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Strategy review: Fed provides asset positives, but be selective

Yesterday was the biggest one-day move in the currency markets since Ben Bernanke’s QE announcement on 18 March 2009, as the FOMC maintained its dovish outlook for the US economy and US rates.

Yellen
Source: Bloomberg

Janet Yellen’s speech actually evoked an off-the-cuff line from Ben Bernanke, who said ‘we will never see “normalised” monetary policy in my lifetime’ (he was talking globally here). But it still holds true.

Market analysts are starting to a line with this assessment – Morgan Stanley, for example, doesn’t see any Fed funds rate movements in 2015. Goldman Sachs sees a solitary move in 2015 and most agree that the maximum number of moves that will occur this year is two, based on the new ‘dots’ estimates.

Now overnight, a lot of the moves off the back of the Fed have been retracted with over two-thirds of losses in the USD recovered. However, its continued march higher looks capped for now.

Themes for the remainder of 2015:

- A dovish FOMC that won’t be ‘impatient’ on moving rates – this has caused strong rally in equities and bonds and will probably continue to.

- Equities markets are now pricing out the prospect of imminent US tightening concerns in June.

- Emerging markets (particularly Asia) are in for big positives on the back of the capped USD – but traders need to be selective.

- Valuations are stretched. However, momentum and quasi-bond plays globally remain favourable as payout ratios continue to expand.

- In terms of yield, accommodation is here to stay. Equity yields will remain incredibility well bid – but I’ll continue to be selective due to high values and those with squeezed yields.

- With currencies, the AUD, EUR, JPY and GBP have earnings tailwinds. USD headwinds have somewhat diminished.

What to look for in the market

With the Fed now signalling it will remain in accommodation mode for the foreseeable future, along with the rest of the globe opening the accommodative taps (24 central banks and counting), the pause seen in yield stocks over the past month is likely to reverse and return to full steam ahead.

I am aware valuations in the typical yield names are stretched – the consistently quoted line on CBA is that it’s the most expensive bank on the planet compared to book.

However, its relatively stable earnings from the east coast of Australia, a cheaper funding model compared to peers and a payout ratio in the high 70s means CBA continues to demand a premium.

Here are the yield trades that I think matter (with yields based on consensus estimates for FY15)

The current cash rate is 2.25%, which is expected to fall to 2.0% in the next six weeks. The average 90-term deposit in Australia is 2.25% (which is eroded by tax and inflation).

- CBA net yield: 4.35%; gross yield: 6.22%

- WBC net yield: 4.58%; gross yield: 6.55%

- ANZ net yield: 4.88%; gross yield: 6.94%

- NAB net yield: 5.05%; gross yield: 7.21%

- TLS net yield: 4.6%; gross yield: 6.68%

- WES net yield: 4.8%; gross yield: 6.88%

- WOW net yield: 4.79%; gross yield: 6.84%

CBA is under the ASX 200 yield average (which is currently 4.36%), so this may slow its appreciation. However, the other three banks are likely to remain well bid on any dips and their higher yield thematics.

There are plenty suggesting BHP, RIO and WPL are now part of the trade as well. This is a risk in my eyes but the yield estimates are pressing for these names to be bid up as well.

Yields for cyclicals plays based on consensus estimates for FY15

- BHP net yield: 5.42%; gross yield: 7.75%

- RIO net yield: 5.14%; gross yield: 7.35%

- WPL net yield: 3.85%; gross yield: 5.5%

The assumption here is that BHP will continue on its ‘progressive dividend’ policy, that RIO will achieve its cost-cutting goals (which it is) and WPL will maintain its 80% payout ratio in the current price environment. There is plenty of risk that these yields may not be achieved.

Ahead of the Australian open

With the yield trade back in favour, it will be a major support for the market. On the other hand, the moves in iron ore from today and yesterday are not priced in, so we can expect to see slides in materials as well as energy as oil has normalised on the back of the USD snapping back after the FOMC announcements.

We are currently calling the ASX down eight points to 5943. What might also slow the market’s moves back towards the 6000 point is the fact the interbank market also snapped back. Expectations of a rate cut by May have fallen back to the low 80s at 83.04% after closing yesterday at a 98.1% chance.

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