RINGING THE BELL BY CHARLIE AITKEN so far

Transcription

1 RINGING THE BELL BY CHARLIE AITKEN so far

2 Table of Contents DATE NOTE SUBJECT PAGE 12 JAN Ringing the Bell on JAN The four twos 8 16 JAN US Dollar leverage JAN Big 4 Banks: UPGRADE JAN The Union is Strong & Macquarie Group (MQG) JAN Central Banking on it & Disc retailers JAN Bonds vs. Equities & BOQ JAN Applestra, Property and Fairfax (FXJ) FEB RBA & Medibank Public FEB The search for yield broadens FEB USD & Bank Hybrid Portfolio FEB Downgrading Australian Dollar target, upgrading ASX200 target range FEB Applestra: upgrading price target again FEB The end of the beginning FEB Mid-cap 13 month yield CGF and AHE FEB Fund managers FEB Crown Resorts: if you build it they will come FEB QANTAS: TAKE +200% TRADING PROFITS, switch to SYD and CWN MAR The Dash from Cash accelerates...upgrading ASX200 trading range again MAR Frank-ly, I m still backing the Lowy s +$12b later MAR The Greenback is back (again) & Servcorp (SRV) 94 About Ringing the Bell Ringing the Bell is authored by Charlie Aitken and provides comprehensive, insightful equity market analysis before the market opens every trading day. Charlie has spent over 22 years working in financial markets, starting his career in 1993 on the floor of the Sydney Futures Exchange dealing SPI futures for clients of Ord Minnett/Jardine Fleming. He worked with County Natwest and its future owners Salomon Smith Barney and Citigroup until he joined Southern Cross Equities in 2003 which was acquired by Bell Financial Group in He has worked in both large and small firms, but has always been focused on the core business of finding undervalued stocks and investing with conviction. Charlie provides specialist market commentary to advisers and clients of Bell Potter.

3 P JAN RINGING THE BELL ON 2015 Good morning, happy new year What s catching my eye? 1. US Dollar Index 2. WTI Volatility 5. T20 Big Bash (TEN) 6. Bond yields 7. High end Sydney property 8. Bay of Islands (NZ) 9. US job creation 10. US unemployment rate As we enter a new calendar year the temptation in writing macroeconomic and equity strategy is to change course. However, the lesson of the last few years is clearly the trend is your friend and premature contrarianism can have dire portfolio performance ramifications. My three key global macro long ideas of 2014 were the US Dollar, Chinese equities and rising volatility. That trifecta paid in 2014 and I expect more of the same in 2015.

4 P. 4 RINGING THE BELL: 2015 SO FAR US Dollar Index (DXY) Shanghai Composite Index VIX

5 P. 5 Thankfully, the other major negative global macro event of 2014, the oil price crash, we were on the right side of being underweight/short major Australian E&P stocks and overweight Qantas (QAN) and Westfield (WFD). Don t get me wrong, that was probably good luck/gut feel/learning from the iron ore mistake, more than good forecasting, as I never dreamt we d see a WTI Oil price with a 4 handle ($48.36). Either way, you accept good luck when it happens and let it run. ASX Energy Index (XEJ) Qantas (QAN) Westfield Corp (WFD) post-split

6 P. 6 RINGING THE BELL: 2015 SO FAR The Oil price crash has MAJOR inflationary implications which you can see the bond market is all over and pricing in. In fact, both input prices in terms of commodity prices have fallen across the board and wage inflation also remains anaemic. The bond markets could well be right in pricing in an extended period of low inflation/deflation and low GDP growth. Let s just remind ourselves of some of these stunningly low long bond yields globally. Country 10 year Government bond yield Australia 2.71% United States of America 1.95% United Kingdom 1.59% Germany.48% France.78% Japan.28% Italy 1.88% If anything, they are right about the only developed economy in the world having UPSIDE interest rate (cash rate) risk being the United States. Every other developed economy, from the UK, through Eurozone, Japan and even Australia has a flat to lower interest rate trajectory ahead. This is why I continue to believe in the currency world all roads lead to the US Dollar and we are in the infancy, yes infancy, of a major US Dollar revival which has major cross asset class and volatility ramifications. I continue to recommend shorting the Japanese Yen, Euro and Australian Dollar. My target on the US Dollar Index (DXY) is 100 in the near-term, while I have to admit that I also forecast the NZ Dollar will go above parity to the Australian Dollar due to the differentiated growth and interest rate directions of the respective trans-tasman economies. The key point is that for Australian based investors there remains a clear case for increasing US Dollar exposure either directly or indirectly. I am targeting 75usc as my AUD/USD target. It s only 7usc away and we have all seen how quickly currencies can move. I will explore US Dollar exposure more in further notes later this week. Australian based investors also need to strongly consider what the global and domestic bond yield curves are trying to tell you. The Australian 10yr bond yield is now only 21bp above the current RBA cash rate setting of 2.50%. The entire Australian bond yield curve with the exception of the 10yr yield is now below the current cash rate. That discount to the cash rate has widened since I last wrote on the topic in December and it s fair to say the RBA is getting further and further behind the curve. My core strategy is the RBA will cut rates by 50bp in the 1H of 2015 as GDP surprises on the downside and unemployment on the upside. That clearly has currency, asset allocation, stock and sector recommendation ramifications for Australian based investors. Clearly, for one, the equity yield trade would be far from dead in that scenario.

7 P. 7 I am going to start the year by banging the drum on a core high conviction stock pick and portfolio overweight, Telstra (TLS). This is a classic example of letting a winner run. TLS could well be the top 10 stock to own. It has dividend growth, positive earnings revision, regulatory certainty, pricing power, excess capital and massive grossed up yield advantage to any duration of Australian government bond. TLS is an equity growth bond. In FY15 I forecast TLS to pay 32c of fully franked dividends. The interim dividend is a little over a month away. At the current share price ($6.07) TLS has a prospective dividend yield of 5.27% or 7.52% grossed up based off that 32cff annual dividend forecast. With the huge move down we have seen in bond yields and yield curves this morning I am upgrading my TLS price target to $7.00 from $6.40. There is simply no way that TLS will continue to yield grossed up more than 3.5x the equivalent 3yr government bond rate, or potentially more than 3x the future RBA cash rate. TLS yield will be bid down and inversely capital growth will be solid. TLS vs. 3yr AGB yield That s my first piece of stock and portfolio advice this year: make sure you own enough Telstra (TLS) was not an easy year for Australian based investors and I expect 2015 will be somewhat similar. However, there will be capital gains and income to be generated we just need to remain extremely focused on where that will come from. The key lesson from 2014 remains to be a ruthless cutter of losers and to let winners run. I suspect that will be even more valid in 2015 as the Fed starts the interest rate normalisation cycle, while the rest of the world is heading in the other direction. I hope I can again help you negotiate through what will continue to be volatile markets. Go Australia, Charlie

8 P. 8 RINGING THE BELL: 2015 SO FAR 14 JAN THE FOUR TWOS Good morning after another night of cross asset class volatility What s catching my eye? 1. US Dollar Index US 10yr Bond 4. Dr Copper looking sick 5% 5. Gold remaining bid 6. Brent 7. Nickel 3% 8. Zinc 2.7% 9. Resmed (RMD) ADR 10. Telstra (TLS) making fresh highs No doubt the rally in safe havens and protection is a sign we can expect further equity market volatility. The fact we are seeing the US Dollar, US long bonds, global long bonds, gold and volatility (VIX) all rally at once is a sign of investors becoming increasingly defensive. On the other side of the equation the sell-off in the commodity complex can accurately be described as a rout. The world appears to be positioning for an extended period of low GDP growth, low inflation and ultra-low interest rates. That is all you can conclude from the pricing of long bonds and commodities. That view, outside of the USA, is most likely correct in my opinion and clearly has stock, sector and asset allocation ramifications for Australian investors. I thought I d spend some time today giving you my top down views on Australia for the year ahead. My core thesis for Australia this year is based around the four twos. Those being: 2% GDP Growth 2% Inflation 2% Cash rate 2% ASX200 EPS growth While they appear very conservative forecasts vs. historic Australian economic performance, I believe they could even prove optimistic by the end of the year. In my opinion the RBA is now significantly behind the curve with its current cash rate setting of 2.50%. The bond market is calling the RBA s bluff with every Australian bond below 10yrs in duration now yielding lower than the current cash rate. Since I last wrote about this on Monday the 10yr yield has dropped another -10bp to 2.61%, a yield of just 11bp above the cash rate. I am forecasting two 25bp rate cuts from the RBA in the 1H of 2015 in response to our deteriorating terms of trade, over-priced currency and weaker than expected GDP. I agree with Bill Evans from Westpac that the RBA should move in February ahead of what could be a negative headline GDP print for Q that will be released in early March.

9 P. 9 At the end of 2014 the RBA published a simple illustrated summary of the Australian economy. Personally I think it paints too bullish a story My forecasts for 2015 would see the top 3 lines be 2%, the AUD/USD cross rate at 75usc, the population growth of +1.6% being maintained, unemployment rising to 6.7%, AWE being flat, the savings ratio rising a notch as households struggle with uncertainty, residential property prices rising up to another +5% (as lower cash rates meet population growth) and services accounting for 60% of economic output as mining declines. I m not trying to paint an overly-bearish macro picture for Australia, simply a realistic one as the prices of our key commodity exports drop faster than anyone forecast. No doubt, at some stage the lower Australian Dollar, lower petrol prices and record low interest rates will drive a GDP recovery, but in my view that is not yet and we remain in that volatile transition phase from the mining investment boom to what comes next. Fiscal austerity is also not helping the economic transition. Underneath that macro overlay we can still generate positive total returns in Australian equities. We will have to be focused and concentrated, but if I am right about where the currency and cash rates are headed we will be able to make money in the right Australian equities this year, as was the case in This is all about stock-picking now. As you well now I have been overweight Australian listed USD earners and non-bank industrial yield stocks. I ll write more on USD earners on Friday: today I want to focus on non-bank industrial yield stocks. Quite frankly, any equity that has bond like characteristics will outperform. You can see this is happening globally and domestically in early This will continue in my opinion and that is why I started the year by upgrading my Telstra (TLS) price target from $6.40 to $7.00. What I am most focused on is stocks that offer dividend growth in 2015 not simply dividend yield. TLS is clearly in that category and other high conviction non-bank dividend growth ideas are listed below. AMP (AMP), APA Group (APA), Challenger (CGF), Goodman Group (GMG), GPT (GPT), IAG (IAG), Transurban (TCL), Sydney Airport (SYD), Suncorp (SUN), Tabcorp (TAH), Wesfarmers (WES) and Spark New Zealand (SPK). Yes, it s a boring and predictable list, but boring and predictable is going to a big P/E premium to volatile and unpredictable in The way I look at this is what grossed up yield premium ratio to a government bond should an equity with bond like characteristics command??? The answer is not the current 3 to 3.5x.

10 P. 10 RINGING THE BELL: 2015 SO FAR We have an ageing population that favours investment income over capital growth and a superannuation and taxation system that strongly rewards franked income streams over unfranked income streams. My point is we might be all underestimating the further scramble for fully franked equity yield ahead and I wouldn t be surprised, if I am right about domestic cash rates heading to 2.00%, to see the dividend growth stocks above bid down in yield in the year ahead. Capital growth will simply be an inverse relationship to yield. In a funny way while I see daily commentary about the equity yield trade being dead, on my screens looking cross asset class it appears more alive than ever. That s my second piece of portfolio advice for 2015: make sure you own enough reliable dividend growth stocks. The list above is a good place to start. Go Australia, Charlie

11 P JAN US DOLLAR LEVERAGE Good morning, The Swiss National Bank (SNB) unexpectedly scrapping the cap on the Swiss Franc/Euro cross has caused another night of wild cross asset class volatility. The CHF/EUR cross is +18.5% (despite Swiss cash rates being lowered to negative -.75%) and that appears to have driven further buying of safe haven assets and protection. Oil and US equities have also had huge intraday swings. What s catching my eye? US Dollar 3. Gold 4. US 10yr bond (stunning) WTI 7. US bank earnings 8. India cutting cash rates 9. Cattle year highs 10. Utilities and Telcos outperforming As you know I attempt to get the top down (macro) right then pick the right stocks/sectors for maximum leverage to those medium-term top down themes. I believe equity markets are becoming more and more top down driven and accurate views on currencies, interest rates, bond yields and commodities are essential for successfully navigating the equity asset class. Similarly, top down views on volatility and sentiment play a role in timing investments/trades. You have to have a view on all pieces of the investment puzzle, not simply a myopic bottom up view on equities. That view doesn t have to be overcomplicated: it simply needs to be more right than wrong in a world of high frequency trading and instant everything. The playing field in current information has never been more level. The present is highly efficiently priced in: the arbitrage opportunity in equities is 3, 6 and 12 months away. My goal is to attempt to work out what they key macro indicators are pricing 3, 6 and 12 months away and set an equity portfolio strategy to benefit from those future prices. In reality, I am basically trying to predict what my trading screens have on them 3, 6 and 12 months from today. That worked pretty well in 2014 and that is what I am again trying to do in Many readers ask me why are you still so bullish on the US Dollar after such a strong move up?. That s a fair question with the US Dollar Index (DXY) up +16% since June My answer is because by the end of 2015 I expect US cash rates to be 50bp higher and Australian cash rates to be 50bp lower. I believe the USD/AUS cash rate spread will move 100bp in the USD s favour in 2015.

12 P. 12 RINGING THE BELL: 2015 SO FAR That s only from an Australian perspective. Versus every other major currency the USD will move by +50bp. In reality this like a stock with dividend yield growth when every other stock has a flat to lower dividend growth outlook. Many other major currencies are still having rights issues (QE). A wall of money will continue to rotate back to the USD as its dividend yield rises. The initial move up in the USD has simply been due to the end of the six year rights issue known as QE. For all of 2013 and 2014 I have been bearish the Australian Dollar and bullish the US Dollar. While my AUD/USD target of 75usc is now within sight, the asset allocation ramifications for Australian based investors remain the same. I continue to urge you to lose the home bias via either physically buying US Dollars, physically buying units in an unhedged Australian based offshore investment manager (including Bell Asset Management s Global Fund which has done very well), or physically buying Australian stocks with a high proportion of USD earnings (ex resources). If nothing else, buying Australian stocks with a high proportion of USD earnings will lead you to holding a portfolio that has greater FY15 earnings growth than the ASX200 on simple USD/AUD earnings translation alone. In a market where earnings growth is hard to find, and earnings downgrades easy to find, currency translated EPS growth is EPS growth. I suspect in the pending FY15 interim reporting season the upside risks to current consensus forecasts lies in stocks with a high proportion of USD earnings (ex resources). My key high conviction USD earning ideas are listed below. All have earnings upside revision risk in my opinion. Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). In the banks, ANZ (ANZ) generates the greatest proportion of USD earnings. The other way I like to play the rising USD theme is through domestic beneficiaries of the falling AUD. On that basis I continue to like the inbound tourism sector as Australia as a destination becomes better relative and absolute global value. It was interesting to see that Australia, and New Zealand, both moved up the rankings of Chinese travellers preferred destinations for This is good news. You can see below that the Chinese Renminbi is trading at a 5 year high vs. the Australian Dollar. This coupled with increased directly airline capacity from mainland China to Australian (and New Zealand) will drive a spike in Chinese inbound tourism.

13 P. 13 CNY/AUD: 5 year high This is occurring at the same time as Australian s start to holiday at home. The fall in the AUD has made overseas travel less attractive to the average Australian and I think you can see that reflected in the recent series of profit downgrades from Flight Centre (FLT). I continue to be overweight key Australian (and New Zealand) inbound tourism exposures, with the high conviction list including Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Qantas (QAN), Air New Zealand (AIR.NZ), Village Roadshow (VRL), Ardent Leisure Group (AAD) and Sealink Travel Group (SLK). For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt. That s my 3 rd piece of portfolio advice for 2015: make sure you own enough USD exposure either directly or indirectly Have a good weekend, Go Australia, Charlie

14 P. 14 RINGING THE BELL: 2015 SO FAR 19 JAN BIG 4 BANKS: UPGRADE What s catching my eye? 1. Volatility US Consumer confidence 4. US Dollar Index 5. AGB 3yr 6. Silver +4% 7. FX broker carnage 8. Consumer prices 9. Eurozone deflation 10. Here comes the ECB with QE The stunning moves down we have seen in global and domestic yield curves, combined with record low 10yr bond yields and collapsing commodity prices, suggests we are entering a period of low inflation, low GDP growth and ultra-low cash rates. The only developed country in the world where cash rates will rise this year is the United States of America. However, even if I am right and the Fed raises US cash rates by +50bp it only takes the US cash rate to the still ultra-low setting of.5%. The rest of the developed world has downside cash rate risk and some will embark on further QE. Savers will continue to be punished for a crime they didn t commit. Anyone requiring investment income to live will be forced up the risk curve, both globally and domestically. Investors looking for historic fixed income like income returns will be forced into equities and buy-to-let residential property. In terms of equities, that means they need to become far more accepting of short-term capital volatility in seeking those historic fixed income style returns. Quite simply, if the long bond yields we see in front of us today are sustained for an extended period the price paid for any instrument that has bond like characteristics will rise as yields are bid down. That was the basis of my Telstra (TLS) price target upgrade to $7.00 last Monday and last Wednesday s reinforcement of key non-bank dividend growth ideas (AMP, APA, CGF,GMG, GPT, IAG, TCL, SYD, SUN, TAH, WES, and SPK). In Australia, with our ageing population and the nuances of the taxation and superannuation system, franking credits become even more valuable in an ultra-low interest rate environment. This is particularly relevant to anyone who has entered the pension phase of super (0% tax) who gets the full franking credit rebated from the ATO. The only liquid way the man in the street who doesn t own a private business can accumulate franking credits is via buying listed Australian equities. I ve tried to explain to foreign investors that to understand Australian equities who have to think like an Australian investor in the pension phase of super. You have to think grossed up yield because that is effectively exactly what certain fully franked dividend stocks physically yield to holders over 60 years of age. That is how I approached TLS over the last 5 years and the big 4 banks via setting dividend yield based share price targets. I get the feeling that any liquid Australian industrial equity that can demonstrate fully franked dividend growth is going to be re-rated. I strongly prefer demonstrable dividend GROWTH over basic dividend yield. In terms of the BIG 4 Australian banks I need to reassess my view to take into account these dramatic moves in bond yields and the likely direction of Australian cash rates.

15 P. 15 In recent times being underweight the BIG 4 banks and overweight non-bank dividend growth stocks has worked pretty well. ANZ, NAB and WBC have broadly gone sideways/down for a year, yet CBA has moved ahead into its record interim dividend in February. This somewhat lacklustre performance from Australian bank equity is despite the sharp moves down we have seen in bond yields, CMT rates and TD rates. That is why I am looking again at the sector this morning. Let s start by looking at forecast EPS growth in FY15 over FY14 Bank FY14 EPS FY15 EPS (est) % EPS growth yoy ANZ % CBA % NAB % WBC % Now let s look at forecast dividend growth in FY15 over FY14. Bank FY14 dividend FY15 dividend (est) % div growth yoy ANZ % CBA % NAB % WBC % Now let s look at current FY15 forecast raw and grossed up dividend yields based off the last closing price Bank FY15 yield FY15 grossed up yield 3yr Bond yield ANZ 6.04% 8.62% 2.07% CBA 5.12% 7.31% 2.07% NAB 6.29% 8.98% 2.07% WBC 5.80% 8.28% 2.07% In summary for FY15 (est) Bank FY15 P/E FY15 EPS Growth FY15 DPS growth FY15 grossed up yield ANZ 11.2x +6.9% +6.1% 8.62% CBA 14.5x +6.9% +6.7% 7.31% NAB 12.3x +23% +6.0%% 8.98% WBC 12.6x +5.3% +4.3% 8.28% With every form of Australian fixed interest having a 2 handle (unfranked) it is now unlikely that Australian banks will prospectively yield more than 4x those fixed interest yields on a pre-tax basis. I expect these bank yields to be bid down in the year ahead and this morning I am reverting to setting 12 month Australian bank share price targets inverse to a 5.00% FY15 fully franked dividend yield. 5.00%ff is 7.14% grossed up, so still a hefty equity risk premium to fixed interest to compensate for the volatility and risk of equities. 5.00%ff FY15 dividend yield based share price targets Bank FY15 div (est) 5%ff yield target FY15 % gain from current SP ANZ 189 $ % CBA 428 $ % NAB 210 $ % WBC 190 $ %

16 P. 16 RINGING THE BELL: 2015 SO FAR This fully franked dividend yield based approach to 12 month bank share price target setting worked very well over 2013 and 2014 when 5%ff targets were hit. I expect it to work again in 2015 as cash and bond yields plumb record lows. In table above you can see potential FY15 total return scenarios (inc franking credits) of between +9.71% for CBA up to +34.8% for NAB. With benign bad debts, NIM maintained, falling wholesale funding costs and quantified regulatory capital risk, the sector now looks primed for total return outperformance. Prospective dividend yield alone will support the sector at current share prices. Similarly, in this yield environment any capital raisings will be swamped. EPS growth will be better than the ASX200 in FY15 as ASX200 consensus earnings are revised down. The big 4 banks will be volatile in the weeks and months ahead but I believe you are now being compensated in terms of yield premium for that volatility risk. I expect bank dividend yields to be bid down inside volatile trading ranges. With the CBA interim pending, which will confirm all of the above, it is time for portfolio action. This morning I am UPGRADING ANZ and WBC to buy alongside the NAB buy recommendation, neutral on CBA. I am moving to mildly overweight the sector. Go Australia, Charlie

17 P JAN THE UNION IS STRONG & MACQUARIE GROUP (MQG) Good morning, What s catching my eye? 1. US Dollar Index WTI US 10yr 7. AGB 10yr 8. Volatility 9. Denmark cutting cash rates 10. Dr Both the World Bank and IMF have cut global growth forecasts in recent days but interestingly the one developed economy where growth forecasts are being revised up is the United States of America. It is therefore no surprise the US Dollar Index made a fresh high last night (93.05) and now has my near-term target of 100 in sight.

18 P. 18 RINGING THE BELL: 2015 SO FAR IMF forecasts The positive revisions to US growth forecasts come ahead of the President Obama s State of the Union address this morning (Aust time). It is fair to say that in economic terms The Union is Strong, in fact, strengthening its relative and absolute growth lead to the rest of the world, most likely because it has previously had QE and ZIRP for longer than anyone else. USA growth being revised up comes as the Eurozone embarks on QE tomorrow and China prints its worst GDP growth number in 24 years. You can see why I think all roads lead to the US Dollar.

19 I think it s worth looking at a series of top down charts of macro indicators of the US economy (source WSJ). P. 19

20 P. 20 RINGING THE BELL: 2015 SO FAR The chart above is interesting. It shows of total US December retail sales of $442.93b that gasoline station sales fell by -6.9% or $39.42b. If current gasoline pump prices are maintained, which given the price action in WTI Oil seems likely, then US consumers are saving $1b per day vs. pcp on gasoline costs. That s the equivalent of a genuine tax cut for middle America remembering gasoline prices are a regressive tax: they hit low income earners harder proportionally (and vice versa). Similarly, in further good news for middle America, 30 year fixed mortgage rates are tumbling due to haven demand for US long bonds in US Dollars. Remember, it is long bond rates that decide mortgage rates in the USA with the ability to refinance also easier than in jurisdictions like Australia. US job creation is also strong with readings of positions vacant at multi-year highs while lagging indicators such as unemployment and underemployment are also at the lowest levels since the GFC. In my view there is no doubt that low gasoline prices, low mortgage rates and employment growth will continue to drive the US economy ahead of ALL developed world economies. US equities will have to deal with the negative earnings translation effect of the higher US Dollar at some stage, but judging by the early Q4 numbers being reported now that is not yet. So in my simple way of approaching currency forecasting the US Dollar has the strongest earnings growth (aka GDP growth) and strongest dividend yield growth (aka rising cash rates). It has also finished its multi-year rights issue (aka QE) while others are just embarking on it. At the macro level I continue to forecast the AUD/USD cross down to 75usc, the Euro down to parity with the US Dollar and US Dollar moving towards 130yen. My near-term target of 100 on the US Dollar Index (DXY) may well prove conservative and I encourage all readers to continue to lose the home bias and increase US Dollar leverage both directly and indirectly. In an Australian context these global growth downgrades mean ASX200 earnings growth will be harder to find. That is why I am looking for industrial ideas that can most likely grind out +6% EPS growth and generate a 6%+ pre-tax dividend yield. A +12% pretax total return may well look extremely attractive by the end of 2015 if bond yields are to be believed. That is why I recently upgraded TLS and the big 4 banks.

21 P. 21 As I wrote last in Friday s US Dollar leverage note currency translated EPS growth is EPS growth and that key USD earning stocks were cum consensus upgrades. We got evidence of that earlier this week when Macquarie Group (MQG), who generates 65% of revenue outside of Australia, revised up their earnings guidance. MQG is a member of my key high conviction USD earning ideas list alongside Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). In the banks, ANZ (ANZ) generates the greatest proportion of USD earnings. MQG is now more of a fund manager than investment bank. I tend to think comparisons to US investment banks, and their cyclical profitability, are out of date. MQG has a lot more in terms of better quality, higher ROE, and lower volatility income than its US-based peers. With 62% of operating income now generated from annuity-style businesses than generate an ROE of 24%, and as I said above, 65% of revenue generated from offshore, I suspect MQG s PE is about to rise a few points to reflect the greater forecastability of EPS and DPS. MQG didn t give details of the drivers of the profit guidance upgrade but it s fair to assume currency and advisory fees played a role. I also keep hearing market rumous they had a big win in oil trading, but that is yet to be confirmed. Either way, I m not too interested in the minutia, more that MQG has confirmed they have earnings leverage to our key macro themes: the US Dollar. TS Lim has upgraded his FY15 NPAT estimate to $1,455m and we now forecast MQG to generate +20% EPS growth in FY15 and +16% DPS growth. Despite the share price bounce from Monday MQG remains a cheap US Dollar leverage stock with the ability to deliver total returns above most ASX200 members. Again, that should lead to P/E expansion as growth becomes harder to find. Based off a MQG share price of $60.00 below are our forecasts and multiples. FY15 FY16 FY17 NPAT $1,445m $1,550m $1,635m EPS 460c 492c 521c EPS Growth +20% +7% +6% PE 13.04x 12.19x 11.51x P/book 1.4x 1.4x 1.3x ROE 13.2% 13.4% 13.5% DPS 302c 334c 366c DPS growth +16% +10.5% +9.5% Dividend Yield 5.03% 5.56% 6.10% The only slight negative with MQG is that dividends are only 40% franked. However, this is the trade-off. If you want earnings growth driven via offshore revenue exposure you are going to have to tolerate a lower level of franking. Interestingly though, and this is a positive, shareholders are now getting a greater share of the growing revenue pie with the compensation ratio down to 43% in FY15 from 45% in FY14. MQG remains a high conviction buy. The EPS/DPS forecasts are in an upgrade cycle. That cycle will be underestimated if I am right about my 75usc AUD target. By the time we get to end of FY16 (March 2016) I expect MQG consensus EPS to be 500c. I expect the market will pay 14x for that 500c EPS and therefor set a 12 month price target for MQG at $ That would equate to a +16.6% capital gain and 5.03% yield, taking potential total 12 month return above +20% even from today s $60.00 share price. Have a good day, Go Australia, Charlie

22 P. 22 RINGING THE BELL: 2015 SO FAR 23 JAN CENTRAL BANKING ON IT & DISC RETAILERS Good morning, These are certainly extraordinary times. There is no reference book for what we see in front of us today which leads to high shortterm cross asset class volatility. However, high near-term volatility and uncertainty is actually ideal for setting medium-term investment strategy. Over the last 5 years all you really had to do at the macroeconomic and investment strategy level was front-run central banks, most notably the US Federal Reserve. The concept of not fighting the FED proved 100% accurate. Fast forward to today and the FED is slowly reducing its largess but the rest of the world is increasing monetary policy stimulus, albeit a bit late in certain jurisdictions. It s like a free money baton change from the FED to the ROW and it clearly has investment strategy and portfolio construction ramifications that I have been trying to address in these notes firstly in currencies in 2014, and now in equities in early This year alone we have seen China, India, Denmark, Switzerland, and Canada all cut cash rates. The SNB abandoned the EUR/CHF peg. The ECB has confirmed a $50b a month QE program, the BOJ is going full tilt with Abenomics, while interestingly the BOE had no dissenters (previously two) at its last Board meeting when it came to maintaining QE. Interest rate expectations globally, with the exception of the USA, have been lowered sharply in early 2015 in response to a clear global deflationary threat. The commodity complex collapse, led by energy, is having a major downside interest rate expectation effect as measured by yield curves. Similarly, global growth forecasts have just been downgraded by the World Bank and IMF, with the only positive growth revision to US GDP forecasts. Australian GDP growth forecasts and inflation forecasts are also being revised down. This makes perfect sense as our terms of trade falls with our key export commodity prices. The AUD fall is offsetting a touch, but the AUD hasn t (yet) fallen as far as our key export commodity prices. About the only industries raising prices in Australia are Private Health Insurers and Private Schools. As you know I forecast the four 2 s for Australia in 2015: those being 2% GDP Growth 2% Inflation 2% Cash rate 2% ASX200 EPS growth There is no doubt in my mind that the bond market is now thinking and pricing similarly to these forecasts. Bond yields started moving down early this year and the Australian equity market has been a little slow to react to what is occurring. In my opinion the RBA is now significantly behind the curve with its current cash rate setting of 2.50%. The bond market is calling the RBA s bluff with every Australian bond below 10yrs in duration now yielding lower than the current cash rate. Since I last wrote about this on Monday 12 th of January the 10yr yield has dropped another -13bp to 2.58%, a yield of just 8bp above the cash rate. The 3yr bond yield has dropped to 2.06%, 44bp below the current cash rate, and could even have a 1 handle shortly. I am forecasting two 25bp rate cuts from the RBA in the 1H of 2015 in response to our deteriorating terms of trade, over-priced currency and weaker than expected GDP. I agree with Bill Evans from Westpac that the RBA should move in February ahead of what could be a negative headline GDP print for Q that will be released in early March. Whether the RBA moves in February is a coin toss. They may well wait another month, but in terms of investment strategy that is broadly irrelevant. Australian cash rates are coming down this year and I have to set a strategy to be ahead of domestic and global flow from fixed interest & cash to equity dividend yield.

23 P. 23 Borrowers caused the GFC, but the over-indebted will continue to be rewarded with the lowest interest rates in history. Whoever thought an Italian 10yr bond would yield 1.72%!! Conversely, savers and those who rely on investment income to live will continue to be punished for a crime they didn t commit. However unfair that is, it is the reality of the day and my job is to forecast who will be the beneficiaries of income seekers moving up the risk curve in search of higher returns. I have attempted to move quickly at the Australian strategy level in three ways. Firstly upgrading TLS ($7.00 target) and the major banks (5.00%ff yield targets), secondly reaffirming high conviction non-bank yield growth ideas, and thirdly reiterating USD leverage and inbound tourism exposures as the AUD heads towards 75usc. I have tried to get the message across in the big liquid stuff first. Major Banks ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC) Non-bank dividend growth AMP (AMP), APA Group (APA), Challenger (CGF), Goodman Group (GMG), GPT (GPT), IAG (IAG), Transurban (TCL), Sydney Airport (SYD), Suncorp (SUN), Tabcorp (TAH), Telstra (TLS) Wesfarmers (WES) and Spark New Zealand (SPK). USD leverage Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). In the banks, ANZ (ANZ) generates the greatest proportion of USD earnings Inbound tourism Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Qantas (QAN), Air New Zealand (AIR.NZ), Village Roadshow (VRL), Ardent Leisure Group (AAD) and Sealink Travel Group (SLK). For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt As most readers are well versed in the views above, and hopefully well positioned, I thought I d end the week by analysing a yield based tactical trade we recommended back in mid-november. Discretionary Retailers On 19 th of November 2014 in a note simple titled Ho, Ho, Ho I recommended a tactical trade in 4 domestic discretionary retail stocks. My key discretionary retail plays are all small to mid-caps and the investment arithmetic for FY15 is below. P/E EPS Growth Yield ROE Open short JBH 11.9x +4.8% 5.44% 42% 12.7% SUL 13.6x +7.9% 5.23% 14% 10.6% RCG 14.5x +6.1% 6.68% 22%.16% AHE 12.7x +15.2% 5.87% 14% 1.13% The table above suggests these stocks will be supported at current share prices by prospective dividend yield alone. All the yield forecasts above are fully franked. Fast forward to today and this tactical idea has been ok, without being outstanding. 3 of the 4 stocks have risen, while AHE has fallen. I want to stick with this long discretionary retailers tactical trade for three reasons. Firstly, the fact we haven t seen any negative news from these names is actually positive, while at the macro level I forecast mortgage rate cuts and petrol prices to remain low. Thirdly, I expect the search for fully franked dividend yield to broaden to 2 nd tier industrials, including industrial cyclicals. I will reassess the trade during the interim reporting season.

24 P. 24 RINGING THE BELL: 2015 SO FAR The current FY15 investment arithmetic is (EST) Disc Retailer FY15 P/E FY15 EPS Growth FY15 grossed up div yield ROE Open Short JBH 12.4x +4.8% 7.48% 42.5% 10.55% SUL 15.2x +5.5% 7.00% 14.3% 18.93% RCG 15.8x +6.1% 9.01% 22.7%.15% AHE 11.6x +15.2% 9.15% 13.9% 1.56% Interestingly the JBH open short has reduced while the SUL open short has increased quite sharply as the share price has risen. That s arguably the final reason I will stay with this tactical trade: the chance of a solid short squeeze. The technical picture for SUL also looks supportive. However, I must stress the fundamental dividend and currency translated GROWTH ideas are at the top of this note and the bottom is a short-term tactical trading idea based off yield support. They key investment strategy point remains that we are witnessing the lowest fixed interest, bond and cash rates in modern economic history. They may well go lower. The price investors pay for any form of higher yield may well surprise us all. In this environment any equity with bond like characteristics will trade like a bond: inverted to its yield. Happy Australia Day, Have a great long weekend, Go Australia, Charlie

25 P JAN BONDS VS. EQUITIES & BOQ Good morning, What s catching my eye? 1. Volatility 2. Bond yields 3. US Durable goods orders 4. Gold 5. Dr Copper looking sicker 6. Resmed s (RMD) sales growth 7. Melco Crown Entertainment +10% in 2 sessions 8. Iron 9. Caterpillar Inc. 7.3% 10. US Utilities outperforming It seems increasingly clear that the Australian and New Zealand equity markets are starting to price in what bond markets and yield curves have been trying to tell them since late last year. No doubt you can see that equity price action is starting to mimic bond market price action as equity market investors reluctantly accept the sanguine medium term growth and inflation outlook that bonds are pricing. That is leading to any stock with bond like characteristics being re-rated and any stock with demonstrable earnings growth, even currency translated earnings growth, being re-rated. On the other side of the equation any stock that is a price taker is being de-rated. Bond yields and industrial commodity prices/commodity currencies are moving in different directions and that makes fundamental economic sense. The clear risk is that post ECB QE being confirmed that bond yields globally and locally move even lower. That is a stunning comment when we are already at record low yields for most developed world bonds. However, we must remember the aim of QE, that being to make returns from safe instruments unattractive, lower borrowing costs, and get money moving into risk assets. That s exactly how the playbook worked for the USA and now we have the Eurozone, Japan and UK all embarking on similar programmes. The results will be the same: yield compression and capital gains in the right risk asset classes, albeit overlayed with capital losses in the given currency that is embarking on QE. I think it s worth reminding ourselves of current world 10yr bond yields. The 3 rd column is the change in yield over the last 3 months. Country 10 year bond yield 3 month change United States 1.82% -.44% Canada 1.41% -.59% United Kingdom 1.48% -.72% France.57% -.71% Germany.38% -.48% Italy 1.52% -1.02% Spain 1.38% -.75% Portugal 2.41% -.95% Sweden.69% -.53% Netherlands.43% -.60% Switzerland -.13% -.60%

26 P. 26 RINGING THE BELL: 2015 SO FAR Greece 9.23% +1.92% Japan.24% -.21% Australia 2.56% -.67% New Zealand 3.29% -.67% South Korea 2.29% -.42% China 3.39% -.31% Hong Kong 1.40% -.36% Not only are these remarkably low long bond yields, the pace of decline in yield over the last 3 months is what I am reacting to in my equity strategy. For example, when you see people are willing to pay a negative yield for the safety of Swiss Bonds for 10 years you realise there will be major equity market ramifications in terms of sector outperformance/underperformance. In terms of Australian equity strategy I am attempting to position for globally driven yield compression meeting domestically driven yield compression as the RBA cuts cash rates. I have a feeling we are all going to be surprised how much money attempts to move down a reasonable narrow street and that is why my entire focus this year has been on dividend growth stocks (and currency translated winners). I have attempted to move quickly at the Australian strategy level in three ways. Firstly upgrading TLS ($7.00 target) and the major banks (5.00%ff FY15 yield targets), secondly reaffirming high conviction non-bank yield growth ideas, and thirdly reiterating USD leverage and inbound tourism exposures as the AUD heads towards 75usc. I have tried to get the message across in the big liquid stuff first. My high conviction ideas are listed below. Major Banks ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC) Non-bank dividend growth AMP (AMP), APA Group (APA), Challenger (CGF), Goodman Group (GMG), GPT (GPT), IAG (IAG), Transurban (TCL), Sydney Airport (SYD), Suncorp (SUN), Tabcorp (TAH), Telstra (TLS) Wesfarmers (WES) and Spark New Zealand (SPK). USD leverage Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). In the banks, ANZ (ANZ) generates the greatest proportion of USD earnings Inbound tourism Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Qantas (QAN), Air New Zealand (AIR.NZ), Village Roadshow (VRL), Ardent Leisure Group (AAD) and Sealink Travel Group (SLK). For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt My theory is as we have never seen long bond yields this low we could be underestimating what price equity investors pay for stocks with bond like characteristics. Remember these are long bond yields that are being compressed which implies we all need to hunker down for a low growth, low inflation environment where collecting coupons and capital growth from yield compression is the best way to generate acceptable risk adjusted total returns. Yield compression is starting in large caps and will spread to mid-caps over the next few weeks. That is why after tilting the large cap strategy aggressively and quickly in January I am now looking to increase mid-cap exposure to stocks with bond like characteristics that will confirm those characteristics at the interim reporting season. With the RBA cash rate headed to 2.00% and long bond yields at 2.56% it is highly unlikely that ANY Australian equity will yield 6.00% raw or over 8.5% grossed up under that macro overlay in 12 months time. What I am doing is screening our analyst forecasts for dividend growth/dividend yield and focusing firstly on financials that still offer likely prospective deliverable dividend yields over 6.00% raw, or over 8.5% grossed up. That brings me this morning to Bank of Queensland (BOQ).

27 P. 27 Mid-way through last year I recommended selling BOQ around $12.00 and switching to SUN after the surprising departure of the BOQ CEO. That switch worked well with BOQ basically going nowhere and underperforming its peer group. That underperformance now sees me change my view on BOQ back to BUY. The stock is now cheap on all investment criteria and is likely to see its prospective dividend yield bid down in the weeks and months ahead. Interestingly, and that is what drives my upgrade today, is the stock has not responded to positive AGM guidance late last year. As TS Lim summarised at the time 2015 YTD momentum positive. BOQ held its AGM today. The outlook statement suggests underlying fundamentals continue to head in the right direction. Business Bank lending volume growth remains in line with expectations (with more new business generated outside QLD) while the Retail Bank has experienced 20% higher home loan approvals since September (boosted by ongoing strong performance in the broker network) that should translate into greater settlements and lending balances. As a result, we expect BOQ to comfortably meet its internal management targets (excluding BOQ Specialist): Lending asset growth of times system (BP times system); NIM in the low-mid 160s range (BP ~185bp including BOQ Specialist); Cost-to-income ratio in the low 40 s (BP 43% down to 41% in 2016); BDD charge as a percentage of GLA of around 20bp (BP 20-21bp); and ROTE of 13%+ (BP % including BOQ Specialist). In the two months since the AGM funding costs have fallen further and we d expect these trends to be evident in the interim result (April). At $12.15 BOQ offers +12% EPS growth in FY15, a 6.17%ff prospective yield (8.81% grossed up) and trades on 12.1x earnings or 1.3x book value. NIM (1.86%) and ROE (11.1%) are edging higher. No doubt regional banks generate lower returns than the major banks and are a degree riskier. However, I am setting FY %ff yield based targets for the big 4 and think that a 5.50%ff yield based target for regional banks is justified. A FY %ff yield based target for BOQ equates to a $13.63 share price target in months time. On that basis BOQ is upgraded to buy for the potential total return of +21% (including the value of franking credits). Even if I am proved wrong for some reason on the capital growth forecast, the 8.81% grossed up yield is more than acceptable compensation for taking equity risk. Go Australia, Charlie

28 P. 28 RINGING THE BELL: 2015 SO FAR 30 JAN APPLESTRA, PROPERTY AND FAIRFAX (FXJ) Good morning on a cracking Sydney morning, What s catching my eye? Denmark cutting rates for the 3 rd time in 2 weeks 3. Singapore cutting rates 4. Gold 2.22% 5. US Dollar Index 6. WTI 7. US Natural 8. Comex 9. Melbourne traffic 10. German deflation It s the last trading day of the month and what a month of expectation change and price movement it has been globally and locally. Bond yields have plummeted, commodity prices have plummeted, commodity currencies have plummeted, Central Banks have responded with rate cuts and further QE, while any equity with bond like characteristics has been re-rated. In Australia in the ASX top 20 Telstra (TLS) has led the way as global and domestic income seekers bid down its yield. Thankfully the first thing I did in 2015 was upgrade my TLS price target to $7.00 and after seeing Apple s blowout quarterly numbers I remain even more convinced TLS is an earnings and dividend upgrade cycle. I have previously written numerous notes on the Apple effect on Telstra. My simply thesis is Apple is enabling mobile data addiction (MDA). What is interesting is since Apple introduced large screen iphone models, of which yours truly uses, sales have gone through the rough (74.5m in qtr plus 22m ipads). Large models are clearly more effective for heavy mobile data users. The table below charts Apple s Q on Q iphone sales growth. This is all good news for TLS who dominates mobile data in Australia. It s a little known fact that over 1 million Australians now use two mobile phones: one for work and one for personal use. I forecast further product penetration per household and TLS s 4G network advantage (see also reliability advantage) will see TLS add more customers than its lesser competitors.