Global equity markets appear to have run out of short-term puff, with the S&P500 again baulking at 1,350 this week. It does appear we are in for some sort of consolidation of the huge moves from the October lows, which in the scheme of things would be quite healthy for markets.
All the sectors that led Wall Street’s five-month rally have led the profit taking (banks, housing, transports, materials) and sectoral leadership changes often proceed periods of index consolidation.
Where’s the growth in big-cap Australia?
The top 10 weightings in the benchmark S&P/ASX200 index account for 52% of the index itself. That level of index concentration is one of the reasons the Australian equity market, as measured by the ASX200, continues to underperform the world in raw terms.
The problem is, with a couple of exceptions (like the recovery in Wesfarmers’ earnings per share), that the top 10 stocks in the ASX200 lack earnings growth relative to what is available in the region.
In a world where most investors are looking for earnings leverage to a global economic recovery, consensus earnings growth estimates for this year for leading Australian equities are anaemic. Yes, there is yield support, but genuine double-digit earnings growth is hard to spot in the big end of our market. This is before consensus numbers are lowered again to reflect the reality of the two-speed economy and the structurally higher Australian dollar.
Earnings per share (EPS) growth for the top 10 ASX-listed stocks
On that basis, you need price to earnings (P/E) expansion to get large-cap Australian equities up as the world becomes less risk averse, yet in that environment of rising risk tolerance small and mid-cap growth stocks will benefit more than mega-cap stocks. Similarly, with the mergers and acquisitions (M&A) cycle picking up, the mega-caps are far more likely to be predators then prey.
This lack of genuine earnings growth in Australian mega caps – which will get worse as the two-speed economy and high Aussie dollar kick-in this year – is one key reason I am strategically pushing a high conviction, high index tracking-error, concentrated portfolio with a real mid and small-cap structural growth stock tilt.
This year will be a highly divergent year of stock and sector performance. I would like to thank the billionaire who last week replied to my comment, “You will never overtake anyone by driving in the same lane,” with “You’ll never overtake anyone flying in the same plane”. I suspect he was telling me he agreed with my strategy!
Mid and small-cap stocks
The point is, the more I sit here and attempt to pick the key themes of the year ahead, I think the key one is building as the outperformance of mid and small-cap stocks both globally and particularly locally. In the search for portfolio alpha, I think the early trends of this year, one being the outperformance of mid and small-cap stocks, will continue.
I have to say, the awful performance of the listed discretionary retail sector and their landlords this week was a clear signal that east-coast discretionary retail is getting worse. That agrees with all direct feedback I have had from unlisted retailers who continue to report very tough trading conditions. It really is only a matter of time before serious job shedding starts in the retail sector, which of course is like a virtuous circle for discretionary spending. There are 1.2 million people working in Australian retailing. Year-end unemployment is underestimated in Australia.
Money can still be made
Nobody wants to believe me, but I am strongly of the view that 2012 is the year when Australia realises it has all the symptoms of ‘Dutch Disease’ (the counter relationship between resource exploitation and manufacturing), and that is another of the reasons, perhaps the key one, why I downgraded our domestic equity strategy to ‘selectively bullish’ on Tuesday. The fact Australian politicians are asleep at the wheel is another factor in my decision to tone it down a notch.
This is going to be a very tricky economic and market adjustment period to negotiate successfully, so that’s why I remain vigilant and highly aware of what price action and global trends are trying to tell me before the consensus-following analysts work it out.
We can still make money in Australian equities but we have to work a lot harder for it. The point is this gets trickier now.
Evolution Mining (EVN) – Buy
The corporate combination of Conquest, Catalpa and Newcrest’s Mt Rawdon and Cracow mines has created a new mid-tier $1.3 billion gold stock in Evolution Mining. The transaction will prove to be of benefit to shareholders in the long run in being part of a stronger, larger, more diversified group. A rerating could occur similar to that of Alacer Gold (AQG) (which formed in February 2011) and was one of the best performing mid-cap gold stocks of the past year. Evolution stands out amongst its mid-cap rivals in consisting entirely of 100% owned Australian-based assets. The company is well funded after a recent capital raising ($152.5 million), while net cash stands at about $150 million.
12-month target price: $2.25
Last closing price: $1.83
Consolidated Media Holdings (CMJ) – Buy
We view Consolidated Media as a cashbox – net cash coupled with strong associate free cash-flow as Foxtel’s (it owns 25%) PVR and HD services near their peak take-up. While we remain cautious on the macro environment, Foxtel’s result highlight the attractiveness of the STV model, including the levers it can pull to grow earnings relative to traditional media, which is skewed to cyclical dvertising. On a proportionate basis we estimate CMJ is trading on a 7.6-times EV/EBITDA multiple for fiscal 2012 in line with its peers, BSkyB and SKT.
12-month target price: $3.15
Last closing price: $2.69
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