My no.1 stock pickings to survive the “new normal”

Chief Investment Officer and founder of Aitken Investment Management
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Can some of you please remind me to take August off next year and sit in the sun in the South of France!

August 2011 will go down as the wackiest month in Australian equities I ever remember. Alongside massive global and local macro driven volatility, we had a full-year reporting and dividend season. It was top down volatility meeting bottom up volatility, which translated into a volatility that was beyond any single month I recall at the peak of the GFC.

In August, the ASX 200 had a range of 4,517 to 3,765 – and that’s larger than you’ll see in many annual periods! If you’re a long-only fund manager and you beat the index in August, you’re a genius, because stock correlation was also at record levels.

If you had simply taken the month off, turned off the blackberry and returned to work today, the screens would tell you that all you missed was a small month decline in Australian equities at the index level – yet many stocks are actually higher than a month ago.

My gut feeling suggests this is the new normal for equity markets. It actually has been for a few years now as we cycle between greed and fear in an underlying environment of ultra-low global interest rates and anaemic OECD growth. We need to condition ourselves for far greater short-term volatility and lower overall investment returns.

Unfortunately, the volatility is too much for many people and you can understand why ANZ’s new convertible preference shares got swamped with bids for $1.25bn in just a couple of days. An 8% fully-franked yield from an AA-rated bank with no equity risk is clearly very attractive to most superannuants.

Interestingly, the ASX 200 came off its highs on Tuesday once ANZ announced the take-up of its preference issue, with traders clearly aware that the $1.25bn won’t actually add to equities, but will most likely be funded by selling other equities. Some may even have sold Telstra after the ‘anti-everything’ ACCC made some predictable noise about the Telstra/National Broadband Network deal. We think much of this was expected and we reinforce our ‘buy’ recommendation for TLS with a target share price of $3.55.

However, let’s not sugar-coat things, Europe is a huge mess, the US is slightly less of a mess, global banks are thinly capitalised, Chinese growth is slowing, and in Australia, the two speed economy (one going forward and the other in reverse) is really starting to become entrenched.

Australians are saving because they have no confidence and I even had the CEO of one of the big four banks tell me last week that he doubted whether Australian households would actually consume even if the Reserve Bank of Australia (RBA) cut rates. His view is they would keep their monthly mortgage payments the same and build equity in their homes. And he may well be right, but with the RBA showing no signs at all of cutting rates, it’s a hypothetical argument. Either way, credit growth will remain anaemic.

We also need to be realistic. All feedback we have from our network is that July and August trading conditions in East Coast Australia remain very, very weak – particularly in retail, manufacturing, newspapers, building materials, investment banking, mortgage broking, real estate and tourism.

Unemployment is definitely ticking up. But maybe this is the new normal of structural change – structural change brought on by competition from the internet, lower cost producers in Asia, a savings culture at home and the high Australian dollar. Perhaps this isn’t a cyclical downturn in these sectors, but structural.

That is why we won’t be going bottom fishing in beaten-up domestic industrial cyclicals – that’s potentially a low-reward, high-risk trade if this proves to be structural change. Sure, we’ll buy a few retailers with growth plans (such as JBH, TRS and MYR), or over-sold strategic media stocks (like SWM, AUN and CMJ), but our entire Australian equity strategy revolves around recommending stocks with structural tailwinds, not headwinds.

One bit of good news for Australia is that commodity prices were as solid as a rock during August. Spot iron ore ($178.90), thermal coal ($120), coking coal ($285), copper ($4.14), manganese ($475), nickel ($10.00), silver ($41.30) and gold ($1837oz) are all mostly flat to higher for the month.

There was a total disconnect between the performance of commodity equities and physical commodities prices, one that must close in favour of equities over the remainder of 2012. I have a feeling gold, coking coal, copper, nickel and iron ore equities are going to remain solid for the rest of the year. That is, what’s left of them after bids for MCC, CNA and MRE in August.

Anyhow, enough from me. Here’s a look at our top picks in those set to benefit from solid commodities prices.

Our no.1 stock picks

  1. Our no.1 diversified recommendation is BHP Billiton (BHP target $57.64)
  2. Our no.1 iron ore recommendation is Fortescue (FMG target $9.17)
  3. Our no.1 mid-cap Gold recommendation is Beadell Resources ( BDR target $1.27. Note: BDR should be added to the ASX 200 index tomorrow.)
  4. Our no.1 small cap coking coal recommendation is Aspire (AKM target $1.16)
  5. Our no.1 nickel recommendation is Western Areas (WSA target $6.21)
  6. Our no.1 manganese recommendation is Jupiter Mines (JMS target 88c)
  7. Our no.1 copper recommendation is Sandfire (SFR target $9.50)

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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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