TRANSCRIPT OF FINANCE NEWS NETWORK INTERVIEW WITH AUSBIL DEXIA
Clive Tompkins: Hello Clive Tompkins reporting for the Finance News Network. With Australia the first G20 country to raise interest rates, and the market up 50% from its lows, John Grace from fund manager Ausbil Dexia gives us his assessment. John welcome to FNN. The Reserve Bank recently lifted the official interest rate, is this the strongest signal so far that the economy is on the mend?
John Grace: Thanks Clive and thanks for the invitation. Yes it is certainly a very strong sign for us that the economy is on the mend. You have seen that the interest rates have been lowered from 7.25% all the way down to 3%, so an emergency level setting effectively. We are now starting to see the interest rate cycle rise and that rate is starting to creep up, 25 basis points last month. We do expect another rate rise on Melbourne Cup day and from there perhaps more towards a more normalised, neutral type level from the Reserve Bank perspective and we do expect that to be around 4.5% maybe 5%. But it is certainly a low way down from 7.25% last year.
Clive Tompkins: So why are we fairing better than other developed economies? John Grace: In our assessments it is four key factors; good government policies coming into the crisis, budget surplus and the ability to lower interest rates having had that relatively high interest rates; well capitalised corporate sector; solid banking sector; and the fact that we are quite close to Asia and the strength of those Asian economies which have allowed our exports to benefit from that growth.
Clive Tompkins: What about share prices, have they got ahead of themselves?
John Grace: I have a couple of slides here i would like to refer to; The first slide that I have got here for you today is a comparison of GDP growth rates and the stock market. You can see here, going back to the left hand side of the chart, the fact that the stock market often leads the economy into the recession and gives a good indicator of where the economy is headed. So in every case in the recessions highlighted here and if you go to the right hand side of the chart you will see that the stock market actually anticipated quite an aggressive economic contraction and that certainly hasn't eventuated. Which has meant that the ability of the stock market to rally quite significantly, which we have seen approximately a 50% rally from the low to date. The economy certainly has not been anywhere near as bad as people expected and therefore in our view the Australian stock market was quite over-sold and has rallied back nicely. So from here we expect the economy to recover in a more normal fashion and therefore the stocks to continue to respond to the earnings that are now available in the market. So if i just go to the second slide and take you through this; the EPS growth in fiscal 2009 experienced a 20% fall. Thats largely as a result of a weak economy and also the dilution in earnings as a result from the capital raisings. Which meant that the P/E was reasonably high at around 15 times, not to far from its overall average over the last 15 years of around 15 times earnings. But fiscal 10, where we see a very modest increase in Earnings Per Share of only 1/2 of 1%, which is resulting in a P/E of around 16.5 times. What we do expect is that as the economy recovers we will see some upside to that earnings growth forecast for fiscal growth 2010 and if you look at 2011, this is a consensus forecast coming into our database, you can see the earnings recovery of around 24%. Now one of the key factors for us, which makes the market for us look far more attractive on a P/E multiple, you can see the yields picking up as a result of better corporate earnings in the market. But more importantly, most companies have lowered their cost of doing business. So you have seen fixed cost lowered, labour shed and working capital made to literally made to work more efficiently and therefore as the economy recovers, the fixed cost leverage from these corporates will mean that earnings will surprise on the upside. We do believe that this will be evident in the second half of 2010 and certainly into fiscal 11, which makes the stock market recovery that we have seen, now justified by the earnings starting to come through.
Clive Tompkins: So at this stage of the recovery which sectors are expected to outperform? John Grace: We favour the domestic cyclicals against the defensives. There has been a very interesting dynamic occurring in this market. I want to show you the next slide and just refer to what i am talking about. You can see that in the slide, particularly where it has been circled there, you can see that the difference between the P/Es that you are paying for defensive stocks against those cyclical stocks had quite a wide gap. That was the opportunity to populate portfolios with good quality cyclical stocks, trading at trough cycle earnings and trough cycle multiples. That has been a large part of the rally that we have seen over the last 6 months in particular. Those industrial cyclicals as well as the banks have really responded to this discount that has been available in the market. So we have sold some of our defensive positions to buy some of these cheap cyclical positions.
Clive Tompkins: John the Aussie dollar has been particularly strong, what are the main drivers? and implications for stock selection? John Grace: There have been two main drivers of the strength in the Aussie dollar; one has been a weaker U.S dollar; two has been a high appetite for risk; and particularly for the Aussie dollar with a high level of commodities involved in our export industry. Now what that means for stock selection is that you have to be very careful and you make sure that the portfolio starts to benefit from those stocks that benefit from the higher Aussie dollar. That is particularly on the import side and to a lessor extent, starting to under-weight some of those exporters that will be hurt from currency translation impact.
Clive Tompkins: The price of gold has also been quite solid, do you own gold stocks? and what is your view of that sector?
John Grace: Now that we have a higher risk appetite we have sold down our gold weightings to zero and re-deployed those assets into domestic cyclical type stocks, the ones I mentioned such as, transport, media, retailers and the banks in particular. So our view on the gold price is that we are going to under-weight that from a portfolio weighting perspective for quite a while. We do believe that the gold price does not have much left in terms of its commodity price and therefore those stocks will underperform the more cyclical parts of the market.
Clive Tompkins: John Grace, thanks for your insight.
John Grace: Thankyou
