Market update – October 2010

Adapted from the various market and economic commentary that flow past our inbox each month – Sources include Macquarie Equities, JB Were and Citigroup research.

The month that was – October 2010

The Australian equity market performed positively in October, delivering a return of +1.7% for the ASX Top 200 companies.

The Australian equity market’s return was again driven by resources which were up 5.6% for the month and 17.6% for the past 12 months.   These continue to rally on a stabilising outlook for China (Shanghai market +12.2%) an appreciating Australian Dollar and consequently stronger commodity prices.

Merger and acquisition activity has been a strong feature over the past month as available finance, more conservatively geared balance sheets and stable markets provided an attractive backdrop for corporate transactions. These included the Singapore exchange attempting to acquire ASX Ltd (+13.9%), KKR bidding for Perpetual (+24.5%), Consolidated Press Holdings acquiring 17.9% of Ten Network (+11.8%), a Goodman Group (-2.3%) led consortium also made an offer for ING Industrial Fund (+7.1%).

Positive response to banks that have reported so far, with ANZ (+4.8%) and National Australia Bank (+0.5%) both reporting solid results, marginally ahead of consensus expectations in a difficult operating environment of slowing credit growth and rising costs.

US reporting season (80% complete) again exceeded expectations, with aggregate earnings 5.6% above expectations.  The earnings recovery is being driven by revenue growth with the S&P500 up by 3.7% in October, reflecting the strong reporting season to date.

The Reserve Bank Australia surprised and remained on hold for the fifth consecutive month in October, despite expectations of a 25 basis points (0.25%) increase in the cash rate.  They surprised again in early November when this time they did decide to raise on the back of strong forecasts for the Australian economy.

Equity Strategy

The tone out of our morning meetings from our equity strategists has been loud and clear. Be long resources, resources, and more resources.  We are forecasting a “once in a generation” rise in commodity prices with the perfect storm only enhanced by the Feds recent decision to pour more money at their economy via their latest round of Quantative Easing.  The copper price continues to breach new highs on the back of supply concerns and a weaker US dollar.  Iron Ore is strong, coal Is solid and the gold price also continues to make new highs. We are continuing to recommend an overweight position in resources and for those that may think its too late or they have missed the boat think again.  In particular, we recommend taking advantage of where spot prices are now and this means be invested in companies with net cash on the balance sheet and more importantly with mines in production. Sure there is a place for speculative exploration mining companies however only as a small percentage of portfolios. The overweight positions should be given to the likes of the names above.

Overall our market forecast now sits at 5387 comprising a capital return of +14.4% and dividend yield of 4.6%.  Of course resources continue to be the primary driver of these forecast returns given their strong earnings profile, attractive valuations and supportive macro economic conditions.