Recovery continues as China talks of stimulus

DESPITE some justifiable scepticism from analysts, the recovery in global share markets continued yesterday.

despite some justifiable scepticism from analysts, the recovery in global share markets continued yesterday after officials from the US Federal Reserve and the Bank of England last week talked about delaying rate hikes and, in the case of the Fed, the end of its latest money-printing binge.

Over the weekend, Chinese press reports suggested further monetary policy stimulus was likely there, and Japanese Prime Minister talked about backing off on the next consumption-tax hike.

Will the Reserve Bank of Australia will play its part in reassuring markets that policy can be loosened if need be?

Market expectations for domestic monetary policy in 12-month’s now lean slightly toward an interest rate cut, whereas a few weeks ago, the market was favouring a hike.

“If the current ‘risk-off’ environment were to turn into a full-blown crisis and a global recession, then there’s little doubt that the RBA would utilize its firepower,” Mr. Bruten says. “With the cash rate at 2.5 per cent, there’s no reason why the RBA couldn’t cut the rate by 150 or 200 basis points in a hurry. It’s one of the few developed-market central banks with the scope to deliver such a round of conventional easing.”

According to Mr Bruten, pre-conditions for RBA easing would include lower long-term forecasts for commodity prices, an appreciation that housing construction will start to lose momentum soon, a loss of business confidence leading to persistently high unemployment, and enough inflation “headroom” to allow interest rate cuts.

Commodity price angst is growing, with persistently weak spot prices and aggressive volume expansion from the major suppliers leading UBS to cut its long-term forecast to US$75 a tonne last week.

Domestic construction activity is still rising thanks to record low interest rates, but as Mr. Bruten points out, housing finance and building approvals are now levelling out, and with macroprudential measures on the cards, “the housing downside could be more abrupt than currently anticipated.”

Unemployment data in Australia are currently unreliable due to shortcomings with the seasonal adjustment factors used in the survey, but the drop in the employment component of the National Australia Bank’s Business Survey this month is a “worrying development” according to Mr. Bruten.

And third-quarter inflation data tomorrow is expected to show underlying inflation falling toward the mid-point of the Reserve Bank’s 2 to 3 per cent target range.

Notwithstanding , the weaker exchange rate, falling energy prices, consumer confidence, inflation expectations mean there is “plenty of headroom for a rate cut,” Mr. Bruten says.

The Reserve Bank will release minutes from its October 7 board meeting today.

Banks looking better value

With the Australian bank reporting season just around the corner, and valuations not so stretched after the recent pullback in share prices, UBS analysts say it’s getting harder to justify the Underweight stance they’ve held on the sector all year.

Notwithstanding some margin compression, the Australian housing boom is expected to drive a 5.8 per cent rise in revenue, the strongest since the recovery that followed the global financial crisis.

A pullback in trading income should be the only drag on revenue according to UBS, although the broker expects costs to rise 5.5 per cent due to regulatory, IT and employee pressures.

Asset quality trends are expected to remain benign, but bad and doubtful debts are expected to trough, and UBS sees 9 per cent growth in earnings per share for the sector, ex-National Australia Bank.

“Valuation stretch and the potential impact of the Financial System Inquiry have been our key concerns in the sector,” UBS analysts Jonathan Mott says and Adam Lee say. “Following the correction we are less concerned with valuations, provided lead indicators for asset quality remain benign.”

“While the Financial System Inquiry still remains a point of risk, we believe the likely impacts are quantifiable. The Australian banks do not look cheap. However, unless the economic situation deteriorates, we think the case for a material Underweight stance in the banks now appears harder to justify.”

UBS has a Buy rating on ANZ Bank and a Neutral view on the other three major banks.

CIMB analysts Jon Buornaccorsi and Ashley Dalziell also updated their view on the banks yesterday, reiterating the Underweight recommendation they adopted on October 1.

In their opinion, all the focus should be on the next wave of regulation that is likely to emerge from the Group of 20 meeting and Financial System Inquiry in Australia.

“We have an Underweight stance on the sector as we believe yield stability is no longer enough to offset increased regulatory risk, low growth and lower sustainable returns,” they say. “In our view the Australian bank sector remains overvalued despite its recent correction.

“We estimate that the sector trades 15 per cent above intrinsic ‘fair value’ on a price-to-net-tangible-assets and a price-to-earnings basis.”

Higher capital targets will restrain the earnings outlook for banks, and yield-based buying from offshore investors should offer less support as the Australian dollar falls, they say.

CIMB has an Add rating on ANZ and National Australia Bank, a Hold on Westpac and it rates Commonwealth Bank of Australia at Reduce.

It feels ANZ and NAB are cheaper than their peers, and NAB has more scope to use asset sales to boost capital in response to higher regulatory capital target ratios.

National Australia Bank kicks off the bank earnings season on Thursday October 30.