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.

29 P. 29 So despite the sharp move up in TLS shares in January I encourage you to stay the course. David Thodey and his team have this company very well positioned to capture the structural growth in mobile data. This is structural growth and below is a chart that confirms Apple and TLS shares are joined at the hip. I call it Applestra. Apple (APPL) vs. Telstra (TLS) Clearly TLS shares have been a short-term beneficiary of changing domestic interest rate expectations, expectations that I think are correct. As you know I forecast 2 x 25bp rate cuts in Australia in 1H I forecast a 25bp rate cut next Tuesday, but even if that proves wrong the rate cut will come in March. It s quite basic that a 2.50% cash rate is too high and behind the ever lowering global and domestic yield curve. All my currency and Australian equity strategy is based off a 2.00% cash rate in That brings me to Australian residential property where I get endless questions from investors. I also get endless phone calls from local real estate agents after a couple of big sales in my street. To my way of thinking residential property prices are driven by a combination of the cost of money, the availability of money, affordability, population growth and the Australian Dollar. The residential property market has often been characterised by a tug-of-war between first home buyers and investors. At the moment, it appears that investor activity remains the dominant force in the current cycle. Yet, although investors and first home buyers are often in competition for the same property, their reasons for home ownership can vary. Investors are invariably in search of yield and capital gain, while first home buyers are more driven by family and affordability issues. While the reasons for property purchases may differ, a major driver of home ownership by both investors and first home buyers is affordability. The two main determinants of affordability are the level of interest rates ( mortgage rates ) and the price of residential property. There is little doubt that affordability, in the form of multi decade lows for mortgages rates, has provided a major contribution to the strong gains for residential property over the last 2 or 3 years. Therefore, it would appear logical, that an understanding of the future direction of interest rates over the next few years, is absolutely crucial for any prospective property buyers whether they be investors or first home buyers. The level of short and long term interest rates, are determined by a complex variety of global and domestic factors. The short term

30 P. 30 RINGING THE BELL: 2015 SO FAR interest rate, or the cash rate, is set by the RBA. In contrast, the long term interest rate, which is usually the 10-year commonwealth bond yield, is set by fixed interest investors. Importantly, while short and long term rates are set by different entities at varying rates, both remain a function of future economic growth and inflationary expectations. In short, the bond yield is merely a reflection of the cash rate over a longer time frame. In a growing economy, bond yields are priced at a premium to the cash rate a positive yield curve ( i.e. upward sloping ) to reflect the expectation of stronger economic growth and higher inflation over the longer term. In contrast, in a weak economic environment, bond yields can trade at a yield discount to the cash rate inverted yield curve ( downward sloping ) due to an expectation of an extended period of slow growth. Yesterday, the yield on 10 year Commonwealth bonds fell to 2.49% or slightly below the cash rate of 2.5%. As a result, currently Australia has an inverted yield curve which reflects an expectation by professional fixed interest investors that both domestic economic growth and inflation will remain weak for an extended period. While falling Australian bond yields are largely a function of a weak domestic environment, they are also influenced by global trends. As such, in an increasingly correlated financial world, it is virtually impossible for any economy to remain isolated. Due to the anaemic economic outlook and deflationary forces effecting the majority of the Western world, Japanese and German 10 year bond yields have fallen to historic lows of just 0.24% and 0.47% respectively. In the US, where the outlook is significantly better, 10 year bond yields still remain extremely low having recently fallen to 1.72%. Incredibly, real short term rates ( cash rate minus inflation) in Europe and Japan are negative while the US has a zero cash rate. Clearly, if the Australian economy weakens further, short and long term interest rates can fall significantly lower than current levels. In this regard, the professional money markets ( bank bill futures ) are already expecting another 50 bp fall in the cash rate to 2% this year. Clearly the fall in the 10 year Commonwealth bond yield is also reflecting this likelihood as the economy struggles in the aftermath of the mining boom. So what is the implication for the Australian residential property market? Considering, the cash rate is the primary determinant of variable mortgage rates, and the 3, 5 and 10 year Commonwealth bond yields remain the benchmark for fixed interest only loans, the outlook for mortgage rates for at least the next 18 months or longer, is lower or flat at best. Importantly, this represents a significant change to expectations last year when the consensus view was for interest rate rises beginning June this year. This is a major change in expectations. As a result, it appears that residential property affordability, based on interest or mortgage rate criteria, should be supported again this year. This is good news for both investors and first home buyers. It is worth remembering however, that affordability is also a function of property prices. In this regard, the majority of forecasters are expecting further gains of around 5% this year for East Coast residential property. My base case is for +5% median house price gains in 2015, yet that could easily be +10% as record low mortgage rates meet strong population growth and the AUD brings in expat and international buyers of Australian residential property. This view on further Australian residential property price gains is one reason I recently upgraded the major banks and Bank of Queensland (BOQ). Other leveraged derivatives of this view would include the property developers Lend Lease (LLC), Mirvac Group (MGR) & Stockland Group (SGP). REA Group (REA) will also be in an upgrade cycle. This brings me to Fairfax Media (FXJ) who could well prove the forgotten but leveraged way to play residential real estate. FXJ has not been killed. It s like a cockroach scuttling round your kitchen. In fact, if my analysis is right that cockroach has been breeding and the worst is behind FXJ. I feel FXJ earnings have bottomed as both cost-out and revenue growth beats expectations. The reinvigoration of the Domain brand is driving the renewed revenue growth. You can see below that FY15 consensus EPS estimates have been sneaking up and I feel FXJ is a positive earnings surprise candidate in the pending interim reporting season. Yes, you read that right I used the words Fairfax and positive earnings surprise candidate in the same sentence.

31 P. 31 FXJ consensus FY15 estimates: sneaking up Interestingly, if FXJ share price had matched the consensus EPS upgrades it would be trading $1.05. FXJ will generate over $1.8b of revenue in FY15, EBITDA over $300m and EPS above 7c in my view. This debt free company trades on an EV/EBITDA of 6.59x, EV/sales of 1.09x, price to book of 1.02x, price to cash flow of 12x and P/E of 13x. Dividend yield is forecast at 4.7%ff in FY15. On the basis of macro drivers meeting bottom up leverage I recommend FXJ as a trading buy up to 90c. If I am proved right at the interim result FXJ shares will break the 5 year technical downtrend and the medium-term price target would be $1.50. This whole situation reminds me of Qantas (QAN) a year ago. FXJ: 5yr downtrend break approaching Have a good weekend, Go Australia, Charlie

32 P. 32 RINGING THE BELL: 2015 SO FAR 02 FEB RBA & MEDIBANK PUBLIC Good morning, What s catching my eye? 1. US 10yr bond 2. US Dollar Australian 10yr bond 6. Australian 3yr bond yields with a 1 handle 7. Just how far the RBA is behind the curve 8. Socceroos 9. WTI Oil having a bounce on falling US drill rig count 10. Shake Shack IPO Since the RBA Board last met there have been dramatic moves down in bond yields, commodity prices and inflation/growth expectations. Seven other central banks globally have lowered interest rates, the ECB has embarked on QE, the Swiss have abandoned the CHF/EUR peg, while it even appears the US Federal Reserve is getting a little nervous about the timing of rate rises. The RBA now finds itself well behind the curve, both metaphorically and literally. I am of the view a 25bp rate cut on Tuesday afternoon is a certainty. A 25bp rate cut would still see Australia with one of the highest cash rates in the world, but the more important point is that a 25bp rate cut is now 100% priced into the Australian bond market, the Australian Dollar and Australian equities. Don t believe anything you read about only 50% of economists predicting a rate cut on Tuesday. The Australian financial markets are fully discounting the rate cut and in my view it is 100% priced in. The risk the RBA board faces is NOT delivering on the markets expectations. It would a terrible misjudgement to feel the Australian Dollar has fallen and NOT to cut rates. The Australian Dollar is 77.69usc because the world expects the RBA to cut rates by 50bp in the 1H of That lowered interest differential was the reason I had set a 75usc AUD target and now we are only 2usc from that target. The RBA needs to deliver on the financial markets expectations or be prepared to watch the AUD move quickly back above 80usc. So my point this morning is I 100% believe the RBA will cut rates by 25bp on Tuesday and I also believe it is 100% priced in to the AUD, AGB s and yield sectors of the ASX. I expect no dramatic price reaction to confirmation of the rate cut, the only dramatic price reaction would come if I am proved wrong and the RBA stands pat. Below is an overlay of the Australian Government 3yr bond yield and the AUD/USD cross rate, reminding you that the currency is just one big interest rate differential game. AGB 3yrs and now 55bp below the current cash rate. This confirms the Australian Dollar is now pricing in a series of rate cuts.

33 P. 33 What is also interesting is that the ASX200 is starting to outperform Wall St. Not in USD terms but in raw terms. I think we are starting to see underweight international investors starting to nibble in leading Australian equities as they feel the downside in the AUD from here is a manageable risk. That is the correct view in my opinion. Quite simply if foreign investors have been underweight, naked or short Australian equities for the last few years they have avoided a 30usc drop in the currency (-28%). With changing global and domestic interest rate expectations and a currency that has corrected to reflect those changing expectations, I think you are seeing foreign investors starting to come back to Australian equities for yield. The chart below overlays the ASX100 Industrials Index (XTI) and the US S&P500 Index. It is not in currency adjusted terms, simply a raw overlay which confirms a cross-over in performance since mid-january. I believe this is confirming that international money is nibbling again in leading Australian industrials with yield support. You can see we have been outperforming Wall St in raw terms most days in 2015 which will again be evident today.

34 P. 34 RINGING THE BELL: 2015 SO FAR The investment world is hunkering down for a medium-term period of low growth and low inflation. You can see that equity investors are starting to accept the message that bond markets and yield curves are telling them. Grinding out high single digit total returns will look good versus any form of fixed interest or cash. That lowered total return expectation is the right way to approach a macro overlay of low growth and low inflation. As you know I am looking for predictable businesses at reasonable prices that have the attributes to deliver total return outperformance under that macro overlay. I have tried to move as quickly as possible in these strategy notes to adjust to what the bond markets are telling us all. Today that brings me to MediBank Private (MPL), or Medibank Public as I like to call it, the largest IPO in many years in Australia that has gotten off to an excellent start as a public company (+19%). Due to MPL s huge retail investor ownership, and Bell Potter s role in the IPO, I do get many questions on what I think of MPL. From what I can tell most retail investors were allocated less shares in the IPO than they wanted due to the huge demand and are deciding whether they take the stag profit or buy more MPL and make it a significant holding in portfolios. My answer to that question is buy more and make it a significant holding in portfolios. Below I will explain my thinking behind that recommendation with help from our excellent Healthcare sector analyst John Hester. I think MPL is a CLASSIC story where top down growth meets bottom up leverage. The top down drivers of the Private Health Insurance industry will continue as Australia s population gets older and healthcare expenditure increases. Consider these series of macro charts of John s MPL initiation research.

35 Industry structure is also supportive with MPL controlling 29.5% of the industry and BUPA 26.8%. P. 35

36 P. 36 RINGING THE BELL: 2015 SO FAR In terms of the bottom up, stock specific MPL story, I think it s very simple. MPL is emerging from Government ownership and is likely to have significant scope for margin enhancement. I think margins and earnings growth will exceed analysts expectations and MPL will be in an earnings upgrade cycle for many years. I have attached John s full MPL initiation report in PDF and I strongly encourage you to read it. It s a really good piece that will bring you right up top speed on the industry and MPL s leading position in it. This is a $6.5b market cap company with 100% free float and no debt. Very kindly the Federal Government floated a debt free company. That is its first attraction. The second attraction is MPL is a growth stock. No doubt MPL will generate greater leverage to the structural growth sector theme due to its ability to enhance margins beyond the sector. Management are very capable. The third attraction is it controls a great brand. The successful IPO has enhanced the brand further and delivered greater brand loyalty from shareholders. And finally, I think FY16 and FY17 EPS is underestimated and the stock will be in a positive revision cycle for the next 24 months. There are now 14 analysts covering MPL and the consensus view is quite sanguine. 3 buys, 5 hold, and 6 sells. What is occurring is analysts are baulking at the highish near-term P/E and being conservative in their recommendations and price targets. The median 12 month price target is $2.33, below the current share price. However, as you know, taking on analyst scepticism at the right point is one of my key investment strategies. We forecast MPL to generate 11c EPS in FY16. I think by the end of FY16 that number will be higher. Yet even using 11c and the FY16 estimate the stock is trading on 21.4x, offers +24% EPS growth and ROE is rising to 20.8%. Remember, this is a debt free company so basic P/E comparisons to other geared healthcare companies are unfair to MPL. On EV/EBITDA comparisons and PEG ratios MPL is not expensive versus domestic peers and arguably has more earnings revision upside. Medibank Private FY16 FY17 Revenue $7,125m $7,565 NPAT $302m $323m EPS 11c 11.7c EPS Growth +24% +7% PE 21.4x 20x ROE 20.8% 20.9% FF Dividend yield 3.7% 4.0% Debt $0 $0 At the investment strategy and portfolio construction level I think MPL has all the attributes to generate outperformance and I am going to rate it a high conviction buy. John has a 12 month price target of $2.63 which is the highest in the analyst community. I am a touch more bullish than that and expect MPL to track towards $3.00 over the next 18 months as the upgrade cycle kicks in and the world seeks reliable growth stocks. On that basis I recommend accumulating Medibank Private (MPL) shares under $2.50 and making them a core portfolio holding in Australian equity portfolios. Let winners run: in fact, buy more of them. Go Australia, Charlie

37 P FEB THE SEARCH FOR YIELD BROADENS Good morning, What s catching my eye? 1. Australian 3yr bond 2. SMSF demand for yield equities 3. SMSF demand for bank hybrids 4. AMP above $ US oil 75yr highs 6. WTI Oil price volatility 7. Denmark cutting rates for the 4 th time to.75% 8. LME Copper 13 year highs 9. record high 10. The 5 year chart of Fairfax (FXJ) FXJ: downtrend breaking The search for yield comes to Australian residential property The decimation of cash as an asset class continued earlier this week when the RBA lowered the domestic cash rate to 2.25% with a further cut to 2% a near certainty. Clearly, the recent actions of global central banks forced the RBA's hand, but in reality it was in grave danger of being left badly behind the yield curve as we had written repeatedly in these notes. In addition, a failure to cut rates would have seen the AUD back above $US80c. Consequently, we have now become the latest country to adopt competitive currency devaluation as a monetary tool. Welcome to the global currency wars. Make no mistake, this was a big decision for the RBA. To suddenly change tack with the cash rate already below GFC crisis levels, and abandon "a period of stability" in favour of a new aggressive easing policy, is a monetary event which should not be taken lightly. Clearly, it surprised many economists and some institutional investors. However, against a global backdrop of deflationary forces and competitive currency devaluations, I think there is a very real possibility of the cash rate with a "1" handle at some stage over the next months. I know that prospect is hard to imagine. But instead of asking "why", ask yourself " why not."

38 P. 38 RINGING THE BELL: 2015 SO FAR As the "the once in a century" windfall of from the mining boom becomes a distant memory, it doesn't require a huge leap of faith to envisage our economy experiencing the same anaemic growth as the rest of the Western bloc in the aftermath of the GFC. As such, it is absolutely critical for the RBA to target a lower cash rate and a lower AUD. Unfortunately for savers and retirees, that means an extended period of very low ( or even lower) cash rates and fixed interest returns. Australian Government bonds of 5 year duration and shorter all currently have a 1 handle. While this is stunning, it is a clear signal of what the future holds for returns on cash. RBA Cash Rate 2.25% AGB 1yr yield 1.94% AGB 2yr yield 1.90% AGB 3yr yield 1.86% AGB 4yr yield 1.91% AGB 5yr yield 1.98% AGB 10yr yield 2.38% AGB 15yr yield 2.58% Cash certainly is not king. However, despite the prospect of zero returns ex-inflation, it appears many retirees remain overweight cash or cashequivalent assets. According to recent ATO figures, SMSF trustees held $161b in cash, term deposits and debt securities. With SMSF retirement assets now totalling $557b, this represents a cash weighting of 29%. Another report from the Financial Services Council revealed a higher cash weighting, with the average SMSF asset holding 35% in cash, 23% in domestic equities, and just 7% in residential property and 1% in overseas equities. Although the data may differ slightly, the key issue is that SMSF trustees remain heavily overweight cash and very underweight property and international equities. Given the strength of residential real estate prices, the very low SMSF property weighting is surprising. It's even more curious in the context of recent RBA warnings of a residential real estate bubble driven by SMSF trustees which in turn has prompted the threat of regulatory action aimed at curbing leveraged property borrowings within super. In contrast, it appears that SMSF property weightings remain low compared to cash and domestic equities. While it s true that SMSF property exposure has more than tripled over the last 2 years, it has been from a very low base. ATO figures reveal that since 2010, property borrowings in super have increased from $2.5b to $8.7b in the period to June last year. Clearly, this figure is dated, but the message is clear. Property borrowings represent just 1.5% of total SMSF assets of $557b. It is worth remembering that the average managed balanced super fund has mix of weightings in equity, property assets and fixed interest. Therefore it makes sense that a similarly balanced approach should be adopted by SMSF trustees when constructing a portfolio of assets. Currently, it appears that SMSF asset weightings are anything but balanced. I believe that will change. If I'm right, and cash rates remain low for an extended period, and possibly fall to 1.5%, then I expect the flood of money in search of equity yield will become a tidal wave which engulfs other high yielding asset classes particularly residential property. Unsurprisingly, after the RBA rate cut, a river of SMSF cash chasing dividend yield stocks has driven the ASX 200 to a 7 year high. Yet the stark reality is that retirees are between a rock and a very hard place. As the first stage of baby boomers enter the pension drawdown stage, they have little choice but to seek fully franked dividend yield which still offers a 400+ bp premium to the cash rate. The conundrum is, while the cash rate is at multi-decade lows, the major listed banks are at, or near all-time highs.

39 P. 39 As the returns on cash continue to fall, and fully-franked dividend is bid lower, I expect the residential property market will see renewed inflows as SMSF trustees continue a desperate search for yield. Clearly, property returns have been strong over the last few years and affordability continues to improve with multi-decade lows for mortgage rates, but I think the trend into residential property for SMSF trustees is still in its infancy. There is no other clear alternative. The latest report from Core Logic RP Data showed that the strong momentum in residential property prices has continued into 2015 with Jan average capital city dwelling price growth of 1.3%. Melbourne was the strongest performing market up 2.7% while Sydney rose 1.4%. The yearly figures also remain strong, with average capital city dwelling price growth of 8%. The standout was Sydney with annualised growth of 13% following a 12.4% rise last year. In addition, RP Data figures reveal that average capital city residential rental yields remained at 3.5% for houses and 4.4% for apartments. Meanwhile, in a yield-driven frenzy of buying, fully franked dividend yields on some of our heavyweights have fallen below 5% yields (historic) for the first time since the GFC. Currently, ahead of their results, the historic yield on TLS and CBA has fallen to 4.4% and 4.3% respectively. Make no mistake I'm no advocating selling the major banks or TLS, but this is good news for property. Clearly, residential real-estate doesn't have the higher after-tax benefits of fully franked dividends, but it currently has 4 times the capital return of cash and double the yield growth. More importantly, property is less volatile, has a significantly lower risk profile and has the added security of providing a good night's sleep for any investors still scarred by the GFC. At the strategy level I remain overweight direct and indirect Australian residential property exposures: Developers: Lend Lease (LLC), Mirvac Group (MGR), Stockland Group (SGP) and at the small cap end AV Jennings (AVJ). Mortgage Banks: ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC) and Bank of Queensland (BOQ). Home improvement/ renovations: Wesfarmers (WES), JB Hi-fi (JBH), Harvey Norman (HVN), Brickworks (BKW), GWA (GWA) and Boral (BLD) Media: REA Group (REA) and Fairfax (FXJ). Interestingly, most of the names above offer higher than market dividend yields which means they could find themselves in a concurrent earnings upgrade cycle and yield compression cycle. This is not a period to overcomplicate. The return on cash has been decimated and will go even lower. My job is to forecast where that cash flows to and its effect on asset prices/cyclical activity. The playbook is the United States of America who have had negative real cash rates for six years. Australia is around 3 years behind the USA in entering a medium-term period of ultra-low cash rates. The search for yield is going to broaden to other asset classes. It started in bonds/fixed interest, has moved to equities and I expect the next two yield compression asset classes to be hybrids and residential property. With record low cash rates and fixed interest yields we might be all underestimating how low equity, hybrid and rental yields are driven over the years ahead. Have a good weekend Go Australia, Charlie 09 FEB

40 P. 40 RINGING THE BELL: 2015 SO FAR USD & BANK HYBRID PORTFOLIO Good morning, What s catching my eye? 1. US economy adding +257,000 jobs in January 2. November and December US jobs data being revised up by +147, November was the strongest month of US private sector hiring since US Dollar Index 5. Which seems to be capping US equities 6. And Gold 2.2% to $1234oz 7. PHLX US Gold/Silver index 5.5% 8. DJ Utility Index 4% 9. SeaLink Travel Group (SLK) result 10. US Dollar Index (DXY) about to break the 30 year downtrend (below) Long-term US Dollar Index (DXY) chart (since 1967): high , low 71.80, average Charlie s target 100 in Bank Hybrid Portfolio As you are well aware my core macro strategy is the bond market and yield curves are correct in anticipating a long period of lower or even lower cash rates. I completely expect the search for yield to widen in Australia/NZ to any sector that can offer reliable coupons. Reliable coupons from reliable issuers have been aggressively bid down globally, with one notable exception: Australian Bank Hybrids. Let s just look at a series of price moves since January 15 th when domestic interest rate expectations started changing. Yield compression has driven everything except pref trading margins for listed hybrids. The average trading margin to BBSW for major bank preferred equity (hybrids) has increased from 3.28% to 3.75%.

41 P. 41 The ASX listed Bank Hybrid market has developed over the last few years to now be a genuine sub-sector with a $44b market cap. It is liquid and it is a clear alternative for fixed income focused retail investors. In recent times as listed Australian bank equity has been bid down to record low yields, bank hybrids from the very same issuers remain broadly unchanged in yield terms. Similarly, yields on wholesale Australian bank debt have been bid down to record lows, yet bank hybrids from the same issuers remain broadly unchanged in yield terms. As I mention above, margins to BBSW have actually risen. The first question to address is why is this so? It appears the arbitrage or yield gap between yields on bank equity, bank wholesale debt and bank preferred equity (hybrids) is both a function of ratings agency opinions on hybrids and new supply. The rating agencies have recently downgraded bank hybrids after the Basel III non-viability clause was introduced. Never mind that the banks are bigger, stronger and more profitable (i.e. CBA at $150b market cap ahead of record earnings and dividends) Major domestic bank senior debt is rated AA-, yet hybrids are rated BBB-??? Does it make any sense??? Only if you think the credit rating agencies got it right giving CDO s a AAA rating. What has happened is that larger institutional clients who hold these issues have sold bank hybrids pre-empting the next ratings agency downgrade to BB+. That would make bank hybrids under investment grade according to the ratings agency scale. Many institutions can t hold below investment grade paper. The second issue has been an increase in new supply. ANZ recently up-scaled its issue from $750m to $850m while NAB is also considering a new hybrid issue. Taking on ratings agencies is one of my favoured investment strategies. History suggests ratings agencies are the ultimate reverse indicator and those investors who are forced to follow their recommendations tend to be buying high and selling low. In my opinion ratings agency opinions should be utterly irrelevant to Australian retail investors. If you re happy to hold Australian bank equity, or an Australian bank TD or CMT, you should be also happy to hold Australian bank preferred equity (hybrid) from the same issuer assuming you are being compensated in yield terms appropriately. The credit spread or risk spread between major bank senior debt and Tier 1 hybrids has widened after the issuance of the CBAPD series in October, yet spreads in the wholesale market have contracted as institutional investors chase yield higher along the yield curve Let s look at some comparable current six year yields:

42 P. 42 RINGING THE BELL: 2015 SO FAR Comparative securities AGB May %p.a. NSWTC Apr %p.a. Senior Bank debt Bank TD Bank Sub-debt Major bank hybrids 3.30%p.a. 3.50%p.a. 4.15%p.a. 6.15%p.a. gross As I mentioned above, the ASX hybrid market has yet to gather this momentum presenting yield hungry fixed interest investors with an opportunity to lock-in an historically high margin. In my view that historically high margin won t last and this morning our fixed interest/credit specialist analysts, Barry Ziegler and Damien Williamson put together a model bank hybrid portfolio based on their bottom up analysis of each listed hybrid. Below is a portfolio of selected major bank hybrids with an average duration of 6yrs. This portfolio is yielding over 6.0%p.a. gross for taking on preferred equity risk in the big 4 banks, all of whom are making record profits and have CET1 ratios in excess of the Basel III requirements.

43 P. 43 I think there are clear grounds to roll maturing Australian bank term deposits into the Australian bank hybrids listed above. I don t believe this hybrid yield premium to all other fixed interest products will last. If I am proved right about a long period of low or even lower cash rates then this portfolio of bank hybrids will not only generate income streams significantly above cash, TD s and CMT s, but also potentially capital growth driven by yield compression. Sure, there is also potential for capital loss as there is in all listed instruments, but under my macro strategy the chances of capital gain from yield compression far outweighs the potential for capital loss. I think the pricing of these bank hybrids is an anomaly driven by forced institutional selling (following credit ratings agencies downgrades) and short-term supply (new issuance) and I am advising private investors to take advantage of the current mispricing situation in preferred equity (hybrids) vs. all other forms of Australian bank debt and TD s. In my opinion you are being currently overcompensated in yield terms for the true risk of holding preferred bank equity. Cash is not king. Go Australia, Charlie

44 P. 44 RINGING THE BELL: 2015 SO FAR 11 FEB DOWNGRADING AUSTRALIAN DOLLAR TARGET, UPGRADING ASX200 TARGET RANGE Good morning, What s catching my eye? 1. US Dollar Index 2. Fed heading for mid 2015 rate hike 3. WTI ( 5.2%) 4. Comex 5. NZD/AUD heading to parity (95.29) 6. CSL ADR 7. Resmed ADR 8. Baltic Dry Index 9. Jason Day s gutsy PGA Tour victory 10. Melco Crown Entertainment +3.7% Below is a chart of the AUD/USD cross rate (green), the RBA cash rate (purple) and the Baltic Dry Index (white) over the last decade. Mind the gap. Both the Baltic Dry Index and RBA cash rate are below levels seen at the peak of the GFC. I now believe it s only a matter of time before the AUD/USD cross rate re-correlates to GFC levels. On that basis this morning I am DOWNGRADING my medium-term AUD/USD price target from 75usc to 68usc.

45 P usc Last week the RBA joined the globally currency war. This is a very important development that requires a medium-term forecasting reaction. We have now become the latest country to adopt competitive currency devaluation as a monetary tool. Welcome to the global currency wars. Make no mistake, this was a big decision for the RBA. To suddenly change tack with the cash rate already below GFC crisis levels, and abandon "a period of stability" in favour of a new aggressive easing policy, is a monetary event which should not be taken lightly. Clearly, it surprised many economists and some institutional investors. However, against a global backdrop of deflationary forces and competitive currency devaluations, I think there is a very real possibility of the cash rate with a "1" handle at some stage over the next months. I know that prospect is hard to imagine. But instead of asking "why", ask yourself " why not." As the "the once in a century" windfall of from the mining boom becomes a distant memory, it doesn't require a huge leap of faith to envisage our economy experiencing the same anaemic growth as the rest of the Western bloc in the aftermath of the GFC. As such, it is absolutely critical for the RBA to target a lower cash rate and a lower AUD. Unfortunately for savers and retirees, that means an extended period of very low ( or even lower) cash rates and fixed interest returns. The ramifications of the RBA s clear policy shift are multi-faceted and cross- asset class. To my way of forecasting this now ensures that the Australian Dollar trades in a lower trading range, Australian fixed interest yields move into a lower trading range, Australian commercial property cap rates move into a lower trading range, Australian equity dividend yields move into a lower trading range, and inversely the ASX200 moves into a higher trading range and Australian residential/commercial property moves into a higher trading range. The playbook on all this is the USA 3 years ago. Outside of downgrading my medium-term AUD/USD forecast today I am also upgrading my forecast for median residential property price gains to +10% from +5% in 2015 and upgrading my ASX200 trading range forecast to from to It also means dips in equity dividend yield stocks and USD earners will be bought by the SMSF army who are being squeezed out of cash as an asset class with negative real returns. In recent days I have had many questions from advisors and investors about profit taking in dividend yield and USD earning stocks that have performed well in 2015 so far. My answer to those questions is DO NOT TAKE PROFITS. The investing world has not yet adjusted to what I write above and I think there s a very real chance we are all underestimating the amount of money that will attempt to move down a narrow street. My advice is to use any trading dips or ex dividend dips to INCREASE EXPOSURE to key dividend yield/dividend growth and USD earning ideas. Where these stocks have come from is not the issue: it is where they are going that matters. You will read report after report from my competitors and comments from some professional investors about how expensive these names have become. But expensive versus what????. History??? Their valuation model?? I must remind all readers that P/E s, and dividend yields for that matter, can be ANYTHING. If demand for the attribute outstrips supply then the P/E can be ANYTHING. History is NOT a guide to future market valuations. My theory remains that if the Australian bond market and fixed interest curves are proved right with their medium-term implied forecasts then we are all underestimating the P/E that will be paid by investors for stocks with the right attributes for the times. That is why I am recommending NOT TAKING PROFITS in key dividend yield/dividend growth and USD earning equities. Any pullbacks will be shallow and it will prove too cute for most investors to attempt to trade short-term volatility in this theme.

46 P. 46 RINGING THE BELL: 2015 SO FAR Today I am going to reiterate my strongest sector and stock selections based on an extended period of ultra-low Australian interest rates and taking into account my new lower AUD/USD forecast/higher ASX200 forecast. I have made a couple of additions to these list which are bolded. In Friday s note I will have a look bottom up at one or two of our key ideas after they have reported 1H earnings this week. Major Banks ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC) Regional Banks Bank of Queensland (BOQ) Non-bank dividend growth AMP (AMP), APA Group (APA), ASX (ASX), Challenger (CGF), Fairfax (FXJ), Goodman Group (GMG), GPT (GPT), IAG (IAG), IOOF (IFL), Medibank Private (MPL), Perpetual (PPT), 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), Mesoblast (MSB), Treasury Wine Estates (TWE), 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 Developers: Lend Lease (LLC), Mirvac Group (MGR), Stockland Group (SGP) and at the small cap end AV Jennings (AVJ). Home improvement/ renovations: Wesfarmers (WES), JB Hi-fi (JBH), Harvey Norman (HVN), Brickworks (BKW), GWA (GWA) and Boral (BLD) Media: REA Group (REA) and Fairfax (FXJ). Tactical trade: discretionary retailers JB Hi-Fi (JBH), Super Retail Group (SUL), RCG Corporation (RCG), Automotive Holdings (AHE) With my new 68usc AUD/USD price target I also reiterate my long-held view that Australian investors need to lose the home bias and increase asset allocation to proven, unhedged, Australian based, offshore fund managers. On that basis I am sitting down with one of Australia s best in that field this afternoon and will have more to say next week on the topic. Go Australia, Charlie

47 P FEB APPLESTRA: UPGRADING PRICE TARGET AGAIN Good morning, What s catching my eye? 1. NZD/AUD edging towards parity (96.00) 2. Kiwis are coming for Australian property 3. Australian unemployment at a 12 year high 4. Australia s Q GDP print could be negative 5. Australian yield curve 6. MPEL +3.6% 7. Has Macau bottomed??? 8. WTI Oil volatility 9. Medibank Private 10. Sweden moving to negative cash rates 11. Switzerland issuing 10yr The great American activist investor Carl Icahn believes APPLE is worth $1trillion dollars. With a current market cap of $735b and forward P/E of 14.8x, it s hard to argue with Mr Icahn s view that APPL.NAS could rise another +36% and become the world s first trillion market cap company. For the record Mr Icahn s listed vehicle, Icahn Enterprises, would be a top 20 stock in Australia. One of the key reasons I have been bullish on telecommunications stocks for the last few years is what I call the Apple effect. Smartphones are driving mobile data addiction (MDA) which in turn is driving revenue growth for Telco s with reliable 4G networks. It makes complete sense that the correlation below Apple and Telstra (TLS) is as strong as evidenced in the chart below. Apple vs. Telstra: Applestra

48 P. 48 RINGING THE BELL: 2015 SO FAR There was clear evidence of the Apple effect in Telstra s (TLS) record 1H FY15 earnings reported yesterday. What we can all observe in our daily life (1m Australians now have two mobile devices) did translate to mobile driven earnings growth for Australia s dominant telecommunications company. To me this is clear confirmation of our thesis on TLS actually being a growth bond. TLS David Thodey, who has done a terrific job running TLS, made a few comments yesterday that were very similar to what I think is are the genuine structural growth drivers of TLS earnings. To quote Thodey directly: TLS stands to benefit from our customers love affair with high-tech gadgets. We ve got a long way to go in the mobile industry in terms of connectivity. The use of tablets, the connectivity to machines, the opportunity to replace every PC, or augment every PC with a mobile device, you know cars will be connected etc.. Demand for mobile data was growing rapidly across industries as diverse as agriculture, mining and education. It s a fundamental change in the way we behave. We really just touched the top millimetre here. I couldn t agree more with those comments as I can see them in my own and my peer groups commercial behaviour. This is the start of a major structural change and to my way of thinking telecommunications companies are the railroads of the next century. I ve written before that the Australian economy simply can t open for business each day without TLS s networks, and as each day passes that becomes a more and more accurate statement. TLS should command the P/E of a monopoly critical infrastructure stock such as Sydney Airport (SYD) or Transurban (TCL) and that s where I think TLS s P/E is headed as investors bid down it s highly reliable fully franked (and growing) dividend yield. Let s now look at a series of slides from the TLS interim results pack.

49 P. 49

50 P. 50 RINGING THE BELL: 2015 SO FAR Mobile revenues grew +9.6% in the half and mobile is now +42% of TLS revenue mix. The EBITDA margins on mobile remain a very healthy 40%. Mobile revenue growth drove EBITDA +.5% in the half, but as has been the recent trend in TLS, analyst again underestimated the translation to strong NPAT and EPS growth in the half. NPAT rose +21.7%, EPS rose +23.4c, and the interim dividend was lifted from 14.5c to 15c fully franked. ROE rose from 26.8% to30.7% while ROIC rose from 15.2% to 16.4%. Gearing dropped from 51.4% to 49%. Capex dropped -4.7%. TLS has been my single best large cap total return idea of the last 5 years. Ever since the note Telstra, a gift from the Nation when the Future Fund was dumping TLS at $2.70, TLS has been a high conviction buy. Only for a very short period last year I downgraded TLS to neutral at $5.75 then upgraded it again back to shortly after. The first note I wrote in 2015 was upgrading my TLS price target from $6.45 to $7.00 when TLS was $6.07. Even though TLS has served me and readers of these notes very, very well, in all the time I have recommended TLS I have never seen the top down and bottom up drivers of growth being so strong, combined with macro factors such as cash rates driving demand for the stocks income attributes. The natural contrarian in me gets a little concerned by that, but this is a classic example of letting a winner run and that is exactly what I intend to do with TLS.

51 P. 51 The industry has structural growth, the company is superbly positioned to capture a disproportionate percentage of that growth, the brand is getting stronger daily, and the company s products have effectively become an essential service. If I then look at what Australian long bond yields are telling me about the medium-term interest rate and growth outlook in Australia and I see further growth in demand for large cap stocks that have TLS s attributes. All the macro and micro ingredients are in place and this cake (share price) will rise. Interestingly, and one of the key reasons I am staying with TLS, is the consensus analyst view remains sceptical. This has been the case the entire way up from $2.70 with analyst forecasts chasing the share price higher. As we sit here this morning the buy/hold/sell ratio on TLS is 5/13/4 and the median 12 price target is $5.87. Good luck with that. The chart below confirms TLS analysts (yellow line) have been chasing the share price for the last 2 years. Their scepticism is again evident in this morning s broker research on TLS. Below is TLS s FY15 consensus EPS forecast vs. the TLS share price over the last six months. TLS is in a structural earnings upgrade cycle. Note well the analysts only change their forecasts after results. I call that back-casting.

52 P. 52 RINGING THE BELL: 2015 SO FAR 17 of 22 TLS analysts are neutral or negative but this is the EPS growth they forecast for the next 4 years. My forecasts for FY15 for TLS remain unchanged. I expect FY15 EPS of 35c and FY15 DPS s of 32c. That implies a 17c ff final dividend on top of the 15c interim. With TLS cum the interim 15cff today and prospectively paying another 17cff in September, the 7 month yield is 4.96%ff assuming my final dividend forecast proves correct. 7.08% grossed up for 7 months is highly attractive vs. cash at 2.25%. In my first note on TLS this year I said 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. Since I wrote that note the RBA has cut cash rates to 2.25% and the interest rate futures market, post yesterday s sloppy employment data, is pricing in a 60% of another 25bp rate cut in March and a 90% chance of a 2 nd 25bp rate cut in April. Australian 3yr government bond yields have dropped from 2.16% to 1.87% since early January. It think it s very fair to assume the RBA cash rate will be 2.00% and AGB 3yr yield remain below 2.00% for Both may well ended up even lower. On that basis I am going to set a TLS 12 to 18 month share price target based off a pre-tax yield 3x the cash and fixed interest alternative. I am setting a grossed up yield target of TLS div Raw yield Grossed up yield 6.00% grossed up yield share price target 31c 4.80% 6.85% $ c 4.96% 7.08% $ c 5.11% 7.30% $7.85 The result is for the 2 nd time this year I AM UPGRADING MY MEDIUM TERM TLS PRICE TARGET. Taking into account yesterday s result and movements in interest rates I am upgrading my TLS price target from $7.00 to $7.50 Anywhere below $6.50 while still cum the 15c ff interim dividend (ex 27 th Feb, payable 27 th March) TLS shares should be added to portfolios. TLS remains a core high conviction buy and core portfolio overweight. Have a good weekend, Go Australia, Charlie

53 P FEB THE END OF THE BEGINNING Good morning, What s catching my eye? 1. (record high) 2. Here comes the parity party 3. Here come the Kiwi buyers of Australian property 4. Sydney Auction clearance rates 5. US Dollar Index (DXY) Australian 3yr bond 9. Pebble Beach 10. Macau bottoming What a stunning start to 2015 it has been as risk asset classes react strongly to central bank stimulus and currency wars. There should be absolutely no doubt that savers are being forced out of cash by negative real rates. Let s start today by looking at the 2015 ytd performances of global equity markets in raw, USD and AUD terms. Index Raw performance USD performance AUD performance Dow Jones +1.10% +1.10% +6.25% S&P % +1.85% +7.04% NASDAQ +3.33% +3.33% +8.60% Euro Stoxx +9.12% +2.36% +7.58% FTSE % +2.96% +8.19% CAC % +4.32% +9.64% DAX % +4.50% +9.82% FTSE MIB % +4.43% +9.76% Nikkei +3.17% +4.25% +9.52% Hang Seng +4.75% +4.71% % Kospi +2.23% +3.06% +6.78% CSI % -1.62% +3.36% NZX % -.57% +4.46% ASX % +3.58% +8.83% Last week's note on the decimation of cash as an asset class appears to have been well timed. The Australian equity market's performance on Friday was nothing short of stunning. Clearly, the decision to cut the cash rate has sparked the next leg up for equities and property. It seems the RBA's new aggressive easing policy has proven to be an inflection point for cash-up SMSF investors who have finally come to the conclusion that cash is no longer king. Despite being a latecomer to the party, February s rate cut and commentary confirmed that the RBA has now joined the central bank world of ultra-low rates and competitive currency devaluations. While the bad news is that savers and retirees continue to be punished by central bank policy, the good news is the playbook has already been written for the Australian equity market. The US provides the classic example.

54 P. 54 RINGING THE BELL: 2015 SO FAR Since 2009, US equity markets have more than tripled following 3 rounds of Fed quantitative easing policy (QE) and zero interest rate policy (ZIRP). Given the primary aim of such policy is to inflate asset prices hasn't it worked a treat? While the RBA hasn't committed to outright QE by buying government bonds, I expect the new and aggressive interest rate policy targeting a lower AUD will have the same effect on asset prices. I think Friday's local equity market performance is clear proof. In contrast, with the end of QE and the expected normalisation of US monetary policy, it appears clear that the tailwinds provided by QE, ZIRP and a weak US dollar which have driven a threefold increase in US equities, will now become headwinds, and an anchor around the neck of US corporate profitability. It is worth noting that 46.3% of S&P 500 revenues are derived from overseas. The earnings drag of a significantly higher $US on multi-national profits is already obvious in the current reporting season. The Fed's unconventional monetary policies have also supported a massive misallocation of resources. In 2014, US corporates spent approx $US560b on share buybacks and paid out $US350b in dividends from total profits of just under $US1 trillion. In two quarters last year, cash returned to shareholders exceeded total profits. According to Bloomberg figures, over 60% of S&P earnings growth over the last 5 years has come from share buybacks. As a result, average earnings growth ( 6%) has expanded at nearly 2.5 times the level of sales growth ( 2.5%). This is clearly unsustainable. In addition, ZIRP and QE polices have created such a low return environment that capital has been redirected away from business investment and capital expenditure. The result has been 5 years of anaemic economic growth. Wall St profits have not translated to Main St prosperity. Last year the average age of US plant and fixed assets reached 23 years which is the highest level in over 60 years. Clearly, stronger economic growth (hopefully) is expected to support earnings, but the end of the Fed's monetary largesse has created some serious headwinds for US corporate profits.

55 P. 55 In contrast, the major central banks ex US, particularly Europe and now Australia, remain committed to either ultra-low policy, new or renewed QE or competitive currency devaluations. It appears that the winds of monetary change have shifted away from the US, which I believe will support relative outperformance from other equity markets including Australia, in the continued global search for yield and higher returns. At this point, I expect many readers will highlight the RBA's recent downgrade of both GDP growth and inflationary expectations as a very high barrier for further gains in Australian equities. Indeed, last week I did mention the possibility that the domestic economy could soon experience a quarter of negative growth. It is worth remembering however, that the tripling of US equities, supported by over 5 years of QE and ZIRP polices, occurred against a backdrop of very weak, or sometimes negative economic growth, up until only very recently. Make no mistake, PE expansion driven by central bank liquidity rather than strong economic and corporate earnings growth is unsustainable over the long term. The domestic equity market is probably slightly overbought after the recent strong run and will no doubt suffer small pullbacks once ex interim dividends. But the US playbook has been written. " Don't fight the Fed. " This has proved a very, very reliable maxim over the last few years for US equities despite many warnings to the contrary. Similarly, "Don't underestimate the RBA." The decision to cut the cash rate was both a courageous and very aggressive move. The RBA is very committed to lower interest rates and a lower currency given a fiscal policy vacuum and a slow economic transition following the end of the mining boom. We have moved to our own version of unconventional central monetary policy. History shows that the result is a move up the risk curve for investors in search for yield and higher returns. In this regard, I don't think the Australian experience will be any different and that is why I have been moving so aggressively in portfolio strategy since early January. Don't get me wrong, I'm not suggesting a tripling of domestic equities from current levels. But my expectation is that higher US interest rates and a stronger currency will act in reverse and provide a headwind for US equities. Conversely, I believe Australia equities, which are now entering a similar economic cycle to the US in the aftermath of the GFC, are likely to relatively outperform their US counterparts. Perhaps not in USD terms, but in raw terms as we have seen so far this year. My job is to highlight macro- economic and big picture equity trends. I see the RBA's recent actions as very supportive for both equities and property. Sure, there will be trading corrections along the way, but for me it's not that difficult to imagine a real bubble forming in fully franked dividend yield as investors desperately chase higher returns up the risk curve which could drive the Australian market towards the all- time high? It's happened in other major equity markets under a similar monetary environment. Don't say why. Ask why not?

56 P. 56 RINGING THE BELL: 2015 SO FAR At the ASX200 Index level it s worth remembering the BIG 4 banks account for 31.2% of the index itself. Telstra is another 5.47%. SMSF and global income investor demand for those 5 equities alone will drive the index higher. In 2013 I created I created the self-fulfilling virtuous circle of bank equity demand in an ultra-low interest rate environment. I should have trademarked it. The conclusion was.. The ultimate winners of ultra-low interest rates in Australia are the oligopoly mortgage banks. I am going to attempt to illustrate my concept of a self-fulfilling virtuous circle that I believe Australian mortgage banks are in an ultra-low interest rate, rising domestic risk asset price environment. Ultra-low cash rates refinancing credit growth risk asset prices low BDD NIM ROE NPAT dividend super system demand for dividends demand for bank equity bank share prices.. And here it is illustrated, with just the key variables. The self-fulfilling virtuous circle of bank equity demand in an ultra-low interest rate environment This thesis is more relevant today at record low cash rates and record low bond yields. I thought it was worth republishing. I continue to encourage readers NOT TO TAKE PROFITS in key fully franked dividend yield equities and USD earners. In fact, the right strategy is buying into trading dips and ex-dividend periods. As Winston Churchill said.. Now is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning Go Australia, Charlie

57 P FEB MID-CAP 13 MONTH YIELD CGF AND AHE Good morning, What s catching my eye? 1. Japan Post s bid for Toll 2. Only a matter of time before Japan Inc. comes for AMP 3. Inbound M&A picking up after 30usc AUD fall 4. The dash from cash 5. Asset managers 6. Short s being squeezed hard 7. AGB 3yr 8. Brambles result 9. Dividend yield compression 10. Milk powder prices 11. Resist the temptation to take profits 12. Refer Tuesday s note The concept of the 13 month dividend yield works very well in an ultra-low interest rate environment. Right now in Australian equities I am looking to reinforce industrial ideas who have passed the interim profit and dividend season, yet who remain cum their interim dividends and associated franking credits. The ability to pick up the interim dividend, the annual FY15 dividend and the next interim dividend over 13 months stacks up extremely well versus the CMT (2.25%) or bond yield equivalent (1.90%). It stacks up even better when you take into account franking credits and the likelihood of further cash rate and bond yield declines over the next 13 months. However, we must focus on relative earnings certainty and dividend growth to get the most from the 13 month dividend yield strategy. That rules out every natural resource stock and the old adage that you don t buy resource stocks for yield is absolutely right in the current environment. You buy resource stocks for capital growth and you generally only get capital growth when commodity prices are rising. Others may well recommend them, but you will not see any resource stock recommended purely for yield in these notes. The two industrial ideas I want to reaffirm today appears cheap on all investment criteria, yet also have strong 13 month dividend yield/dividend growth attractions. They are both mid-caps and both members of my high conviction buy portfolios. Both have performed well since confirming earnings and dividends, yet I think there s more to come in a total return sense from here. With Australia s aging population and the medium-term prospect of ultra-low cash rates I think we are underestimating the cyclical and structural drivers of demand for annuity products. Challenger (CGF) is the clear market leader in Australian annuities and to my very simply way of thinking looks a certainty to be taken over if it remains as cheap as it currently is ($3.7b mkt cap).

58 P. 58 RINGING THE BELL: 2015 SO FAR Equals: CGF confirmed a 14.5c (70% franked) interim dividend and we expect another 15.5c (100% franked) as the FY15 annual dividend in August. The FY16 interim dividend is forecast at 16c (100% franked in Feb 2016). The raw 13 month expected dividend flow is 46c, while the expected grossed up value of the 13 month dividend stream is 63c. At the current share price of $6.60 that equates to a raw 13 month yield of 6.96% and grossed up 13 month yield of 9.54%. That is highly adequate yield compensation for equity risk and makes CGF a self-funding call option of M&A activity or re-rating. CGF is cum the interim 14.5c dividend until the 2 nd of March.

59 P. 59 That re-rating, either via M&A or naturally, is not a big call when the stock currently commands a FY15 P/E of 11.x and FY16 P/E of 9.8x. In FY16 EPS is set to rise +10%. ROE is rising to 14%, price to book is 1.3x, and this is quite frankly and undervalued stock in a structural growth industry. Challenger (CGF) remains a high conviction buy and if you ve made money from our other high conviction asset management plays (MQG, AMP, PTM, MFG) you should add CGF to portfolios. It will not stay this cheap. My medium-term price target on CGF is $8.00 The second mid-cap industrial 13 month yield idea is Automotive Holdings Group (AHE). AHE is Australia s largest automotive retailer by sales, profitability, market cap and workforce. Logistics also provides 30% of EBITDA with AHE being Australia s largest provider of fully integrated, temperature controlled transport and cold storage solutions. AHE is a cheap structural growth stock that the market currently discounts as a cyclical retailer/transport stock of sorts.

60 P. 60 RINGING THE BELL: 2015 SO FAR 1H FY15 performance was strong vs. FY14. On the back of earnings growth the interim dividend was lifted from 8.5cff to 9cff. We forecast a final FY15 dividend of 13.5c (ff) and an interim FY16 dividend of 10c, taking the 13 month raw yield to 32.5c or 46.4c grossed up. Based off a $4.00 AHE share price that equates to a 13 month raw yield of 8.12% or 11.6% grossed up. AHE is cum the interim dividend until the 12 th of March. Outside of the yield attraction AHE is fundamentally cheap. The industry consolidator/growth stock trades on P/E s of just 12.3x FY15 earnings and 10.8x FY16 earnings. FY15 EPS is forecast to grow +15% and FY16 EPS is forecast to grow another +13%. ROE is rising to 15%. My medium-term price target on AHE is $5.00. That s it today, keeping it short and sweet as I reaffirm high conviction mid-cap ideas with all the attributes for outperformance. The 13 month yields above won t last: take advantage of them before the broader SMSF army finds them. Just remember, the averaged SMSF cash holding is around 28% and cash is returning negative real. That cash is starting to move and we need to be positioned ahead of it. Next note Monday: have a good weekend, Go Australia, Charlie

61 P FEB FUND MANAGERS Good morning, What s catching my eye? 1. Dow Jones Industrial all time high 2. all time high 3. NASDAQ up 8 sessions in a row AGB 3yr 1.86% 6. Sydney weekend auction clearance 87% 7. Crown s (CWN) domestic VIP revenues 8. Servcorp s (SRV) earnings growth 9. Telstra s (TLS) 4GX network 10. Super Retail Group s (SUL) sales growth 11. SUL s 16.6% open short 12. Fairfax (FXJ) buyback 13. Macquarie Group s (MQG) operational update 14. WTI 15. CSL back above $ Virgin Australia (VAH) making a 1H profit Last week I sat down with one of Australia s greatest investors, Kerr Neilson, founder and CEO of Platinum Asset Management (PTM). Over the last few years, due to a top down bearish view of the Australian Dollar combined with a view of relatively weak Australian economic growth, I have encouraged all investors to lose the home bias in terms of asset allocation. That advice has been correct and in the wide-ranging discussion that is linked below Kerr Neilson further explores the opportunities in global markets at this point in time. The interview below plays on YouTube for roughly 20 minutes and I encourage you to view it when you have a spare 20 minutes. PTM shares fell -12% on Friday after reporting 1H earnings. I d also be encouraging you to take advantage of that trading pullback and collect the 27c in interim and special dividends that have been declared (ex 2 nd of March). PTM will pay another 20c dividend in August taking the prospective 7 month yield to 47c or 5.90%. As you can see from the CSL and IAG recoveries from knee-jerk one day results reactions, quality stocks don t stay down for long. PTM remains in my high conviction buy portfolio. If you click on my head it will take you to the full interview with Kerr (refer disclaimer at end of note). Turn the volume to full.

62 P. 62 RINGING THE BELL: 2015 SO FAR At the macro level I remain bullish on listed fund managers as equity markets make fresh record highs. With the return on cash likely to remain low for an extended period, equity fund managers can expect further inflows from retail investors. With relatively fixed cost bases, fund managers have good operational leverage to increases in FUM, both market driven growth in FUM and inflow driven growth in FUM. In my high conviction portfolios we recommend holding Macquarie Group (MQG) who smashed through my $70.00 target price, AMP (AMP), Platinum Asset Management (PTM), Magellan Financial Group (MFG), Challenger (CGF), IOOF (IFL), Perpetual (PPT) and even the stock exchange itself in ASX (ASX). If I am proved right about my macro views on cash rates then these listed fund managers have many years more of outperformance to come as investors abandon cash. When it comes to ASX listed fund managers to two top 20 plays are MQG (1.56% of ASX200) and AMP (1.33% of ASX200). Today I want to focus on AMP after last week s FY14 results. Let s start at the top: the 17 year downtrend in AMP shares has broken. This long-term downtrend break makes perfect sense when you take into account that AMP is now (finally) showing leverage to the structural growth theme known as compulsory superannuation. However, despite the operational improvements (off of a low base), AMP remains under-earning and under-valued vs. it s potential. Last year I called AMP the Coles Myer of financial services when analysing the logic of Wesfarmers bidding for AMP. I remain of the view that AMP is the Coles Myer of financial services and AMP should take that as encouragement because we can all see the value that has been created by WES in turning around Coles. In my opinion AMP remains the ONLY ASX20 stock vulnerable to takeover. Whether it s WES, Japan Inc., a US fund manager or private equity, Australia s 2 nd largest FUM fund manager remains a classic takeover target despite the share price recovery from recent lows.

63 P. 63 Don t get me wrong, new CEO Craig Meller and new Chairman Simon McKeon are doing an admirable job turning AMP around organically, but to me that makes it an even easier takeover play because its cleaner and giving a potential buyer the ability to split AMP up into the pure play, massive scale, wealth manager that could be so valuable. If I had $20b I d bid for AMP myself: that s how big an opportunity there still is in AMP despite the recent share price rise. AMP (a calendar year reporter) has good momentum coming into underlying profit rose +23% There was double-digit growth in all contemporary businesses. Solid net cashflows in wealth management and a $4.8b improvement in AMP Capital external net cashflows Cost to income ratio down 4.6% to 44.8% Surplus capital of $2b Underlying ROE +2% to 12.7% Gearing 10%: interest cover 14.6x +17% lift in final dividend to 13.5c (80% franked). Full year dividend 26c (DRP neutralised).

64 P. 64 RINGING THE BELL: 2015 SO FAR

65 P. 65 It s worth noting that the AMP FUM positions were as at Dec 31 st 2014 and as we all know since then global equity markets have done this in AUD terms Dow Jones +6.02% S&P % NASDAQ +9.00% Euro Stoxx +8.73% FTSE % DAX % Nikkei % ASX % Hang Seng +9.53% It would be fair to assume AMP s FUM has advanced solidly in the first two months of 2015 from both market movements and inflows. To me that simply means AMP is earning management fees from a higher FUM base and the stock will remain in an earnings upgrade cycle for 2015 as analysts chase the share price higher. As has been the case in Telstra (and QANTAS), AMP analysts have been broadly underweight/neutral the whole way up. That remains the case today with the BUY/HOLD/SELL ratio at 3/10/4 and the median 12 month price target recently upgraded to $6.54 from $5.83 before the FY14 earnings surprise. You can see that in the yellow line below. Similarly, consensus FY15 AMP EPS estimates continue to be revised up, chasing the share price.

66 P. 66 RINGING THE BELL: 2015 SO FAR In terms of our own forecasts we see another two years of double-digit EPS growth and associated dividend growth. AMP remains a self-funding call warrant on rising equity markets, the dash from cash, compulsory superannuation and potential M&A activity. AMP are cum the 13.5c (80% franked) final dividend until March 3 rd. We then forecast another 29c of dividends in 2015, taking the prospective 13 month yield to 42.5c (80% franked). At the current share price of $6.63 that equates to a prospective 13 month gross yield of 6.41% (80% franked). Over the last few years we have done well from AMP shares as a turnaround play. It is very similar to Telstra. However, just like TLS I am going to let this winner run as it starts to generate the earnings and dividend growth it should have over the last decade.

67 P. 67 Similarly, with the scrip of potential acquirers also being re-rated do not rule out one morning coming in and seeing AMP has been bid for. Just to remind you below is a long-term common performance base chart of Wesfarmers (WES) and AMP (AMP). Only +720% outperformance in the period! (before dividends and franking credits). On the basis that AMP now has multiple earnings and valuation tailwinds I reiterate our view that AMP is a high conviction buy and set a medium-term price target of.. $8.00 Go Australia, Charlie

68 P. 68 RINGING THE BELL: 2015 SO FAR 25 FEB CROWN RESORTS: IF YOU BUILD IT THEY WILL COME Good morning, What s catching my eye? 1. The dash from cash 2. Dow Jones Industrial fresh all time high 3. fresh all time high 4. NASDAQ up 10 sessions in a row 5. FTSE fresh all time high (15 years later) 6. fresh all time high 7. How long until the ASX200 recaptures the all time high of 6851?? 8. WTI 9. US 10yr bonds below 2.00% CSL ADR With global equity markets making fresh all-time highs I continue to look for mispriced structural growth at a stock specific level. What I am looking for are stocks that are part of a long-term structural growth theme that are currently discounted on a well-known short-term issue. That brings me to Crown Resorts (CWN) today who have tremendous leverage to one of the great long-term structural growth themes: the Chinese outbound tourist, yet are currently being discounted due to a short-term corruption crackdown that has affected both volumes and valuations of Macau based destination casinos. In recent times CWN share price had been tracking Melco Crown Entertainment s (MPEL.NAS) share price almost one for one. MPEL is 34.3% owned by CWN. That relationship changed last week as CWN confirmed 1H FY15 earnings that were +18% above the consensus forecast. The results proved CWN s diversified portfolio of assets have proven more resilient than expected, with the Australian assets, most notably Melbourne, actually benefitting from some of Macau s short-term woes. Last night in New York MPEL shares dropped -7.3% and today is a very opportune day to update my view on CWN and remind readers of the opportunity in CWN that is being provided by MPEL weakness associated sentiment.

69 P. 69 Quite frankly, I think we will all look back with the benefit of hindsight in a few years and realise the one chance you got to buy CWN shares cheaply was during the Macau corruption crackdown. It s also occurring at a time of relatively high capex for CWN which institutional investors with short-term performance benchmarks seem to baulk at. Let s start at the top: Projections are over 200,000,000 Chinese nationals per annum will travel internationally by 2020 and they will complete over 300,000,000 trips. The compound average growth rate per annum is around +18%. Find another consumer sector in the world growing at +18% compound for the last 5 and next 5 years. That is structural growth and when you find a structural growth theme you have to get maximum portfolio leverage to it. The good news is Australia is well positioned to cater for this structural growth in outbound Chinese tourism. The recent Sydney Airport (SYD) traffic stats release confirmed that on current growth rates (+16.4% in 2014), China is on track to overtake New Zealand as our strongest inbound market in What is also little known is the Australian and Chinese governments recently agreed on bilateral air services which immediately increases capacity from 22,500 seats per week to 26,500 seats per week between Chinese and Australian major gateways. A new category has been created between Australian major gateways and regional Chinese cities with a further 26,500 seats capacity. Both capacity categories will grow to 33,500 by October 2016, providing 67,000 seats per week accessible from Australian Major Gateways. That s total annual seat capacity of 3,484,000. When you re at Sydney Airport, or Brisbane or Melbourne for that matter, you can see with your own eyes all the Chinese flagged carriers. This is vastly different to a decade ago and will only get more prevalent in the years ahead as the landmark agreement described above almost triples available capacity and importantly creates extra capacity for new direct services from regional Chinese cities. This agreement on bilateral air services clearly represents the next stage of development of the Chinese inbound market into Australia and provides a significant opportunity not only for the major gateway airports (buy SYD), but also for hotel/destination casino operators tilting their product towards the Chinese inbound market. The other major macro development is just as airline capacity increases Australia is becoming better value to Chinese tourists because of the fall in the Australian Dollar. The chart below confirms that the Chinese Yuan (Renminbi) has appreciated +39% vs the Australian Dollar from recent lows, making Australia now globally competitive as a tourism destination with the advantage of being in the same time zone. This is another reason the RBA needs to cut rates again to keep the currency down and keep us globally competitive. The RBA remains behind the curve (AGB

70 P. 70 RINGING THE BELL: 2015 SO FAR The CWN interim result suggested Chinese VIP traffic is already arriving at their domestic properties, with VIP turnover play rising +61.4% to $37.1b in the 1H. These results were well ahead of our estimates with Crown Melbourne the star of the show. CWN Melbourne EBITDA rose +26.1%, while VIP program play rose +86.4%. That marquee property is really humming and now as the added certainty of regulatory certainty after the November 2014 agreement with the Victorian Commission for Gambling and Wagering that saw the Melbourne Casino Licence amended. This was a good outcome for CWN and the state of Victoria which is already seeing CWN attract more VIP s (VIP super tax removed). The way I approach CWN as an investment is that the existing domestic assets and the MPEL stake underpin the current share price. The 1H numbers were a pleasant surprise in terms of domestic asset performance and give me greater confidence in the near-term valuation. What interests me more, and where future share price appreciation will come from, is the portfolio of development assets both domestically and regionally. If you build it they will come is the right description. CWN is building it and the Chinese tourists are coming. It s that simple and patience through the capex cycle will be rewarded out the other side with a major step up in the CWN earnings base, a major diversification of the CWN asset base, and eventually a major step up in the CWN dividend base. CWN is one of very few major Australian companies actually forgoing high short-term dividend payout ratios and investing in future GROWTH. This is exactly the right strategy and CWN shareholders will be rewarded for this large scale

71 P. 71 investment in future GROWTH over the next 5 years as the assets start coming out of the ground and producing cash flows. Let s just remind ourselves of the major new assets CWN is investing in: Crown Sydney Crown Melbourne: new 5 star hotel (50/50 JV)

72 P. 72 RINGING THE BELL: 2015 SO FAR Crown Towers Perth Queen s Wharf Brisbane (potentially).

73 P. 73 City of Dreams Manila, Philippines, opened February 2015 Macau Studio City: opening late 2015 Many people say to be that Crown and Chairman James Packer seem to have a lot on. It is fair to say that Crown is in a heavy capex investment phase in future growth, but in my mind they are betting on a double certainty. The first is the rise of the outbound Chinese tourist that is occurring before our eyes. The second is the theoretic win rate of large volume destination casinos. To me it s a win/win strategy and CWN shareholders will reap those rewards in the years ahead.

74 P. 74 RINGING THE BELL: 2015 SO FAR In response to the 1H earnings surprise we upgraded our EPS forecasts by +8.7% in FY15, +7% in FY16 and +5.1% in FY17. It s fair to say we weren t alone and you can see the FY15 negative EPS revision cycle has reversed for CWN at the consensus forecast level. CWN FY15 consensus EPS forecast last 12 months Consensus now sees EPS growth for the next 4 years, rising to 122c in FY18 Double digit EPS growth resumes for CWN from FY16 on. The current FY16 multiple of 15x will prove too cheap in a broader ASX200 market where sustainable double-digit EPS growth will be hard to find. Being a supporter of CWN over the last 5 years had been rewarding. We are up over +100% since our initial positive view, and while the last 12 months has been choppy, driven by Macau sentiment, I remain of the view that CWN has the right long-term strategy to capture a disproportionate amount of those Chinese outbound tourist dollars both domestically and in the region. On days like today where MPEL weakness may well see some CWN weakness I strongly recommend accumulating CWN shares (cum 18c interim div) and holding them for the next 5 years when we will reap the rewards of their strategic investments. CWN shares are relatively illiquid for their market cap due to Mr Packers 50.1% holding and that is another reason I encourage you to buy trading dips.

75 P. 75 My whole thesis on CWN has been they are building a luxury brand and that the stock will be re-rated to a luxury brand multiple once that thesis is proven. On that basis I am setting a long-term price target of 20x FY18 consensus earnings. 20x 112c = $24.40 CWN remains a high conviction buy and a core member of high conviction model portfolios. CWN: 1YR technical downtrend broken Go Australia, Charlie

76 P. 76 RINGING THE BELL: 2015 SO FAR 25 FEB QANTAS: TAKE +200% TRADING PROFITS, SWITCH TO SYD AND CWN Good morning, What s catching my eye? 1. Australian Q4 capex 2.2% 2. Australian Q4 capex 8.6% vs pcp 3. Australian Q4 GDP print could be negative 4. Here comes the next 25bp from the RBA 5. AGB 3yr German 5yr bond US Dollar Index 11. WTI Qantas Airways (QAN) has been my single best trading idea of the last 14 months. From a low point of 95c back in December 2013 QAN shares have gained +200%. Today I am recommending taking trading profits in QAN. Airlines are trading stocks: always have been, always will be. They are not long-term investment grade in my opinion due to the fact they control very few of the variables in their business. QAN was clearly undervalued at the bottom of its earnings & sentiment cycle, yet today it is fairly valued with optimistic sentiment and that means from a trading perspective it is the right time to be locking in the substantial capital gains and look for other ways of making our capital work hard for us.

77 P. 77 Pretty much everything went right for us in this QAN trading idea. The Oil price collapsed, the AUD collapsed, the domestic capacity war ended and QAN s earnings recovered as confirmed in yesterday s interim earnings result. The QAN share price has tracked the FY15 consensus EPS revisions up as illustrated below. That drove a +200% share price appreciation and that s enough for me. Despite QAN management doing an excellent job, I suspect the next +20% gain in the QAN share price will be much harder and slower than the last +200%, and that is why I am recommending taking trading profits today. My final reason for recommending taking trading profits is all the analyst bears from 95c are now bulls with price targets above the current share price. The contrarian in me is happy to feed trading stock into that major sentiment change. This is illustrated in the table below where the buy/hold/sell ratio is now 11/1/1 and median price target $3.49. So where do we reinvest our trading profits from QAN??? Earlier this week I wrote in depth about the structural growth Crown Resorts (CWN) offers and that is one of the stocks (CWN cum 18c div) I would reinvest QAN proceeds in to keep myself exposed to the Australian inbound tourism theme.

78 P. 78 RINGING THE BELL: 2015 SO FAR The second idea is Sydney Airport (SYD). I think it s time to take trading profits in SYD s largest customer, QAN, and reinvest in the Airport itself. SYD has been a member of our high conviction list but I want to use the slight post reporting pullback to increase weightings. The chart below confirms QAN has now outperformed SYD on a two year common performance base and that to me says it s now time to own the airport not the airline. SYD vs. QAN: common performance base 2 years SYD is a macro meets micro idea. The falling AUD is improving Australia s relative value as a tourism destination. SYD is Australia s gateway Airport. Airline capacity into SYD is increasing. Passenger numbers are increasing. SYD s margin per passenger is increasing. The risk free rate is collapsing. SYD is effectively a structural growth bond yielding 5.00% for 12 month. It s yield premium of 2.58% to a 10yr Australian government bond (2.42%) will narrow in the years ahead. Inversely, SYD capital growth will come from yield compression. Warren Buffett famously said a monopoly toll bridge is my dream investment. SYD is a monopoly toll bridge that now has strong macro tailwinds for activity and valuation. Sydney Airport does have a genuine strategic, structural advantage over other Australian airports. Just consider the figures below. Look away good people of Melbourne, this might hurt a little. Sydney & NSW combined benefit from: 32% of Australia s population 41% of Australia s top 500 companies headquarters 90% of international banks regional headquarters 34% of Australia s international visitor bed nights SYD Airport 40% share of Australia s international passengers

79 P % share of Australia s premium traffic 37% share of Australia s outbound leisure traffic 517k tonnes or 47% of all international air cargo into Australia $65b value of air cargo each year Yesterday SYD confirmed CY14 earnings and confirmed a final distribution of 12c. They also guided to another 25c of distributions in 2015 (+6.5% on 2014). I only EVER play yield based strategy in individual stocks where the underlying earnings are RISING. SYD has a rising earnings base as confirmed in yesterday s 2014 result.

80 P. 80 RINGING THE BELL: 2015 SO FAR Which is translating to distribution growth. This is a textbook structural growth bond with strong management extracting high levels of economic rent from the monopoly asset base. I can fully understand why SYD s register is dominated by major pension funds, both global and local, looking for a predictable and growing income stream. SYD also confirmed the data I used in my CWN note from Wednesday about increases in bilateral air capacity between China and Australia. This remains big news yet not widely known.

81 P. 81 To me, as I ve written three times already in this note, SYD is a structural growth bond. I d own it over any form of fixed interest, every day of the week. The confirmation of that view is long-term traffic growth data which clearly shows structural passenger growth at SYD. This will continue and will accelerate in the years ahead as Asian capacity is added.

82 P. 82 RINGING THE BELL: 2015 SO FAR So how do we value SYD? The way I do it is to consider SYD a structural growth bond and price it relative to Australian Government bonds. At $5.00 the prospective 2015 distribution yield is 5.00%. Over the months ahead I expect SYD s distribution yield to be bid down to 4.50%, a 200bp premium to a 10yr AGB yield. A 4.50% distribution yield equates to a $ month share price target on SYD. With the potential for another +16% total return in the year ahead, I rate SYD a high conviction buy and the stock remains a core member of my high conviction portfolio as we enter a medium-term period of low or even lower cash rates and an associated lower AUD. SYD wins on yield compression and revenue growth in that scenario. Have a good weekend, Go Australia, Charlie

83 P MAR THE DASH FROM CASH ACCELERATES UPGRADING ASX200 TRADING RANGE AGAIN Good morning, and welcome to autumn What s catching my eye? 1. China (PBOC) cutting cash rates on Saturday 2. ASX % in February 3. Apple adding $66b of market cap in February 4. HFT accounting for 47.5% of US equity trading volume in February 5. NZ Black Caps stunning victory NZ 50 Index closing in on the all time high 8. Sydney Auction clearance rates 9. Woolworths (WOW) guidance downgrade 10. Medibank Private (MPL) making new highs after confirming 6.55% premium rises 11. Warren Buffett s 50 th shareholder letter (I ve used a few of the great man s best quotes in today s note) The central bank driven dash from cash is accelerating and you can see the effect it is having on risk asset prices, but particularly any risk asset price with a reliable coupon. The bond markets have been completely accurate in predicting lower cash rates/further QE and in the first two months of 2015, but particularly in February, we have seen the equity market start to position for a medium-term overlay of ultra-low cash rates. In the last 3 months we have seen 19 central banks, including the RBA lower cash rates. The ECB announced QE, the BOE maintained QE, the BOJ increased QE, while the SNB abandoned the CHF/EUR peg. On Saturday the PBOC cut both lending and deposit rates by another 25bp. The FED has not yet raised cash rates from 0%. I think it s worth reminding ourselves of current 3 and 10 year bond yields and the 2015 to date performance of equity markets in USD and AUD terms. For the USA I ve used the S&P500 Country 3yr bond yield 10yr bond yield Equity index USD Equity Index AUD

84 P. 84 RINGING THE BELL: 2015 SO FAR USA 1.00% 1.99% +2.20% +6.94% Australia 1.79% 2.46% +4.73% +9.57% Japan.02%.33% +7.78% % Germany -.21%.32% +7.64% % UK.76% 1.80% +4.78% +9.63% France -.12%.54% +7.28% % Italy.26% 1.35% +8.77% +13.8% There is a tonne of cash still sitting on the sidelines globally and domestically, earning form 0% real to -1% real in certain jurisdictions. Similarly, corporates are sitting on record cash piles and record low gearing levels. To me there is a growing chance of a style of melt up as investors move from cash into risk assets and corporates simultaneously embark on M&A and buybacks to deploy cash. The monetary policy settings are clearly in place and cash is now starting to burn a performance hole in all investors pockets. While private investors can tolerate underperformance institutional investors can t. Any institutional investors sustained underperformance is a genuine business risk and I am of the view many institutional investors have been prematurely cautious on risk asset markets and are now substantially underperforming due to their high cash holdings. In Australia, for example, you can see when large stocks go ex-dividend the SPI futures are well bid that day. That is the institutional market hedging the cash from the pending dividend for fear of being underinvested in a rising market. You can also see ex-dividend pullbacks have been shallow, a sign institutional investors have inflows and that retail investors are buying whatever dips they can in this environment. In the table above it is clear Australian bond yields are still high by global standards and could easily recouple to the rest of the world as our economy recouples to the rest of the world in a post mining boom environment. Our GDP growth is recoupling and there is no reason why our bond yields and cash rates won t recouple too. Lower Australian bond yields = lower Australian term-deposit rates and unfortunately for savers and those that reply on investment income to live, a somewhat nasty shock is coming from your friendly bank when it comes to rates to rollover TDs. Similarly, CMT s will off no alternative as cash rates drop. Australian banks are well funded meaning there is no reason for them to pay over the odds for retail deposits. The RBA Board meets tomorrow and they face, in my opinion, an easy decision. They should decide to cut the cash rate by another 25bp to 2.00% ahead of what I believe will be a SHOCKING Q GDP PRINT ON WEDNESDAY. After taking into account the very weak Q4 capex and wages data released last week, that Q4 GDP could print negative as I has written in these notes on numerous occasions. The RBA Board would be well aware of the risk of that GDP print being negative and what it could to do consumer and business confidence in this world of instant information, and I think they d be prudent to drop the cash rate to 2.00% ahead of it. If I am wrong and the Q4 GDP print isn t negative on Wednesday, it will only be slightly positive and way below what any central banker would consider trend growth. Inflation is also clearly contained in terms of wages and consumer prices (supermarket elephant fight helping). In February I forecast a 100% certainty of a 25bp rate cut and that came through. This time around I don t think it s a 100% certainty but closer to an 99.9% chance. Either way, Australian cash rates are headed to 2.00% or even lower this year and while I d like it to happen sooner rather than later, my entire strategy is based around it happening and I feel extremely comfortable in that positioning after the recent run of weak Australian data and no bounce in our key commodity export prices. The bond market is telling me I am right and I am positioned, as I have been all year, for the RBA to get back to the curve from its current position well behind the curve.

85 P. 85 However, poor historic GDP numbers don t make me bearish on Australian equities: far from it. In the US example, where monetary policy is 3 years ahead of Australia, the playbook was clearly that bad economic news was good news for risk asset prices as the markets correctly assessed that weak economic data meant more monetary policy morphine from the Fed. This is now the case in Australia, where poor economic data sees bond yields drop, interest rate expectations drop and the currency drop. All three are medium-term positives for risk asset prices. Markets move to the point of most pain. Don t we all remember that from However, today, the point of most pain is higher with the amount of cash sitting in portfolios and on corporate balance sheets. The pain trade is up and in my view it will continue. Earlier is this year I upgraded my ASX200 trading range target to 5500 to Today, for the 2 nd time this year I am upgrading my ASX trading range target to I m increasing both the bottom and top of my projected trading range by another 200 points in an attempt to be ahead of a further dash from cash in our heavy index weight, reliable dividend yield, equities. What we need to remember is this is proving to be a textbook equity bull market, not necessarily in the drivers of share price growth, but in how it has evolved. The great investor Sir John Templeton defined the bull market cycle perfectly: Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria. Right now in Australia we are entering the mature on optimism stage. Let s just look at a couple of excellent pieces of advice from Warren Buffett on the 50 Th anniversary of his investor letter. These all stand the test of time and then I will finish be reiterating our high conviction ideas UPDATED after the reporting season.

86 P. 86 RINGING THE BELL: 2015 SO FAR

87 P. 87 High conviction ideas: UPDATED Major Banks ANZ (ANZ), National Australia Bank (NAB), Westpac (WBC) Regional Banks Bank of Queensland (BOQ) Non-bank dividend growth AMP (AMP), Automotive Holdings (AHE),APA Group (APA), ASX (ASX), Challenger (CGF), Goodman Group (GMG), GPT (GPT), IAG (IAG), IOOF (IFL), Medibank Private (MPL), Perpetual (PPT), Transurban (TCL), 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), Mesoblast (MSB), Treasury Wine Estates (TWE), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). Inbound tourism Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Air New Zealand (AIR.NZ) and Sealink Travel Group (SLK). For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt Developers: Lend Lease (LLC), Mirvac Group (MGR) and Stockland Group (SGP). Home improvement/ renovations: Wesfarmers (WES), Harvey Norman (HVN), Brickworks (BKW), and Boral (BLD) Media: REA Group (REA) and Fairfax (FXJ). Tactical trade: discretionary retailers JB Hi-Fi (JBH), Super Retail Group (SUL), RCG Corporation (RCG), The vast majority of high conviction idea s above have performed well on both a total and absolute return basis. My fortune telling skills have improved!! They have passed the interim reporting and dividend season test. I am happy to stay the course as we move into a higher ASX200 trading range and potentially, at some stage in the next 18 months, challenge the all-time high of Do not rule that out happening and it could happen quicker than we all currently believe as the dash from cash accelerates. Go Australia, Charlie

88 P. 88 RINGING THE BELL: 2015 SO FAR 04 MAR FRANK-LY, I M STILL BACKING THE LOWY S +12B LATER Good morning, What s catching my eye? 1. AFR s headline shares clobbered after RBA leaves rates on hold?? 2. Ahh really?? on my screens the ASX200 lost 25 pts (.42%) after recovering from a kneejerk 55pt loss 3. What a clobbering to up +9.6% (pre dividends, pre franking credits) for 2015 to date 4. The number of Australian fund managers trying to talk large cap yield stocks down 5. Which most likely means they have been caught underweight 6. Today s Q4 GDP data 7. Could make the RBA s cash rate hold look odd 8. The AUD/USD s spike 30 seconds before the RBA rate decision release yesterday???? 9. Hmmmmmmm: 2 nd month in a row that s happened 10. FIRB blocking a $39m Pt Piper residential property sale?? 11. That will help first home buyers..not 12. German retail sales +2.9% in January 13. US Misery Index lowest since CSL ADR 15. MPEL +2% (CWN) 16. Dr Take tactical trading profits in two discretionary retailers Back in mid-november 2014 I wrote a note titled Ho, Ho, Ho that recommended a tactical long trade in 4 discretionary retail stocks into the seasonally strong Xmas retailing season. I reiterated I wanted to stay long that trade in another note on the 23 rd of January. That tactical trade in discretionary retailers has worked well with all 4 stocks delivering solid total returns since the trading idea was initiated. Stock Capital Gain Dividend paid Dividend cum Total pre-tax return (grossed) JBH +12% 59cff % SUL +34.8% 18.5cff +38.5% AHE +9.2% 9cff till 12/3 RCG +15.6% 2cff till 5/3 Adding on the value of franking credits the tactical trading idea generated a +17.3% pre-tax return in JBH and a +38.5% pre-tax return in SUL. However, today I want to lock into tactical trading profits in two of those names yet remain now fundamentally long the other two as I think they have further to appreciate and remain cum dividend and cum franking credits. My recommendation is to lock in trading profits in the ex dividend JB Hi-Fi ( JBH) and Super Retail Group (SUL) while remaining fundamentally long Automotive Holdings Group (AHE) and RCG Corporation (RCG).

89 P. 89 The open short positions in JBH and SUL have decreased quite solidly in the previous three months which is another reason I am locking in trading profits today. The JBH open short has dropped from 12.7% to 8.83%, while the SUL open short has dropped from 18.93% to 11.83%. These previously large open short position where one of the key reasons for my previous tactical bullishness. My approach is to roll trading profits in lower quality stocks into investment in high quality established high conviction ideas. That is exactly what I did earlier this week when recommending taking +200% trading profits in Qantas (QAN) and rotating to Sydney Airport (SYD) and Crown Resorts (CWN). Today I am basically recommend taking profits in two tenants and rotating to the global landlord. It was only mid-way through 2014 when the Lowy s concept of splitting into a domestic REIT and a Global REIT/development company almost got voted down by a handful of domestic institutional investors. What an error that would have been as $12bil of shareholder value creation has occurred since the split. Yep, a cool +$12bil. I think I can take some credit for at least attempting to get Westfield shareholders to vote in favour of the deal (Frank-ly you should give a damn) and our subsequent aggressive support for WFD on a USD, Oil and US consumer view. Supporting the split was the right call, switching from SCG to WFD post-split was the right call, going even harder when the Lowy Family themselves increased their WFD stake was the right call, and today I am going to tell you why sticking with WFD and the Lowy Family remains the right call despite my medium-term (top of the market) WFD price targets being smashed through. At the macro level my attraction to WFD is increased by the sustained fall in oil prices, the race to the bottom in global interest rates, the bond yield effect on cap rates, yield compression in tier 1 property assets, falling debt costs and USD translation. This all bodes well for the US, UK and even Eurozone consumer, remembering the true wealth effect is property but no doubt cash rates, petrol prices and employment levels play a role in consumer sentiment. What also interests me is the growing wealth divide between high income and low income earners. QE and ZIRP have clearly exponentially increased the wealth of the wealthy. WFD is superbly positioned to capture a greater proportion of that wealth effect in its core demographics. The strategy of creating and operating flagship assets in major markets is exactly the right one. Note well in the slides below: NOTHING in Middle America, NOTHING outside of London, NOTHING in peripheral Europe.

90 P. 90 RINGING THE BELL: 2015 SO FAR Westfield is a GROWTH stock: they currently have a $11.4b pipeline of current and future developments. These include Westfield World Trade Centre in New York, Century City in Los Angeles and the expansion of Westfield London and Valley Fair in Silicon Valley.

91 P. 91 Once completed, this pipeline of flagship developments will represent 80% of the total portfolio and WFD s business will be more evenly weighted between the US and UK/Europe. WFD clearly has plenty on over the next 5 years. It was encouraging to see Peter Lowy reconsider his position and agree to remain Co-CEO with his brother Steven. Must have been Guillaume s cooking. Let s now have a look at a couple of key slides from the WFD results presentation pack.

92 P. 92 RINGING THE BELL: 2015 SO FAR The WFD balance sheet is STRONG with 35.1% gearing, 5.2x interest cover and $3.6b in available liquidity. Arguably these offshore assets should be listed offshore and I wouldn t rule out WFD pursing a dual-listing structure in the years ahead. The other thing I wouldn t rule out is WFD becoming and M&A target itself. That M&A would target the development pipeline which is arguably undervalued in the current WFD share price. WFD stated they want to build the company size up by +50% in the next 5-7 years. That would appear an achievable goal taking into consideration the project pipeline. In a world where genuine growth is hard to find, if WFD can grow their company size by +50% in the next 5 to 7 years that growth outlook will be re-rated as the equity market becomes more comfortable it will be delivered. As tends to be the case, the consensus analyst view remains sceptical on WFD as it has all the way up during our high conviction buy campaign pre and post-split. As we sit here today the BUY/HOLD/SELL ratio is 3/7/5 and the median 12 month price target is $9.69, below the current ex distribution (12.3usc) share price. Clearly, the forward P/E of 21x has spooked the WFD analysts into consensus caution. However that has been the case since the split with consensus 12 month share price targets (yellow line) chasing the WFD share price +33.3% higher over the period. Frankly, the WFD analysts are non-believers in WFD. That has been and will continue to be a mistake.

93 P. 93 I ended the Frank-ly you should give a damn note with Through time co-investing with the Lowy s in various Westfield entities has made our clients a lot of money. It s been a great ride and one I encourage you to continue. Fast forward to today, and despite +$12bil in post-split value creation, my view on co-investing with the Lowy s remains unchanged. In fact, that reinforces my view. WFD has a winning formula. It has a globally scalable formula. It is a structural GROWTH stock and completely justifies near-term P/E s premiums versus growth-less competitors. Winners keep on winning: The Lowy Family and Westfield (WFD) are winners. I back winners but winners with a macro tailwind are even better. On that basis I am lifting my month price target on WFD to.. $11.50 However, I must say that if WFD deliver on their vision to grow the company by +50% over the next 5 to 7 years then in probably under 5 years-time WFD will be over.. $15.00 WFD remains an absolutely core member of my high conviction portfolios. I ll be in Perth on Thursday then playing in a charity golf event early on Friday in Sydney. Next note on Monday morning, Go Australia, Charlie

94 P. 94 RINGING THE BELL: 2015 SO FAR 04 MAR THE GREENBACK IS BACK (AGAIN) & SERVCORP (SRV) Good morning, What s catching my eye? 1. US economy adding 295,000 jobs in February 2. US unemployment 3. US Dollar Index WTI Iron 10. KBW US bank index The clear winner of Friday s blowout US payrolls number was the US Dollar. The US Dollar Index (DXY) is now within sight of my long-held target of 100, a target that will need positive revision in the weeks ahead as more and more global capital flows back to the world s reserve currency, most notably from the Euro, Yen and Aussie Dollar. US Dollar Index (DXY)

95 P. 95 I have been and remain a very firm US Dollar bull. I believe this is the infancy of a major US Dollar move which clearly has ramifications for anything denominated in US Dollars. There should be now no doubt at all that the Federal Reserve will start raising cash rates, albeit slowly, mid-way through this year. The Fed will be the ONLY central bank raising rates globally this year and the ramifications for the US Dollar are large as we have argued in these notes for many years. Here s some trivia for you all..on which date did the Fed first take the FFR to 0%???? Answer: 16 th of December The S&P500 subsequently bottomed on March 9 th and despite Friday s pullback, is +206% from that point, reminding you of the old adage don t fight the Fed. We are into our 7 th year of ZIRP. It s actually quite amazing. I don t think many people believed US cash rates would be 0% 7 years later, but here we are and the Fed s policies have clearly worked with US GDP growth outpacing the world and US employment growth outpacing the world. Similarly, who would have thought 7 years ago that the US unemployment rate would be 1% below the Australian unemployment rate. At one stage in 2009 they were 5% apart in Australia s favour!! It all reminds you the Fed was the first to move in scale and the first to play a completely home biased game of currency devaluation via QE and ZIRP. The ECB is only just embarking on QE a year after the Fed completed its 3 rd QE programme. In Australia we only just entered the currency devaluation game. A few weeks ago when upgrading my target trading range on the ASX200 to 5700 to 6200 I also lowered my AUD/USD cross rate target from 75usc to 68usc. I want to reiterate today that I remain extremely comfortable with that 68usc AUD/USD target and feel it could be hit far quicker than anyone currently believes. The pure technical target would be 64usc, which could also be hit on a rout. On that basis I am redoubling my strategic focus on ASX listed USD industrial earners, ASX listed offshore fund managers, ASX listed international equity LIC s and ETFs and ASX listed inbound tourism beneficiaries. I also continue to urge you to lose the home bias in terms of overall asset allocation. One of the reasons I remain bearish on the Australian Dollar is falling commodity prices. Unfortunately for commodity prices they are facing the perfect storm. Chinese GDP growth is slowing. The supply response has arrived in all commodities. Commodities are priced in US Dollars. Major producers are showing NO signs of curtailing production. To make it worse the case for diversification into holding physical commodities has fallen apart and losses in commodity equities are stacking up. You can feel a complete and utter capitulation coming and that is why the ONLY comments I have made on

96 P. 96 RINGING THE BELL: 2015 SO FAR Australian resource stocks this year was warning you NOT to buy them for yield. You simply don t buy ANY stock for yield when its earnings base is falling. That is just dangerous. I don t think we are at the bottom in commodity prices yet or the bottom in terms of sentiment towards resource stocks. We haven t seen the baby thrown out with the bathwater yet. I am watching all this closely, however, falling commodity prices and our collapsing terms of trade are key to my domestic interest rate view (2.00% or lower) and bearish AUD view. In terms of commodity equities I am basically letting the knife fall strategically and waiting for the capitulation moment when the momentum knife sticks in the deep contrarian value floor. I do not think that is yet because that event requires complete analyst capitulation at the consensus forecasting level and as you can see in the table below the consensus view on major Australian resource stocks remains positive in terms of BUY/HOLD/SELL ratios and 12 month price targets. BUY HOLD SELL PRICE TARGET BHP Billiton $34.48 Rio Tinto $68.69 Fortescue $2.64 Woodside $37.37 Santos $10.96 OilSearch $9.22 Origin $13.51 The price targets above have been a death buy a thousand cuts as earnings get revised down monthly. To put this in context, the current BUY/HOLD/SELL ratio on Telstra is 5/12/4 and the median 12 month price target is $5.94. In an iron ore crash there is only 1 sell recommendation on Rio Tinto vs. 4 sell recommendations on TLS..Enough said. Who knows, we might be 3 years into a 10 year bear market in commodities. From the resource companies through to the analysts everyone is throwing darts. Nobody has a clue what comes next. Nobody predicted that iron ore would have a 5 handle and oil a 4 handle, that is why I think setting and AUD/USD target of 68usc is not even a big call. It s just a matter of how quickly it gets there. If I am proved right on my AUD/USD bearishness then these below stocks will be the winners..winners keep on winning in that scenario Currency cycles are long cycles. USD leverage Westfield Corporation (WFD), Servcorp (SRV), CSL (CSL), Resmed (RMD), Brambles (BXB), Macquarie Group (MQG), Mesoblast (MSB), Treasury Wine Estates (TWE), Platinum Asset Management (PTM), and Magellan Financial Group (MFG). Inbound tourism Crown Resorts (CWN), Sydney Airport (SYD), Auckland Airport (AIA), Air New Zealand (AIR.NZ) and Sealink Travel Group (SLK). For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt WORLD S FINEST SERVICED OFFICES In August 2014 I wrote a note on SRV titled Boutiquefication Leverage and set a $6.50 price target. SRV shares were around $5.00 then and we ve collected the 11c final FY14 dividend and 11c interim FY15 dividend. It s been a solid total return mid-cap industrial idea. It s given us the leverage I hoped for. Today I want to update that note to include analysis of the FY15 interim result. Servcorp (SRV) delivered one of the best results of the reporting season. These earnings and dividend trends will continue in the years ahead. Just have a look at this slide: most industrial companies would be very pleased to print this set of numbers.

97 P. 97 SRV is a leveraged play on the global structural trend to boutiquefication. Ok, that s not a word, but it means the trend of professionals learning their trade in a big incumbent firm then branching out in early middle age to start a boutique business. The vast majority of the working world has worked out you can t get rich in a big firm and you can t control your destiny. You need to hang your own shingle out if you want a private jet. This is a structural trend, aided by technology, that will continue. SRV is superbly placed to provide a variety of services to small and medium sized entrepreneurial businesses. The trick to any start up business is to look stronger than you are. SRV via offering small scale serviced offices on high floors in the world s most premium office buildings clearly facilitates that ability to look stronger than you are at competitive rents and without the long tail liability of extended leases/make-goods etc. that come with direct office leasing. SRV clearly does offer the world s finest service offices. The slide below summarised SRV s global footprint. In terms of earnings/dividend growth total floor space, occupancy rates and margins are all heading in the right direction. With head office/management costs stringently watched, the leverage to revenue growth and cash flow conversion is very strong.

98 P. 98 RINGING THE BELL: 2015 SO FAR Growth is also starting to come from virtual office. For those of you who don t know a virtual office is exactly that: virtual. Your incoming phone calls will be answered by a SRV receptionist in your company s name, your registered address will be a SRV office, your systems will be hosted by SRV, and pretty much everything you could want from an office is provided but you don t have a physical office. You are probably playing golf! Perhaps the future of stockbroking is virtual. press 1 to buy, 2 to sell, 3 for advice. To my way of thinking virtual office is a low cost growth option of SRV with the technology required simply piggybacked onto the existing office hardware/software backbone. Clearly the EBITDA margins in virtual office are highly attractive. Back to the core business and SRV has more than doubled in size over the last 5 years, signing long-term floor leases when conditions post GFC were very favourable. Now as the world economy starts recovering they fill those floors and reap the revenue and margin harvest. It s worth noting the like for like results, showing the organic profit growth year on year. But the growth doesn t stop here for SRV with intentions to open a further nine floors and expand three existing floors in FY15, which will add approximately 10% to group office capacity. The new floors include level 85 of the iconic World Trade Centre 1 in New York, the Cheesegrater in London, and also One Mayfair Place in London. This strategy of being only in high income, high tax paying, white collar precincts reminds me strongly of the Westfield Corporation (WFD) strategy I highlighted last week. In terms of management there is no change. Founder, major shareholder (51%) and CEO Alf Moufarrige still runs the show hard. Alf is 74 years old, but has the body of a 73 year old. Only joking Alf, but my point is nobody should be concerned about succession planning at SRV because the next generation of Moufarrige, most notably COO Marcus Moufarrige, is completely capable of taking SRV through its next leg of growth. I have absolutely no concerns about management succession at SRV. In fact, I think

99 P. 99 Marcus is a dynamic, sensible visionary style of operator who could further expand and diversify SRV s revenue streams in the years ahead. I think fund managers would back Marcus s vision too which could lead to a further P/E re-rating of SRV. In terms of earnings and valuation I think SRV is an undervalued structural global growth stock. The yield is a nice bonus but to me SRV is about GROWTH. With the usual caveats about unforeseen circumstances, SRV has guided to NPBT to improve by NO less than +15% in FY15. No less than +15% NPBT growth vs. the ASX200 which offers prospective EPS growth of +5% in FY15 at the aggregate level. This +15% minimum NPBT growth in FY15 comes after +24% in FY14. That s +24% NPBT growth translated to +24% EPS growth and +33% DPS growth. Adding +15% to EPS generates an FY15 EPS forecast of 34c, placing SRV on a FY15 P/E of 17.2x. 2H dividend is guided to another 11c. But I don t think P/E is a fair way to value SRV. This $576m mkt cap stock has $94m of cash on its balance sheet, bringing the enterprise value down to $482m. on FY15 forecasts the EV/EBITDA ratio drops below 8x and that s before I make any forecasts about balance sheet net cash accumulation in the period. SRV ticks all my boxes. Organic global growth in a structurally supported sector, earnings growth, extremely strong balance sheet, strong management, dividend growth, tight register and clear valuation support. It s a classic GARP stock when GARP is getting much harder to find. It s also a great example of an Australian company getting offshore expansion right. I continue to rate SRV a high conviction mid-cap buy and reiterate the 12 month price target of $6.50. Go Australia, Charlie

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