Currency Expectations - Ords003… · decision in 2016, the U.S. election. Investors, perhaps prematurely, have decided that Trump’s fiscal policies of lower taxes and infrastructure

Investment StrategySolving the investment puzzle

Currency Expectations2017: The year of the greenback

2 017 ISSUE ONE

Contents

1 A Message From Our CEO

2 Investment Strategy

10 Preferred Stocks

12 Preferred International Stocks

14 Currency Expectations

16 Cash and Interest Rate Securities

18 Commodities

19 Performance

Investment StrategySolving the investment puzzle

Publisher: Ord Minnett Limited Editor: Simon Kent-Jones Contributors: Tim Gunning, Brad Dunn Senior Designers: Felicity Everest, Sarah-Jane Edis

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Unless otherwise stated, all share prices, information and research as at Monday, 19 December 2016.

Profits and earnings per share are on a normalized basis, except where indicated.

Features

Currency Expectations 2017: The year of the greenback

2

14

Ords Insights | 2017 ISSUE TWO 1

A MESSAGE FROM OUR CEO

A welcome rally in the last months of 2016 capped off a volatile year for stocks. Perhaps most noteworthy was the stunning comeback staged by resources stocks. Miners cut operating costs significantly in response to plunging commodity prices and are now reaping the benefits as prices rebound. An agreement by OPEC members to cut oil production was another boost for the sector.

The effects of ultra-loose monetary policies from major central banks have started to wane. Extremely low cash rates provided a tailwind for higher yielding stocks for a number of years, but the realisation that this support could be unwound, albeit gradually, unsettled a number of sectors, including infrastructure, property trusts and utilities.

On the flipside, banks have started to rally as long-term bond yields inch higher, which offers the prospect of some expansion in interest margins. A lessening of competition between the major banks on mortgage pricing also alleviates margin pressure.

Political uncertainty appears to be a permanent feature of the investment landscape, but markets quickly took a positive shine to possibly the biggest decision in 2016, the U.S. election. Investors, perhaps prematurely, have decided that Trump’s fiscal policies of lower taxes and infrastructure investment will boost the country’s, and by extension, the world’s economic

Tim Gunning Chief Executive Officer

prospects. On the other hand, more inward looking aspects of the Trump manifesto raise the prospect of reduced global activity and trade, which would undermine growth.

While implementation is critical, the overall policy agenda has raised expectations of inflationary pressures, hence the lift in long-term bond yields. The U.S. Federal Reserve has also responded with another rate rise and the promise of another three in 2017.

These factors are likely to buoy the U.S. dollar, which supports our ongoing belief in geographic diversification. This can simply take the form of an exchange traded fund or clients have the ability to invest in individual stocks, such as our preferred international stocks on page 12.

I’d like to take this opportunity to thank you for your continuing support. On behalf of everyone at Ord Minnett, we wish you a very happy and healthy festive season, and a prosperous new year.

" ...markets quickly took a positive shine to possibly the biggest decision in 2016, the U.S. election."

Ords Insights | 2017 ISSUE ONE 3

As we approach the end of an extraordinary year, we have cast our eye forward to 2017. While the momentous events of 2016 (Brexit, Trump) won't be emulated, there are numerous important events on the horizon; including elections in Europe (France, Netherlands, Germany) and China’s National Congress (October).

The outlook for Australia in 2017 is reasonably positive, with our prediction of higher GDP growth (2.9%) and relatively low unemployment (5.7%). The health of the Australian housing market is crucial to the economy as a whole. In our view, housing will decelerate in 2017, but not at a pace that will threaten the economy as a whole. An important driver for the coming years will be the ramp-up of fiscal spending as construction of public transport infrastructure expands.

The one piece of the domestic puzzle missing is inflation, which has been persistently weak over the past year. Our economists see this weakness continuing and ultimately undermining the RBA’s inflation targeting mandate. As a result, we see the central bank coming under increasing pressure to further ease monetary policy settings.

The corollary of our cash rate projection (1% by end of 2017) is a lower currency, which we expect will fall to 0.68 against the US dollar next year.

We see higher global growth, at 2.8%, and global inflation rising to 2.4%. We expect China’s economy will continue to grow at a robust rate in 2017 (6.4%), assuming that a damaging trade war with the US fails to eventuate. The US should also see a healthy pick-up in growth to 2.1% but a dose of fiscal stimulus comes at a time of full employment, which means wage inflation should accelerate further. Europe is unlikely to break free of its modest growth pattern while the UK struggles as the effects of Brexit start to bite.

INVESTMENT STRATEGY

HOW TO APPROACH 2017US economic policy, likely also global, has become more active, if not more volatile and unpredictable. Put another way, a Trump presidency increases the range of outcomes.

Making forecasts for the full year could be considered a fool’s errand. We simply see it as a way to start the year, to be revised as needed.

We begin with a positive view on equities (our primary thematic is to target stocks with growth trading at a reasonable price – ANZ, Oil Search and Rio Tinto are good examples).

Fixed rate bonds,as apposed to floating rate securities, have effectively reached the end of a multi-decade bull market, so further upside opportunities are limited. At the shorter end, we have a downward bias on the RBA cash rate as a softer tone to activity data and persistent weakness in inflation would be consistent with further easing.

In a volatile policy year, we should be more tactical than strategic, with much shorter investment horizons. It similarly implies staying in liquid instruments, allowing you to rapidly change your position if needed.

One of the key global investment themes that appeared in 2016 will persist in 2017; the shift away from monetary policy towards a fiscal one, as reflected in Trump’s projected policies – tax cuts and infrastructure spending.

A large fiscal stimulus is good for growth and reflation strategy but it increases the risk that the Federal Reserve increases the cash rate faster than expected to counter inflation. Higher growth and fiscal deficits are being quickly priced into bond yields.

In turn, this has a negative effect on the value of fixed rate bonds and bond-like equities, including property trusts and regulated utilities.

4 Ords Insights | 2017 ISSUE ONE

INVESTMENT STRATEGY

ASSET ALLOCATION COMMENTARYStock markets have rallied towards the end of 2016, with the Australian market reaching a 12-month high while the US claims record highs. Bonds on the other hand continue to suffer with longer-term bond yields around the world back to their levels of two years ago, fully undoing global fears of recession and deflation.

The growth strategy remains on track, which favours equities, cyclical stocks, energy, commodities and hybrid securities while down-weighting fixed rate bonds, bond-like equities and gold.

The Trump trade arrived with a vengeance post the US election. The first policy tilt involves US tax cuts and reform. This boosts after-tax earnings, even without a stronger economy, and thus boosts a positive view on US equities (iShares S&P 500 ETF (IVV.AXW) provides simple exposure while ideas for direct equity exposures can be found on page 12).

Forward looking US surveys from companies and consumers are showing a remarkable move up, as if the Trump victory created a newfound confidence in the economy. To some degree, making everyone expect better growth and inducing them to prepare for it, can actually make economies grow faster. Expectations can become self-fulfilling.

The second Trump tilt though is less alluring. Threats of tariffs on China and Mexico create downside risk on emerging markets and upside on the US dollar. We are wary of emerging market equity, but see this position primarily as a tactical/hedged position. Trade tensions could escalate or defuse rapidly and we would enter emerging markets (e.g. iShares MSCI Emerging Markets ETF (IEM.AXW)) if tensions fade.

In oil, consensus expectations on the scale and longevity of the proposed OPEC/non-OPEC cuts appear too cautious, skewing near-term price risk to the upside. Our 2017 average price forecast is for US$56.25/bbl on WTI. However, there are appropriate concerns that cheating within the cartel will inevitably undermine commitments to the agreement at some point in the second half of 2017.

ASX 200 SEES EARNINGS MOMENTUMEarnings momentum across the ASX200 has been positive over the past six months. Bank earnings are stabilising, while the momentum remains positive for Materials. With these sectors accounting for more 40% of the ASX200’s market capitalisation, there is the possibility of further aggregate earnings per share gains.

The global reflation thematic is a powerful tailwind for the mining sector. Supply discipline in key commodity markets (iron ore, coal) remains intact and should sustain prices well above levels assumed in consensus forecasts. A crack in supply-side discipline is the key earnings risk to the sector.

With the latest raft of banking results and updates marking the nadir, in our view, we should see earnings stabilise and potentially start an ascent, albeit likely to be at a slow and low rate. The principal risk for the sector is a return to aggressive mortgage discounting.

As has been the case for a number of years, prospective dividend yield will be an important component of the overall return picture for the index.


INVESTMENT STRATEGY

Bull points � Resources upgrades accelerate – Should we see commodity prices, particularly iron ore, stabilise at current levels, there is considerable upside for the ASX200’s second largest sector.

� Banks nudge higher – The pressure on banks eases, with bad & doubtful debts contained and more short-covering, as well as a less onerous capital outcome than expected.

� Non-mining capex improves – Meaningful lift in capex spend in the non-mining sector.

� Energy on a rising tide – Rally in oil prices precipitates a series of upgrades across the sector.

� Healthcare benefits from US policy tailwinds and weaker Australian dollar

Bear points � Resources false dawn – The impulses driving the current upward momentum in iron ore fade, putting pressure on earnings.

� Net interest margin pressures persist – Lower rates fully passed through the mortgage market. Wholesale and deposit funding pressure builds.

� Structural issues continue to haunt consumer staples – Deep structural shift continues to undermine earnings of supermarket operators.


Investment themes to considerGiven the likelihood of a volatile trading year it’s important to focus on specific investment themes in order to travel a smoother path:

� The return of growth at a reasonable price – The market has become more focused on companies delivering growth at a reasonable price. Even though earnings per share growth forecasts for the S&P/ASX 200 Index in aggregate have risen in recent months, it’s been specifically driven by upward revisions in resource stocks while bank earnings appear to have reached their nadir.

Elsewhere, there are lingering concerns around earnings. A growing list of high-multiple companies have disappointed on guidance recently, including Bellamy’s, Healthscope, TPG Telecom and Vocus. Given earnings growth is still not assured in Australia, we expect investors will become more discerning and less willing to pay high multiples for growth. Stocks that offer earnings growth but at a reasonable price include ANZ among the banks, JB Hi-Fi and Service Stream, as well as Oil Search and Rio Tinto in resources.

� US pedals faster – Donald Trump’s agenda, in so far as it advocates fiscal stimulus for the US economy, should be positive for the US market. These policies include tax cuts for low income earners and companies and infrastructure spending, although the positives from other more protectionist measures are perhaps questionable.

Incorporating some fiscal stimulus, circa US$500 billion per annum, adds roughly 0.25 percentage points to US GDP growth forecasts in 2017 and 2018. Our global counterparts forecast a stronger outcome for US equities, with the S&P 500 Index reaching 2,400 by year end 2017 (up 10% from current levels).

Focusing on stocks, tax cuts and wage growth should boost consumer spending, which will be positive for Westfield as a retail landlord. More support for the US manufacturing industry should also help industrial property

owners and developers like Goodman Group which is building a beachhead in the US. Exposure to a more buoyant US equity market can be gained via asset managers such as Magellan Financial, with its funds primarily invested in the US, as well as exchange-traded funds such as the iShares S&P 500 ETF (IVV), which provides a simple exposure to S&P 500 index performance. Our preferred international stocks can also be found on page 12.

� Structural growth – Longer term, we continue to favour beneficiaries of structural trends, such as from the ageing population, the increased attention to health and well-being (Ramsay), the shift online (MYOB), and China’s transformation and growing wealth (Treasury Wine).

� Yield plus – Australia is somewhat out of sync with the rest of the developed world, with a household sector that has yet to deleverage, a residential cycle that is peaking, and more persistent weakness in inflation driven by supply-side factors (e.g. low wage growth, rising competitive forces).

Unlike the US, we do not see the Reserve Bank of Australia raising interest rates in 2017. In fact, there is still a reasonable chance of more rate cuts next year. Against depressed cash rates, yield still makes sense. However, despite short-end rates here coming down, long-end (e.g. 10 year) bond yields are likely to stay elevated given the pull higher from global bond yields.

FORWARD LOOKING U.S. SURVEYS FROM COMPANIES AND CONSUMERS ARE SHOWING A REMARKABLE MOVE UP, AS IF THE TRUMP VICTORY CREATED A NEWFOUND CONFIDENCE IN THE ECONOMY


INVESTMENT STRATEGY

This means investors need to be more discerning about the yield stocks they own. Our preferred yield companies are those that offer a decent yield pick up over cash rates, but can still generate earnings growth and with asset valuations that are less sensitive to rising long-term interest rates.

At the current price, Wesfarmers has an attractive estimated gross yield of 7%. This dividend is supported by booming coal prices, which sees its resources segment moving back into profit. Consensus forecasts are for Wesfarmers to grow earnings by 15% and dividends by 10% in FY17. Other yield-plus stocks we prefer include AGL Energy and Perpetual.

� Declining Australian dollar – While the Australian dollar saw only minor movements against the US dollar in 2016 (its narrowest trading range since 2006), we believe it is still feasible that the local currency declines to US$0.68 by the end of 2017, given narrowing interest-rate differentials between the US and Australia and some moderation in bulk commodity prices.

Should the RBA cut rates again next year, and the US Federal Reserve raise rates, the Australian dollar could yield less than the US dollar. The last time this happened was at the turn of the century, when the exchange rate averaged around US$0.60. Our ideas for leverage to a weaker Australian dollar include Orora, Treasury Wine and Westfield.

� Risky business – Sadly, not every stock will fare well in the new year. We believe that the trends for some companies are deteriorating and we flag some risks around their ability to deliver on earnings expectations. In cases like Flight Centre and Platinum Asset, they are relying on a stronger second half of the financial year to prop up expectations, while the likes of Mirvac and Coca-Cola Amatil are facing tougher sector conditions.


ECONOMICSA notable feature of the current global expansion is that growth has proved both disappointing and resilient. Following a brief bounce out of the 2008 global recession, growth has persistently disappointed forecasters’ expectations, failing to deliver on the normal cyclical pattern of downturns followed by sustained above-trend growth in expansions.

At the same time, in the face of a multitude of threatening shocks, ranging from geopolitical (the Arab Spring, Russian incursions, Brexit), to credit (Euro sovereign crisis, EM credit), to commodities (an oil price collapse), global growth has remained remarkably stable. From 2011-2016, global growth remained in a roughly 2%-3% range.

We expect global growth to pick up modestly from the recent pace, but do not see it breaking the 3% upper bound of recent years. Instead, the most significant action is expected to come from a normalisation of inflation and a narrowing of regional and sectoral divides. In particular:

� Inflation rises close to a percentage point - From its low point of 1.5% early in 2016, we look for global inflation to move up to 2.4% in 2017.

� A rebound in profits – Disinflation along with weaker productivity growth has depressed corporate profits, but as inflation re-emerges, profits should rebound.

� A modest pickup in investment – Stronger GDP and profit growth are necessary conditions to deliver a recovery in business spending.

� United States – We are looking for 2.1% real GDP growth in a year that will be an interesting one. The first and most obvious reason it should

be interesting is the election of Donald Trump, an outcome that could usher in sweeping changes to tax, trade, immigration, and regulatory policies. However, there is another reason economic developments in 2017 should prove to be interesting: the economy is now operating at full employment in a negative real interest rate environment. Wage inflation, which has already begun to pick up, should accelerate further as a result. We are mindful that protectionist trade policies could spark retaliatory measures by other countries that could leave everyone worse off. For now we are keeping that as a downside risk to growth, not part of our base case.

� Emerging markets doing better but not well – As disinflationary drags fade, economies that suffered the largest terms-of-trade losses are likely to benefit most. A subdued expansion in developed markets and tight credit availability are factors limiting the expansion of these regions.

� China – As in previous years, the government will aim to achieve a fine balance between stable growth, economic restructuring, and financial stability. Ongoing structural adjustment and cyclical downturn will produce 6.4% annual growth. Weaker macro-policy support, and adjustment in real estate investment and auto sales, together with the uncertain trade relationship with the US after Trump’s triumph, will likely slow growth closer to 6% in the first quarter. This will cause the shift of policy priority back to growth stabilisation, which will deliver a modest pickup in activity in the second half.


INVESTMENT STRATEGY

Sector

Share price

($)

Price/Earnings

(FY17E, x)

Dividend yield

(FY17E, %)Franking

(FY17E, %) Comment

Core Blue Chip

AGL Energy Multi-Utilities 21.52 17.9 4.0 80

Free cash flow generation to increase over the short-term driven by improving retail margins and higher wholesale electricity costs.

Commonwealth Bank of Australia Banks 81.18 14.5 5.2 100

Quality banking name with a strong domestic focus.

CSL Biotechnology 96.80 26.3 1.9 0Core health-care exposure as global leader in supply of plasma products.

Ramsay Health Care Health Care Providers 67.02 27.6 2.0 100

Additional growth potential and further procurement savings.

Rio Tinto Metals & Mining 60.96 16.5 3.9 100 Long-life mining investment opportunities

WesfarmersLimited Consumer 41.60 16.8 4.9 100 Generating significant cash flow.

Westfield Corp Real Estate 9.70 21.6 3.8 0Business model captures global demand for quality retail property.

Westpac Banking Corp Banks 32.35 13.4 5.8 100

Domestic mortgage focus is proving advantageous.

Income

ANZ Banking Group Banks 29.89 11.6 5.4 100 Attractive yield among the major banks.

AusNet Services Electric Utilities 1.53 17.4 5.8 50

Preferred regulated utility company on the basis of good dividend cover and valuation support.

DUET Group Utilities 2.79 23.6 6.6 0Owns energy utility assets in Australia. Currently subject to takeover

Event Hospitality & Entertainment Media 13.95 17.4 4.0 0

Improved conditions will generate stronger returns for hotels division while strong film slate provides medium-term support.

JB Hi-Fi Consumer 27.29 16.0 3.8 100 Solid sales growth.

Perpetual Capital Markets 46.80 17.7 5.2 100Strong cashflow generation supporting an attractive dividend yield

Suncorp Group Insurance 13.36 12.9 5.2 100Solid yield through capital management initiatives

Telstra Corporation

Telecommunication Services 5.02 12.1 6.2 100 Reliable yield and quality management

PREFERRED STOCKS


Sector

Share price

($)

Price/Earnings

(FY17E, x)

Dividend yield

(FY17E, %)Franking

(FY17E, %) Comment

Growth

Brambles Commercial Services & Supplies 12.10 28.1 2.2 25 Attractive competitive position in key markets.

Goodman Group Pty Real Estate 6.97 15.6 3.6 0

Success of development expansions in China, Japan, US and Brazil

Healthscope Health Care Providers 2.30 20.9 3.4 0Expansion program will lead to earnings growth

LendLease Group Real Estate 14.05 10.6 4.4 25

Well-funded development pipeline to deliver earnings growth

Magellan Financial Group Capital Markets 23.31 22.2 3.4 100 Exciting opportunities from new strategies.

Oil Search Oil, Gas & Consumable Fuels 7.06 25.6 1.5 0

The company is strong operationally while also holding corporate appeal.

Orora Containers & Packaging 2.80 19.4 3.6 32Strong cash-flow generation allows value-creating acquisitions.

Treasury Wine Estates Beverages 10.35 28.4 2.4 25

Company’s turnaround continues with multiple growth drivers.

Emerging Companies

Cleanaway Waste Management

Commercial Services & Supplies 1.16 24.3 1.9 100

Provides solid and liquid waste management services in Australia.

Corporate Travel Management

Hotels, Restaurants & Leisure 16.87 34.2 1.8 0

Well positioned with market share gains from a low base and international expansion strategy.

Hansen Technologies Software 3.88 26.3 1.5 83

IT services company that combines recurring revenue from a diversified customer base and material M&A option value.

Hotel Property Investments Real Estate 2.74 13.7 7.1 0

Yield backed by attractive portfolio of hotels with income sourced from a strong tenant – Coles.

Mineral Resources

Commercial Services & Supplies 12.36 18.9 2.8 0

Substantial upside if the market were to recognise the value of its lithium assets.

MYOB Group Software 3.44 37.2 3.3 0SME cloud accounting adoption will benefit MYOB.

oOh!Media Media 4.78 14.5 3.1 100Leading operator in the outdoor media sector, seeking to merge with APN Outdoor.

Sealink Travel Group

Hotels, Restaurants & Leisure 4.35 16.3 2.9 0

Provides an attractive mix of secure earnings and leverage to domestic and inbound tourism growth.

Service Stream Construction & Engineering 0.78 13.8 3.4 0

As a contractor to the NBN, SSM is well positioned to participate in the rollout and increased mobile infrastructure spending.

Tassal Group Food Products 3.99 11.9 4.8 75

Potential for more favourable supply/demand dynamics as TGR wins share back from imports and the export price improves.

Source: Iress, Ord Minnett Research

PREFERRED STOCKS


Stock Industry Exchange Currency

Market cap’n

(bn)Share price

EPS Growth (FY17E)

Price/ Earnings

(FY17E, x)

Dividend yield

(FY17E)

Consumer

Diageo Distillers & Vintners LSE GBP 52 20.56 8% 18 3.2%

Kraft Heinz Packaged Foods & Meats NSM USD 104 85.37 19% 22 2.9%

Masco Corp Building Products NYS USD 10 31.54 22% 17 1.4%

Nestle Packaged Foods & Meats VTX CHF 228 72.45 6% 20 3.4%

Newell Brands Housewares & Specialties NYS USD 23 46.68 4% 16 1.7%

RelxResearch & Consulting Services AEX EUR 35 15.64 8% 17 2.9%

PREFERREDINTERNATIONAL

STOCKS

PREFERRED INTERNATIONAL STOCKS

Stock Industry Exchange Currency

Market cap’n

(bn)Share price

EPS Growth (FY17E)

Price/ Earnings

(FY17E, x)

Dividend yield

(FY17E)

Energy

TotalIntegrated Oil & Gas PAR EUR 122 47.50 24% 12 5.6%

Financials

BlackRockAsset Management & Custody Banks NYS USD 64 393.75 15% 18 2.5%

Intercontinental Exchange

Financial Exchanges & Data NYS USD 35 58.33 12% 19 1.3%

MastercardData Processing & Outsourced Services NYS USD 114 104.35 14% 24 0.8%

Partners Group Holding

Asset Management & Custody Banks SWX CHF 13 477.00 6% 24 3.2%

Healthcare

Edwards Lifesciences Health Care Equipment NYS USD 19 90.48 18% 27 0.0%

GerresheimerLife Sciences Tools & Services GER EUR 2 69.05 6% 16 1.6%

Thermo Fisher Scientific

Life Sciences Tools & Services NYS USD 57 143.50 12% 16 0.5%

Zimmer Biomet Holdings Health Care Equipment NYS USD 21 102.65 10% 12 1.0%

Industrials

EquifaxResearch & Consulting Services NYS USD 14 117.13 10% 19 1.2%

Honeywell International Industrial Conglomerates NYS USD 89 116.34 7% 16 2.3%

Raytheon Aerospace & Defense NYS USD 42 142.62 0% 19 2.1%

Thales Aerospace & Defense PAR EUR 20 91.92 12% 19 2.0%

Technology

Activision Blizzard

Home Entertainment Software NSM USD 27 36.99 5% 17 0.7%

AlphabetInternet Software & Services NSM USD 556 815.65 19% 20 0.0%

Amazon.comInternet & Direct Marketing Retail NSM USD 362 761.00 89% 85 0.0%

FacebookInternet Software & Services NSM USD 348 120.57 27% 23 0.0%

Other

BetaShares Japan ETF- Currency Hedged Regional ETF ASX AUD n/a 12.29 n/a n/a n/a

Source: Thomson Reuters Eikon, Ord Minnett Research. Share price, target price and market capitalisation are in the company's base currency. Target prices, earnings and dividend estimates are consensus based. Prices as at 19th December.


CURRENCYEXPECTATIONS2017: THE YEAR OF THE GREENBACK

CURRENCY FORECASTS

Rates per $A

Quarter (average)Long-term forecasts

(average for year)

Current Mar-17 Jun-17 Sep-17 Dec-17 2018 2019 2020

US dollar 0.75 0.73 0.71 0.69 0.68 0.70 0.72 0.74

Euro 0.70 0.70 0.67 0.64 0.59 0.57 0.57 0.57

Japanese yen 86 79 75 70 67 70 72 74

GB pound 0.59 0.60 0.60 0.58 0.54 0.50 0.47 0.45

Canadian dollar 0.98 1.02 1.02 0.98 0.96 0.87 0.88 0.90

NZ dollar 1.04 1.07 1.08 1.08 1.10 1.08 1.07 1.06

Chinese yuan 5.17 5.15 5.11 4.93 4.83 4.97 5.11 5.25

Hong Kong dollar 5.81 5.69 5.55 5.35 5.27 5.43 5.58 5.74

Swiss franc 0.76 0.74 0.70 0.66 0.61 0.63 0.65 0.67

Source: Ord Minnett Research, IRESS


The typical framework for thinking about the year ahead is to identify what might be

different relative to the current year. In general, a number of familiar drivers are in play for AUD/USD in 2017; rate differentials between the two countries will compress, commodity prices could halt their run and the Chinese growth rate will continue to ease.

What makes 2017 different from recent years are the risks around growth and inflation on the back of increased scope for fiscal stimulus in the US. In turn this will mean that the narrowing of interest rate differentials will be a more powerful headwind for AUD than has been the case in recent years.

In Australia, the economy’s gradual recovery in domestic demand should continue, with the mining capex drag fading, and non-mining business investment gathering more momentum. But more importantly, core inflation will stay weak, pressuring the Reserve Bank into a further 50 basis points of easing.

In contrast, we expect the Federal Reserve to continue on its normalisation path with 50 basis points of hikes next year. And as the balance of risks around US growth and inflation shift, it is likely that the market will be keener to price in the prospect of higher rates than has been the case in the past. This means that rate spreads should compress by close to 100 basis points in 2017, taking the spread to the lows seen over the last 15-20 years.

We expect a further slowing in Chinese growth next calender year; 6.4% vs.

Rates per $A

Quarter (average)Long-term forecasts

(average for year)

Current Mar-17 Jun-17 Sep-17 Dec-17 2018 2019 2020

US dollar 0.75 0.73 0.71 0.69 0.68 0.70 0.72 0.74

Euro 0.70 0.70 0.67 0.64 0.59 0.57 0.57 0.57

Japanese yen 86 79 75 70 67 70 72 74

GB pound 0.59 0.60 0.60 0.58 0.54 0.50 0.47 0.45

Canadian dollar 0.98 1.02 1.02 0.98 0.96 0.87 0.88 0.90

NZ dollar 1.04 1.07 1.08 1.08 1.10 1.08 1.07 1.06

Chinese yuan 5.17 5.15 5.11 4.93 4.83 4.97 5.11 5.25

Hong Kong dollar 5.81 5.69 5.55 5.35 5.27 5.43 5.58 5.74

Swiss franc 0.76 0.74 0.70 0.66 0.61 0.63 0.65 0.67

Source: Ord Minnett Research, IRESS

6.7% in 2016 and 6.9% in 2015. Our forecast expects more of the same, in the sense that the moderation in growth will be modest, but with AUD already looking rich vs. Chinese growth momentum and China’s leverage ratios having risen further over the course of the year, it is hard to see the China narrative as supportive for the Australian dollar in coming quarters.

And the outlook for commodities – while highly uncertain given the recent price action in both coal and iron ore – isn’t expected to deliver much in the way of support over the medium term, given that the recent momentum in commodity prices is unlikely to be sustained.

The key uncertainty, given the prospect of US fiscal stimulus and the expectation that much of this will be delivered via infrastructure spend, is not so much whether commodity prices fall from extremely elevated levels, but how far they fall.

In terms of our forecasts, we forecast AUD/USD to USD0.71 by June 2017. We see a move below USD0.70c as more a story for the second half of the year, as compression in real rate spreads finally becomes a powerful drag on the currency, and target AUD to USD0.68 by year end. A more bearish profile for the currency would probably require a negative shock to Chinese growth or a more rampant inflation dynamic in the US, but this may well be a story for 2018 rather than 2017.


We continue to believe that the RBA cash rate has not yet reached its trough for this cycle, and expect a further 50 basis points of easing in 2017.

Australia’s economy is growing below its historical trend rate, but a pivot towards the more trade-sheltered services sectors is supporting labour utilisation.

The rotation to non-mining growth remains a work in progress. Mining investment will keep falling for a couple of years yet, while investment trends in the non-mining economy have been fluky. Business credit is picking up however.

On housing, national price growth has peaked for the cycle, and most measures show prices having decelerated to low single digit growth. Outright price falls in some cities, and in parts of the higher density market, are occurring.

The RBA has lowered the cash rate to a new record low of 1.5%. While activity is picking up, a run of weaker core inflation outcomes is forcing the RBA’s hand. We forecast a terminal cash rate of 1.00%, with a further 50 basis points of cuts in 2017.

Indications of a more positive outlook for the terms of trade and capital expenditure might buy the RBA more time to consider their position, but we don’t believe these two factors alone will be sufficient to solve the inflation problem.

The Listed Interest Rate Securities market has seen a solid year of replacement issuance by the four major banks, while issuance among corporates has been sporadic. In fact, in recent days both Origin Energy and Woolworths have redeemed existing subordinated notes without a replacement issue.

Issuance margins in 2016 (the margin above the reference rate, established at time of issue) have been at their highest levels since 2011, leading to strong trading performance in the secondary market. Trading margins (the effective margin above the reference rate by paying today’s price rather than the issue price) have contracted by 70-160 basis points over the course of 2016 on the back of strong demand for these higher-yielding securities.

After issuing a security that effectively created the trough in the current margin cycle, Commonwealth Bank subsequently issued PERLS VIII in March with a margin of 5.2% above the reference rate. This has proven to be the top end of the current margin cycle, especially for the major banks. Issuance by other major banks has been able to capitalise on this renewed interest in the sector to price new securities at thinner margins relative to PERLS VIII.

There has been only one notable issuance of a listed subordinated note by a non-financial corporate, with Qube Limited raising more than $300m at a margin of 3.9% above the reference rate. We believe that this rate reflects a range of factors that makes the pricing seem attractive. For example, it takes account of the fact that Qube has not issued a listed debt instrument before, and also that it does not carry a credit rating. Secondary market pricing tends to agree with this reasoning, as the trading margin has contracted by 70 basis points in the days since listing.

CASH & INTEREST RATE SECURITIES


PORTFOLIO PREFERENCES UPDATEWe have recently changed our list of preferred securities, which we arrange based on the various security structures available in the listed market.

In senior unsecured bonds, we have changed our view among Lend Lease bonds, now preferring the longer dated May 2020 bond yielding 3.5% per annum. This compares to the November 2018 bond yielding 2.7% per annum. In our view, an additional 80 basis points of yield more than compensates for the extra time to maturity.

In subordinated notes, we replace Colonial with Qube notes (QUBHA), on a fundamental

CASH & INTEREST RATE SECURITIES

view that they offer attractive value and can serve as a valuable diversifier in a portfolio dominated by financials. The Qube notes join the perennially popular AGL Energy (AGLHA) and APA Group (AQHHA) notes which have served this valuable diversifying function for several years.

In capital notes, we replaced the ANZ CPS III with the ANZ Capital Notes II (ANZPE), believing that the preference for nearer-term income has bid the values of shorter-dated securities higher than our estimation of fair value. Thus, despite being more than four years longer to a call date, the Capital Notes II represent better relative value.

Issue

Maturity Date / First

ResetLast

PriceCoupon

StructureCoupon

Rate Running

Yield*Yield to

Call*

AGL Sub Notes (AGLHA) 08/06/19 $103.99

BBR90 + 3.80% 5.57%qtly 5.36% 4.23%

APA Sub Notes (AQHHA) 31/03/18 $104.40

BBR90 + 4.50% 6.23%qtly 5.97% 2.71%

ANZ Capital Notes II (ANZPE) 24/03/22 $99.80

BBR180 + 3.25% 3.63%sa 5.19% 6.20%

Bendigo & Adelaide CPS II (BENPE) 30/11/20 $97.80

BBR180 + 3.20% 3.65%sa 5.33% 6.36%

Bank of Queensland CPS (BOQPD) 15/04/18 $104.70

BBR180 + 5.10% 4.97%sa 6.78% 4.26%

Challenger Capital Notes (CGFPA) 25/05/20 $99.85

BBR90 + 3.40% 3.61%qtly 5.17% 5.88%

Crown Sub Notes (CWNHA) 14/09/18 $100.10

BBR90 + 5.00% 6.78%qtly 6.77% 6.97%

NAB Capital Notes (NABPC) 23/03/20 $100.98

BBR90 + 3.50% 3.67%qtly 5.19% 5.40%

Qube Sub Notes (QUBHA) 05/10/23 $105.20

BBR90 + 3.90% 5.64%qtly 5.36% 6.02%

Westpac Sub Notes II (WBCHB) 22/8/18 $101.10

BBR90 + 2.30% 4.06%qtly 4.02% 3.76%

Source: Ord Minnett Research, IRESS. BBR: Bank bill rate; sa: semi-annual; qtly: quarterly. * Yields are on a grossed up basis.


Capital expenditure cuts and increased efficiencies continue to act as primary drivers in shifting supply and demand balances, having been contributors to commodity price action over the course of the year.

Base metals - Consensus for base metals prices has re-based higher following the US election and the reflationary-driven exuberance could push prices upward from here in the near term. Risks to this bullishness are also high given the likelihood for the continuation of oversupplied markets for copper, aluminium, and nickel next year.

Bulks – Momentum in iron ore and coal prices to continue in 2017 while Chinese economic data remains supportive. The start of US infrastructure spend could add marginal support.

Energy – Reflecting upon OPEC’s historic agreement to cut production in conjunction with non-OPEC, our 2017 average price forecasts for Brent sits at US$58/bbl and US$56/bbl on WTI. However, we harbour concerns that cheating within the cartel will inevitably undermine the the agreement at some point in the second half of 2017. Awkwardly, this is likely to coincide with a rebound in US shale output, a consequence of higher prices. Hence, we expect the oil price will fade by year end.

Precious metals – As monetary policy turns less accommodative, gold has fallen from favour. The US growth story is solid enough to dispel any strong reasons to own gold at the moment. That said, US trade protectionism and the potential spread of populism in Europe could add upward risk to our gold and silver price forecasts.

Commodities

Commodity 2015 2016 2017

Base metals

Aluminium (US$/lb) 0.76 0.73 0.73

Copper (US$/lb) 2.50 2.23 2.26

Lead (US$/lb) 0.86 0.82 0.88

Nickel (US$/lb) 5.40 4.40 4.55

Zinc (US$/lb) 0.88 0.95 1.21

Bulk

Coal – Hard coking (US$/t) 102 114 175

Coal – Thermal (US$/t) 58 63 69

Iron ore – Fines (US$/dt CFR China)

56 58 60

Energy

Oil – Brent (US$/bbl) 54 45 58

Oil – WTI (US$/bbl) 49 43 56

Natural gas – Henry Hub (US$mcf)

2.63 2.51 3.18

Precious metals

Gold (US$/oz) 1,161 1,251 1,225

Silver (US$/oz) 15.7 17.1 17.0

Source: Bloomberg, Ord Minnett Research

Commodity forecasts (period average)


Commodities

Equities market Index1 yr (%)

3 yrs (% p.a.)

10yrs (% p.a.)

Global Developed MSCI World 10.3 5.1 3.7

Australia ASX 200 15.8 7.3 4.3

Eurozone Euro Stoxx 4.5 4.9 1.4

Hong Kong Hang Seng 4.0 7.3 4.7

Japan Topix .7 9.0 0.5

New Zealand NZSE 40 13.1 13.7 5.4

UK FTSE 100 20.1 5.5 4.1

US S&P 500 15.0 9.5 6.0

Emerging Markets MSCI EM 10.5 -1.9 2.5

Source: Bloomberg. As at 16-Dec-16. Returns include dividends reinvested.

Global Markets Performance

Australian Market Performance

-60%

-30%

0%

30%

60%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

12-m

th r

olli

ng

WeeklySource: Iress, Ord Minnett Research

The Australian market has kept pace with the international markets over the last ten years.

Performance

Super shouldn’t be

puzzling

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Ord Minnett Limited ABN 86 002 733 048 holds AFS Licence Number 237121. The trustee of UMA Super is The Trust Company (Superannuation) Limited ABN 49 006 421 638 and holder of AFS Licence Number 235153. This advertisement contains general financial advice only and does not consider your personal circumstances. Before investing in UMA Super you will need to obtain a copy of the Product Disclosure Statement from Ord Minnett.


Ord Minnett Offices

Guide to Ord Minnett Recommendations

Adelaide Level 5, 100 Pirie Street, Adelaide SA 5000, Tel: (08) 8203 2500, Fax: (08) 8203 2525

Brisbane Level 31, 10 Eagle Street, Brisbane QLD 4000, Tel: (07) 3214 5555, Fax: (07) 3214 5550

Buderim, Sunshine Coast 1/99 Burnett Street, Buderim QLD 4556, Tel: (07) 5430 4444, Fax: (07) 5430 4400

Caloundra, Sunshine Coast 79-81 Bulcock Street, Caloundra QLD 4551, Tel: (07) 5491 3100 Fax: (07) 5491 3222

Canberra 101 Northbourne Avenue, Canberra ACT 2600, Tel: (02) 6206 1700, Fax: (02) 6206 1720

Coffs Harbour Suite 4, 21 Park Avenue, Coffs Harbour NSW 2450, Tel: (02) 6652 7900, Fax: (02) 6652 5716

Gold Coast Level 7, 50 Appel Street, Surfers Paradise QLD 4217, Tel: (07) 5557 3333, Fax: (07) 5574 3377

Mackay 45 Gordon Street, Mackay QLD 4740, Tel: (07) 4969 4888, Fax: (07) 4969 4800

Melbourne Level 23, 120 Collins Street, Melbourne VIC 3000, Tel: (03) 9608 4111, Fax: (03) 9608 4142

Newcastle 426 King Street, Newcastle NSW 2300, Tel: (02) 4910 2400, Fax: (02) 4910 2424

Sydney Level 8, NAB House, 255 George Street, Sydney NSW 2000, Tel: (02) 8216 6300, Fax: (02) 8216 6311

Tamworth Suite 3, 344-346 Peel Street Tamworth NSW 2340, Tel: (02) 6761 3333, Fax: (02) 6761 3104

Wollongong Level 1, 17 Flinders Street Wollongong NSW 2500, Tel: (02) 4226 1688, Fax: (02) 4226 1604

Hong Kong 1801 Ruttonjee House, 11 Duddell Street, Central, Hong Kong, Tel: +852 2912 8980, Fax: +852 2813 7212

Ord Minnett Limited ABN 86 002 733 048; ASX Market Participant AFS Licence Number 237121

www.ords.com.au www.ords.com.hk

Our recommendations are based on the total return of a stock – nominal dividend yield plus capital appreciation – and have a 12-month time horizon.

SPECULATIVE BUY We expect the stock’s total return (nominal yield plus capital appreciation) to exceed 20% over 12 months. The investment may have a strong capital appreciation but also has high degree of risk and there is a significant risk of capital loss.

BUY The stock’s total return (nominal dividend yield plus capital appreciation) is expected to exceed 15% over the next 12 months.

ACCUMULATE We expect a total return of between 5% and 15%. Investors should consider adding to holdings or taking a position in the stock on share price weakness.

HOLD We expect the stock to return between 0% and 5%, and believe the stock is fairly priced.

LIGHTEN We expect a loss of between 0% and 15%. Investors should consider decreasing their holdings.

SELL We expect a total loss of 15% or more. Investors should decrease their holdings.

RISK ASSESSMENT Classified as Lower, Medium or Higher, the risk assessment denotes the relative assessment of an individual stock’s risk based on an appraisal of its disclosed financial information, historic volatility of its share price, nature of its operations and other relevant quantitative and qualitative criteria. Risk is assessed by comparison with other Australian stocks, not across other asset classes such as Cash or Fixed Interest.

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Currency Expectations - Ords003… · decision in 2016, the U.S. election. Investors, perhaps prematurely, have decided that Trump’s fiscal policies of lower taxes and infrastructure