AMP announces its themes for 2014 for the Australian market.

As the country prepares to mark Australia Day, AMP Capital has identified the key themes investors in Aussie equities should celebrate and those they should look out for this year.

AMP Capital Co-Head of Fundamental Equities Michael Price said: “Australian equities are a key component of many investors’ portfolios and there are reasons for investors to be positive about the asset class this year. There are signs M&A activity is increasing in response to a rising market while housing construction is also recovering.

“On the flip side, investors should be aware mining capital expenditure is continuing to be rolled over and this may have an impact on the economy more broadly and companies that service major miners in particular. Australian retailers’ supply chain management will also be an issue to watch.

“Aussie equities are a popular investment because they offer the potential for capital growth and income, tax advantages such as franking credits and liquidity in a market most local investors understand and feel comfortable with. They are often the first choice for investors ready to return to financial markets at a time when share valuations are still reasonable.”

The key themes are:

The return of M&A activity

After three to four lean years, mergers and acquisitions (M&A) activity in Australia looks set to increase along with the local equity capital market (ECM). There is a healthy initial public offering pipeline in place for 2014 with signs suggesting the return of contestable M&A. Periods of rising M&A and ECM activity are typically associated with rising margins for those companies linked to such activity. With both rising revenues and improving margins, Australian companies linked to capital markets are set for a strong year in 2014.

Housing construction recovery

Interest rate cuts have taken longer than normal to trigger residential activity due to concerns among consumers around job security and a desire by households to pay down debt. But the pick-up in demand the Reserve Bank of Australia (RBA) has been looking for is finally occurring in a coordinated manner across Australia. House prices are rising, finance approvals are picking up and housing start numbers are at levels consistent with previous peaks. A significant increase in demand for products such as concrete, bricks, plasterboard, glass, steel and concrete roofing, combined with the high fixed-cost nature of building product manufacture, should ensure a housing construction recovery translates into a large leap in profit for most operators. An improving housing market should also support hardware and electronics retailers.

Retailers to face increased sourcing costs and scrutiny on supply chains

Australian retailers’ supply chain management and supplier factory standards will continue to be scrutinised this year and laggards might face brand damage. In addition to margin impact from potential weakness in the Aussie dollar, retailers’ margins could also be impacted by continued wage inflation in Asia, most notably in Bangladesh where minimum wage inflation has lagged China. Emerging sourcing locations, such as Cambodia, also pose brand and operating risks.

Australian mining capital expenditure to continue to roll over

Investors should be mindful of the decline of mining capital expenditure, which is likely to impact companies providing services to the major miners. Factors such as uncertain demand from China and a lower commodity price environment are resulting in project deferrals and cancellations, and the rolling over of mining capital expenditure. Current market forecasts for many of the companies providing services to the major miners, notably those exposed to iron ore mining capital expenditure, continue to look too high and further downgrades are expected during the next 12 months.

All eyes to China

AMP Capital’s view is that Chinese growth will be around 7.5 per cent this year but it is the composition of this growth that is of particular importance. For example, if investment as a percentage of GDP dropped from 50 per cent to 30 per cent it would have a much bigger impact on resources demand than a change in GDP growth from 8.0 per cent to 7.5 per cent. Demand for copper and steel are still high by traditional standards, driven by a similar set of end-use sectors: infrastructure, construction and manufacturing. However, investors shouldn’t necessarily expect more of the same in China. Credit growth has slowed considerably during the past two months and the government appears determined to tighten liquidity conditions this year and in particular the growth of the shadow banking sector. We should expect demand growth to weaken from credit intensive sectors later in the year especially sectors that are highly carbon intensive as environmental controls tighten.

LNG will be a focus

The most interesting development in the Australian energy markets will be the commencement of the huge Gladstone liquefied natural gas (LNG) projects. While this could be a boon to the Australian economy, there are a few things to consider. LNG from the east coast of Australia is sourced from coal seam gas, which carries higher operational costs and potentially lower profits meaning tax revenues from these projects may not be substantial for many years. Also, if the new volumes of LNG being sold were to buoy the terms of trade considerably as some expect, the Australian dollar could be more supported than the RBA would like, providing a conundrum for interest policy.

Executive remuneration and governance in the spotlight

A number of companies have received their first strike since the introduction of the ‘two strike’ rule and a continued focus on executive remuneration is likely in 2014. As a result, companies that continue to have remuneration structures poorly aligned with shareholders’ interest and/or poor disclosure on remuneration details as well as companies with poor overall governance structures might see significant ‘against’ votes in 2014.

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Housing finance report – May 2103

Total housing lending rose by 2.0% in May and is 15.5% higher over the year.

Total lending activity continues to edge higher.  The 1.8% increase in the number of loans financed to owner‑occupiers was just under market expectations of a 2.2% lift (CBA (f): +2.3).  The housing finance data is another confirmation that parts of the Australian economy are responding to lower interest rates.

Both construction‑related and established owner‑occupied lending rose in May.  The number of loans for established dwellings rose by 2.1% in May.  And the number of construction‑related loans was 0.6% higher over the month.  Construction lending has increased significantly over the past twelve months.  This is positive for the growth transition and our residential construction forecasts.  The trend in Australian demographics is one of rising migrant inflows and a lift in the birth rate.  These factors have favoured a lift in residential construction activity for a while.  The improving trend in housing affordability is unlocking this demographic demand and points to a significant lift in construction over 2013.

Lending to investors also continued to edge higher in May.  The construction component of investor lending has been the stronger part of the story recently, with construction lending surging by 17.2% in May.  This also bodes well for our residential construction forecasts.  Total construction‑related lending is up by 26.5% over the past year.

It was encouraging to see a pick‑up in lending across all the States in May.  In the month, lending was the strongest in QLD rising by 3.9% followed by Vic (+2.6%).  Over the near‑term we see the strongest growth in housing lending occurring in NSW and WA.  The number of loans to owner‑occupiers rose by 1.0% in NSW and by 3.4% in WA over the month.

The pick‑up in housing activity is in line with the RBA’s (and our) forecasts.  The 25bpt rate cut in May is likely to provide further support to housing activity in the near‑term.  The slowdown in the mining part of the economy will be partly offset with a stronger housing market.  Part of the baton pass that the RBA wanted to achieve with looser monetary policy settings is on track.  Non‑mining business investment remains subdued and we will need to see stronger activity in this sector to ensure that the growth transition to the non‑mining economy is more even.  We expect that the RBA will cut the cash rate to 2.5% in August, if the QII CPI data prints towards the bottom end of the 2‑3% target band (as we expect).

Click here for the full report.

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