If you’re currently sizing up your portfolio, uncertain about which stocks and sectors to back next year, then you’re not alone. Many investors are also feeling uncertain as we sprint towards the end of 2010. For this reason we put the following questions to economists and brokers: How will the Australian economy fare in 2011? And how will it impact Aussie stocks?

The good news for investors is that the Aussie sharemarket is looking fairly valued, according to brokers. The S&P/ASX200 is trading on an undaunting price-to-earnings ratio (P/E) of 13.6X, and based on consensus 12-month forecasts – capital growth of 9 per cent-plus and 4 per cent-plus yield isn’t out of the question.

And according to many leading economic indicators, the Australian economy will post steady growth in 2011 and 2012. Australia boasts a strong labour market and record terms of trade. Business investment is forecast to jump by 7.5 per cent in full year 2011 and 12.5 per cent in 2012.

But there are clouds on the horizon that could affect the performance of some listed companies. Rising interest rates, low housing affordability, record high personal debt levels and increased costs due to the ongoing resources boom could pose a problem to some parts of the economy.

Commodity upside

Strong commodity prices and healthy economic forecasts for China is good news for Aussie miners. The IMF predicts that China will deliver GDP growth of 10.5 per cent in 2010 and 9.6 per cent in 2011.

Despite some short-term pressure, Chris Stott head of research with Wilson Asset Management expects large diversified miners like BHP Billiton (BHP) and Rio Tinto (RIO) – and stocks closely leveraged to China, like Mount Gibson Iron (MGX), and Atlas Iron (AGO), to outperform the sector.

Smaller companies in the resources sector have run hard in recent months. For this reason Roger Leaning, research head with RBS Morgan’s recommends moving to the established players. Rio Tinto (RIO) is his preferred diversified miner. “Stocks like Rio and Worley Parsons (WOR) are also a safe way for investors to play emerging market thematics,” he says.

His favourite commodities are copper, nickel and iron ore (supply-demand imbalances appear most severe), as well as zinc over the longer term.

For coal, copper, and gold exposure Mark Simpson, head of research at Paterson’s Securities likes Straits Resources (SRL). The stock is currently trading at a 45 per cent discount to his $2.76 target. He also likes high-margin magnetite producer Grange Resources (GRR).

And with emerging nations hungry for clean energy, Simpson is also watching key stocks in the uranium sector such as Paladin (PDN), Extract (EXT), which has the world’s fifth largest uranium resource, and Mantra (MRU), a quality low-cost asset in Tanzania.

GDP Play

Standout stocks in 2011 will be those most leveraged to the BRIC (Brazil, Russia, India & China) economies, says Simpson. These nations are exhibiting stronger GDP growth than stgeloped nations, and Aussie miners and mining services stocks will benefit. “Our overall outlook for mine volumes remains positive. In particular, [we forecast] bulk commodities with met coal and iron ore to increase 22.3 per cent and 19.8 per cent respectively in full year 2010,” says Simpson.

With China and India driving demand for thermal and coking coal, Simpson’s favourite coal stock is Riversdale (RIV), which is stgeloping a new coking province in Mozambique.

Along with telcos, Simpson expects oil and gas stocks to offer the best opportunity for capital growth and dividend yield. His top oil and gas picks include Cooper Energy (COE), Horizon Oil (HZN), and Cue Energy (CUE).

Leaning prefers Australia’s most diversified energy player, Origin Energy (ORG).

Capex and volume expansion

Mining services companies are certainly ones to watch in 2011. Simpson forecasts 12 per cent full-year 2011 revenue growth and 16 per cent EBIT growth across small/mid-cap mining services stocks. His top stock picks within the mining services include Bradken Ltd (BKN), and the VDG Group (VMG) which is currently trading at more than a 50 per cent discount to sector average earnings multiples.

Leaning recommends Ausdrills Ltd (ASL), Worley Parsons (WOR), and Campbell Brothers (CPB).

Stott highlights RCR Tomlinson (RCR) as a stock to watch. One of Australia’s most diverse engineering companies, RCR Tomlinson specialises in heavy equipment, industrial boiler systems, site maintenance and construction.

Housing/construction

Hurt by higher mortgage rates and the winding back of the first home buyers’ grant, Aussie housing finance data has been trending lower since October 2009. Simpson prefers stocks exposed to residential and infrastructure construction activity.

Simpson has a buy on CSR Ltd (CSR). He says its share price is trading 20% below his valuation of $2.25, and its full year 2011 prospective dividend yield is 5 per cent.

He also has a positive view on the engineering/construction sector.

His favourite large cap stock is UGL Ltd (UGL). He forecasts 10-15 per cent net profit growth in full year 2011, and double-digit EPS growth over next four years.

In the small-cap space, he prefers specialised engineering services provider LogiCamms Ltd (LCM). He expects LogiCamm to deliver full year 2011 EPS growth of 19 per cent – and offer a fully franked prospective yield of around 6 per cent.

Currency play

Shane Oliver, head of investment strategy with AMP Capital says that a strong Aussie dollar relative to the US dollar will hurt manufacturers that compete against importers, domestic tourism, fine-margin businesses and companies that compete internationally.

Oliver expects companies with large import bills, such as airlines and select retailers to be among key beneficiaries, while net exporters will struggle.

Included among net-losers to a strong A$, says Stott, will be stocks like Aristocrat (ALL) and Paperlinx (PPX) both of which earn significant chunks of revenue offshore.

Inflation concerns

The RBA is using interest rates to offset the impact of rising commodity prices and Stott is forecasting a further three 0.25 basis point rate rises in 2011. However he expects the pain to be more severe because the big banks will push rates up by as much as 1 per cent.

According to Stott, the big four banks will are facing a tough year ahead and will struggle to boost revenues due to sluggish credit growth.

In the reatil space he believes that retailer Specialty Fashion Group (SFH) – which has interest rate-sensitive shoppers – will suffer more than most retailers.

Meanwhile Leaning expects industrials like Boral (BLD), Fletcher Building (FBU), James Hardie (JHX), and Crane Group (CRG) – all of which ran hard earlier this year – to be badly impacted from lower housing affordability.

This certainly doesn’t mean that all property-related stocks are doomed. Stott expects more bouyant housing activity within pockets of Victoria and South Australia to provide some uptick to GWA International (GWT), Brickworks Ltd (BKW) and Adelaide Brighton (ABC).

Key economic indicators

•    GDP of 3 and 3.5 per cent for 2010 and 2011 respectively.

•    Commodity prices remain strong.

•    Export prices up 27.7 per cent over the last year.

•    Terms of trade to a 49-year high.

•    Household spending in full year 2011 forecast to grow 3.0 per cent.

•    Household spending to recover despite RBA rate hikes.

•    Jobs growth of 2.25 per cent expected in FY2011.

•    Wages growth to rise to 3.75 per cent in FY2011.

•    Consumer confidence trending higher.

•    Business investment growth by 7.5 per cent in 2011 & 12.5 per cent in 2012.

•    SME/General Business Tax Breaks aid recent P&E capex actuals.

•    FY11 expectations bolstered by reinvigorated mining sector.

•    Improved business confidence on easing credit conditions.

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