (EPS) growth momentum:

2. China is preparing to invest abroad

Chinese companies shut up shop to an extent in 2017, amid increased capital controls ahead of the 19th National Congress in October.

With China’s power structure now established for the next five years, authorities have introduced measures to speed up approvals for local Chinese companies investing offshore.

So outbound mergers and acquisitions are likely to rise.

Tevfik and Liu counted 528 deals by Chinese companies offshore in 2017.

They said 40% of those deals provided Chinese companies with access to key intellectual property in fields across tech, data science and healthcare.

“After intellectual property we find companies have clamored to buy into primary industries, including agriculture and commodities,” they said.

There are plenty of Aussie companies which fit that criteria, pending Foreign Investment Review Board approval.

The pair asked industry experts within Credit Suisse which Aussie stocks could be a target for Chinese buyers:

3. Capital expenditure is on the rise

A long-awaited rise in capex by ASX200 companies was one of Tevfik and Liu’s main takeaways from the August reporting season.

“As we progress through the financial year, analysts have previously cut their capex forecasts. By this time of year analysts have usually lowered their guidance by 1.5% compared to June levels,” Tevfik and Liu said.

“However, they are now higher. We find all three major components of ASX 200 capex — Commodities, Cyclicals and Defensives — have contributed to the upgrade.”

“Animal spirits are beginning to creep into the C-suites of Australia Inc.”

That view was backed up by capex data from the ABS for Q3, which showed that Australia’s business investment outlook is strengthening.

The analysts said there are two ways to benefit from increased capex. Firstly, look for companies with a business-to-business strategy, which generate most of their revenue from other companies.

They also highlighted a basket of stocks listed below which are poised to increase both capex and dividends — a combination which typically leads to broader market outperformance:

4. Cash is still on the sidelines

“Despite the dismal returns on cash, we find Australian pension allocations to the asset class remain unusually high,” Tevfik and Liu said.

“Our superannuation pool holds $340 billion in cash and this breaks down into $180 billion for funds with more than four members (APRA regulated) and then another $160 billion for Self Managed Super Funds (Selfies).”

As a percentage of total funds, the cash position held by “selfies” is more than double that of APRA-regulated funds.

The analysts predict those cash levels will fall as interest rates stay low and risk-appetite increases amid an improving global growth backdrop.

So what type of stocks do selfies prefer to invest in? Companies that pay a high dividend, according to research from the duo earlier this year.

However, they added that “selfies” would be better off if they also looked for stocks with positive earnings momentum.

The list of stocks with positive EPS growth and a gross dividend yield of above 6% is comprised of Perpetual, Commonwealth Bank, Regis Resources, Platinum AM and Macquarie.

5. The prospect of a federal Labor government

The coalition is currently in power with a wafer thin one-seat majority. Tevfik and Liu said polls point to a Labor victory if the election were held today.

They noted the Turnbull government is likely to introduce voter-friendly policies in a quest to stay in power, including income tax cuts for Australian workers, who have some of the highest income tax rates in the OECD:

But if Labor does return to power at some point over the next 18 months, the duo said that would likely result in higher government spending.

“If the ALP again do run more expansionary fiscal policy then we should expect, all other things equal, higher bond yields and potentially a weaker currency as international investors re-consider the Australian risk premium,” the analysts said.

“Against this backdrop, equity investors should be cautious on the Bondcano stocks and should expect overseas earners to outperform.”

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