Many investors have moved out of resources in 2012, and into the more defensive sectors of the sharemarket. But is it time to reconsider this strategy – and move back into resources?
The Australian stock market poses a conundrum for investors at present. As Chinese economic growth came under pressure this year, the resources sector followed it downward. The business pages – and the political pages – were full of commentary that the mining boom was over, or at least stalled for the present. For many investors, this triggered a switch to defensive settings – and many of the defensive stocks have profited nicely.
But since mid-July, the XJR (S&P/ASX 200 Resources Index) has recovered nicely, to the tune of 10 per cent.
So, has the window of opportunity for a defensive switch closed?
“If you haven’t already pulled a defensive switch, it’s way too late to be doing it now, because you’ve missed the boat,” says Stephen Hogan, private client adviser at Novus Capital. “The time to do that was in April 2011.
“Back then I was saying on TV and telling clients that the resources space looked like being a risk in the next year-and-a-half, and you needed to be overweight the banks and the defensive sectors like healthcare. But right now, I’m positioning my portfolios now to be more growth-oriented, more based toward the high end of the resources sector,” says Hogan.
Lucinda Chan, divisional director at Macquarie Equities, says there is still time for a defensive move – and more importantly, justification. “I think there could still be be a further move out of mining into defensives. What is appealing in this marketplace currently is income certainty.
“Economic growth is going to be sub-par, if not extremely modest, so people are looking for very low levels of risk in this environment. Healthcare has been picking up a lot of support – the likes of Ramsay Healthcare, Sonic Healthcare and CSL – although the caveat with CSL is that it is certainly not cheap anymore.”
Chan thinks the banks will remain attractive. “As interest rates go lower – I expect another interest rate cut in November – the yield on bank stocks just looks more and more attractive. I mean, 9 per cent on CBA is a very compelling opportunity.”
Another beneficiary of lower interest rates, she says, is the building materials sector. “You can expect a stock like CSR to get the benefit: James Hardie, too, if you think that the US has bottomed.”
Damien Boey, equity strategist at Credit Suisse, says the Australian market has entered a stage where the defensive bias is “not a bad bias to have,” but cautions that investors “have to question just what is defensive” in this environment.
“The likes of Telstra and AGL and Origin and Woolworths, they’ll always be defensive, but a lot of people have been going with REITs and banks as defensive as well, and I’m not so sure that they are defensive. We were on the ‘long banks, long REITs’ trade for a while – about two-and-a-half years – but it’s gone too far now.”
Boey says it is not possible for our economy to have been a “one-trick pony” on the way up, driven by mining – and yet be insulated on the way down when the mining boom collapses. “I think that our banks are not defensive, and the valuations on them are stretched, compared to resources stocks; and I also think that when it comes to housing and employment, I think we’re going to take a turn for the worse over the next year,” he says.
That strategy would imply that a switch back into resources is warranted, says Boey, if you focus on low-cost producers. “The thing is that resource stocks are relatively cheap compared to the market, they’re trading at a 20-30 per cent discount to market. I don’t think a strong recovery will come through from Asia, but I can see enough of a recovery coming through to keep prices stable.
“If you look at the miners, some people say, ‘they’re on low P/Es, but they’re value traps.’ I think quite the opposite: I think that they’re fairly robust in this environment. If you look at BHP and Rio Tinto – the biggest capitalisations and the lowest-cost producers – if you factor in the earnings downgrades and lower commodity prices and volumes, I suspect that they’re trading close to a market multiple. The point there is that when you consider how many stocks are trading at above-market multiples, trading at-market is not a bad thing,” says Boey.
Allan Furlong, manager of private client services at Joseph Palmer & Sons, says the sectoral switch has been happening since about mid-July – since when stocks such as CSL, Ramsay Healthcare, Woolworths and Wesfarmers have rallied strongly, and “a lot of money” has flowed into listed income securities. But he says he would not sell BHP and Rio Tinto to move into defensives now.
“No, I wouldn’t be keen on doing that. I actually think that from here investors have to be mindful that resources share prices – at the quality end, the likes of BHP, Rio Tinto and Woodside – are likely to strengthen. I think they’ve been over-sold, and the biggest risk now is that the markets start to believe that the global economy is not going to fall to pieces, and we move into the next stage of this rally. Particularly for BHP, I think that having a petroleum division and owning the majority share of the biggest copper mine in the world means that some of its other earnings streams should prove their worth,” says Furlong.
Hogan says that far from being a ‘switch out,’ the resources sector is a ‘switch in,’ if the exposures are carefully targeted. “I like the energy sector – particularly Woodside Petroleum and Santos, obviously the higher end of the market, because I think we still need to play it a little bit safe. But we can be fairly confident that LNG demand coming out of Asia out to 2020 is going to increase year-on-year, and both of those companies are well-positioned to do very well out of that.”
Hogan has his clients overweight in the energy sector at the moment, in Woodside, Santos, Horizon Oil, and Beach Petroleum, as well as in offshore services company Mermaid Marine, which he says is a good way to gain exposure to the LNG sector without taking direct exposure to commodity prices.
In the bulk miners, he likes BHP for its diversification. “With a gas price increasing I think Petrohawk will be a good acquisition for them. With its mix of earnings streams, I think BHP will be closer to $50-$60 over the next three to four years, whereas what concerns me a little bit about Rio Tinto is that it is much more leveraged to iron ore prices. I think iron ore will find some stability around US$110 a tonne, but I don’t think we will see $180 a tonne again.”
Other plays in the resources sector Hogan likes are Atlas Iron and Mineral Resources. “Atlas has got three self-funded projects coming on-stream in the next 12 months, it has zero debt, they’re close to infrastructure, they’re very well-placed. Atlas is a very attractive takeover target despite the fact that there’s talk in the market that it may have to do a capital raising with iron ore at lower prices; but I think the iron ore price will stabilise anyway.
“Mineral Resources have a few iron ore projects themselves, but they’re more focused towards the mining services side of things. If I was looking for a pure iron ore play it would be Atlas, and Mineral Resources appeals from the mining services side of things,” he says.