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The Round Up
21 January 2011
Issue No. 483
Daily Monitor
Equity Structured Products and Warrants
Overnight Commentary
Commodities Commentary
SPI Commentary
The SPI traded down 58pts to 4770. Open at 4828 with a high of 4831 and a low of 4760. Volume 32,410. Overnight the SPI traded
down 12pts to 4758.
*SPI report taken from the 9:50am open to the 4:30pm close on the previous trading day. Charts taken from IRESS
Source: IRESS
QAN has embraced ESG reporting, which in our view is important in such a challenging
industry. In this note we update QAN's FY10 sustainability performance in detail, noting it was
generally positive across most measures. With QAN trading below 1.0x P/B, we maintain our
Buy recommendation. Get long QANKZL
Source: IRESS
QAN compares well on ESG metrics to peers and the broader S&P/ASX 200
The aviation industry generally is focused on ESG issues given impending emission trading schemes globally. In our
view, QAN shows particularly strong engagement on ESG issues, with many initiatives integrated into business
operations. Not surprisingly, therefore, comparative data shows QAN generally ranking in the top half on ESG metrics
against peers and strongly against the broader S&P/ASX 200 on ESG related disclosure.
SPFKZQ (Stop Loss at 1,313) is the instrument to play a pullback (Or SPFKZR higher Stop Loss of
1,396) and we believe the S&P500 futures could easily fall from 1,262 to 1,220 and even below 1,200
before the end of January.
Alternatively, some traders will prefer a pairs trade to take advantage of the US outperformance and
therefore mitigate the market risk of global economic news. Traders wishing to use this strategy can
therefore Buy 1 Long MINI XJOKZL for every 4 SPFKZQ shorts (market exposure of 1 XJOKZL is $47
and 1 SPFKZQ is $12.60).
We would look to close out this trade at around 1,220 in the S&P 500 and this would return ~65%
purely in the SPFKZQ MINI.
Source: IRESS
Pairs trade
Buy 1 Long MINI XJOKZL for every 4 SPFKZQ shorts
US economic growth gaining momentum – Alongside continued monetary accommodation in the US, the
economic recovery looks to be picking up momentum, providing a firmer macro backdrop as we move into
2011. The December Philly Fed highlighted the trend, with forwardlooking components returning to the
stronger March-April levels that were interrupted by the European sovereign crisis from May. In particular, the
expected capex component is at its strongest level since mid-2005, and the prices paid component suggests
inflation should normalise. This is particularly important, given monetary policy must now give way to the
private sector to drive economic growth. We highlight US capex as a significant equity market theme as we
move into 2011. In addition, small to medium-sized enterprises are beginning to rehire and income growth is
driving consumer spending.
European stability – While improving economically, Europe remains vulnerable to pockets of deflation and a
resurgence of European sovereign debt woes as this structural issue takes time to repair. From an economic
perspective, the manufacturing PMIs in core Europe have remained resilient as demand in foreign markets
has benefitted the region. The latest survey data continue to point to ongoing recovery in the euro area
business cycle, albeit at muted levels. It will likely
take time for a sustained domestic demand recovery to emerge in Europe, while real income growth remains
moderate in an environment of modest employment and wage growth. We expect peripheral sovereign debt to
weigh on markets from time to time, but we note investors appear less concerned that this will cause outright
financial markets seizure, as was feared in May this year. Also, at the latest ECB press conference there was
a clear desire to ensure the stability of the Eurozone and a greater willingness to use the bond purchase
programme (SMP). Chinese officials have also offered to step up their support of European stabilisation
efforts. What form this might take is unclear, but at the very least should be successful in lifting sentiment.
Chinese property – We highlighted Chinese residential construction as a linch-pin for our investment strategy
going forward, as this sector is 33% of steel demand. The IMF’s new report on Chinese property highlights
some interesting conclusions, notably that house prices do not appear to be significantly higher than justified
by fundamentals. While there may be overvaluation in some coastal cities, developments are still ‘early stage’.
Moreover, there are powerful structural drivers underpinning the housing market, namely low real interest
rates, strong income growth and a low mortgage-to-GDP ratio. We believe these drivers will result in a wider
economic rebalancing, providing the global economy with an invaluable growth engine for the foreseeable
future.
Australian economic growth on a rising trend – RBS economist Kieran Davies expects 3.7% growth yoy for
2011, and we expect Australia to remain in the fortunate position of enjoying buoyant terms of trade while also
generating significant export volume growth through the expansion of iron ore, coal and LNG operations.
Australia’s increasing dependence on China, however, does give rise to risks of greater volatility. RBS expects
the RBA to take the cash rate to 6% by the end of 2011. The RBA responded recently to the risks to medium-
term inflation, given the strong growth outlook and limited spare capacity in the economy. The market is
currently pricing in 25bp to end 2011 and we expect this to change as the outlook for growth in advanced
economies firms. On our forecast cash rate of 6% by the end of 2011, we expect rates to take 2ppt off income,
as the RBA’s actions would be magnified by higher household debt. However, on the positive side, our banks
team does not forecast further increases in the standard variable rate above the cash rate from here. The tight
labour market (unemployment now at 5.2%) is now feeding through to wages growth; this month we saw the
wage price index up 1.1% in the quarter, a sharp increase from 0.8% in 2Q10 and showing the fastest growth
since 4Q08. This gain lifts annual growth in this key measure of wages from 3.0% to 3.5%, although it is still
well short of the peak of 4.3% reached in 4Q08. Also, given hours worked are rising at a rate of 3.1% yoy
combined with wages growing at about 3% (and, given previous experience, that wages could grow at 4% or
Equity Structured Products and Warrants
above), we estimate household income could grow into the high single digits. Indeed, the six-month
annualised growth in the national accounts measure of compensation of employees was 9.6%. Even
detracting an additional 2ppt of debt service given our profile of the RBA cash rate would
leave mid-single-digit household income growth available for consumption growth.
Continued sovereign risk a possibility – Let us not forget the discount applied to Australian equities for
sovereign risk post the Henry Tax Review and, specifically, the handling of the MRRT, a topic international
investors are reluctant to dismiss going forward. Australian sovereign risk will remain topical as 2011 is
unlikely to be quiet on this front, in our view.
RBS targets for 2011 – The continued rebound of corporate earnings means current valuations
continue to look cheap, reinforcing our constructive view on equities. With near-term earnings risk
modest and the outlook for continued earnings growth of 18.8% (IBES) on a 12-month-forward
basis relatively assured, in our view, we project market growth in line with 12-month-forward
earnings to reach 5657. If we then apply a modest 5% PE rating from 12.8x 12-month-forward
currently to 13.5x (still at a 5% discount to long-run average of 14.2x), this indicates the market
has potential upside of 20% to 5700.
Equity Structured Products and Warrants
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