News: FY14 reporting season stocks to surprise

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    Transcription of Finance News Network Interview with CMC Markets Chief Market Strategist Michael McCarthy
     
    Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me from online broker and CFD provider CMC Markets is its Chief Market Strategist Michael McCarthy. Michael, welcome to FNN. 
     
    Michael McCarthy: It’s great to be here. 
     
    Lelde Smits: We are on the verge of reporting season. What are your expectations and what sectors and stocks will you be paying the most attention too?
     
    Michael McCarthy: Well broadly, we’re looking for system growth a little over 3 per cent. And that should translate to profit growth approaching 6 per cent. And that would justify the market at current levels, without really giving us a leg up. So we’ll be looking, not only for the individual stocks, but also for the implications for the broader market that come from particular sectors. 
     
    A key issue for markets over the last six months has been weak consumer sentiment. And so, the performance of the consumer discretionary area will be important. To get a grip on where growth is around Australia I’ll look to the consumer staples stocks. They’re essentially food utilities, this is a basic measure of how the Australian economy is going overall, and, growth in that sector generally reflects GPD growth and could be a good lead in. 
     
    To get an idea of where business sentiment and consumer sentiment are lying in respect to growth I’ll be looking at bank results. And, although the only major report we’ll see will be Commonwealth Bank of Australia (ASX:CBA), it is a crucial report. They are exposed to every sector of the Australian economy. From consumers all the way to the top corporates. So, any growth in their loan books that’s greater than 3 per cent, or greater than the growth that we’re seeing for example in consumer staples, would be a sign that optimism is on the increase, and of course that has clear implications for share valuations. 
     
    Lelde Smits: What are some surprises we could possibly see?
     
    Michael McCarthy: At the moment the markets are factoring in lower prices for iron ore, without compensating for the increased volumes that are driving that lower iron ore price. We saw in trade data from China recently, that not only had volumes of iron ore exports, or imports to China, increased by 19 per cent year-on-year but the value of those imports has increased by 5 per cent. And, that’s not what is being factored into models. 
     
    And, in the upcoming reporting season, I suspect that one of the greatest areas of surprise could be the iron ore producers themselves. Fortescue Metals Group Limited (ASX:FMG), BHP Billiton Limited (ASX:BHP), Rio Tinto Limited (ASX:RIO) in particular, have all been producing at record levels. And, while prices have fallen I believe the total effect on the bottom line will be actually be an increase in revenues not the decrease the market is expecting. 
     
    Lelde Smits: Now Michael, you look at the markets daily, what’s currently catching your attention? Could you give us an example of a great stock story.
     
    Michael McCarthy: One of the best stock stories I believe at the moment is SEEK Limited (ASX:SEK). It’s not just that this is an IT stock with a great growth profile. IT stocks generally are leveraged to the economic cycle. And, as recovery comes through they benefit much more than other companies. Because, the cost of producing another ad is very low. Most of their costs are fixed. So, when we see a pick-up in activity, it is the IT stocks that are particularly leveraged. I like SEEK anyway, I think it is well run, it’s been very aggressive in its expansion. It’s becoming must more of an international stock these days. And, with that leverage to a pick-up in growth, not just in Australia but across the Asia Pacific region, I suspect it is going to be one of the outperformers. 
     
    Lelde Smits: On the flipside, have you identified any stocks poised for downside or any trends we should be watching out for?
     
    Michael McCarthy: I’m particularly concerned about the health care sector. It has been a beneficiary of legislated earnings. That is, because the government pays most of the bills in the health care sector, investors have piled in, seeing it as a defensive approach through the risky times the markets have travelled through. That’s lead to some lofty valuations. And, while we have seen some corrections, I believe that there is still plenty of vulnerability on the downside for health care stocks. 
     
    Lelde Smits: And are there any stocks in particular to watch out for?
     
    Michael McCarthy: In particular I’m concerned about Cochlear Limited (ASX:COH) and ResMed Inc (ASX:RMD). Cochlear has had some well known problems with their products. However, competition is ramping up, and changes to legislation in the US could severely affect their earnings. And, ResMed is in a similar situation. Not only do we have currency issues for both of these companies, because of their offshore earnings, but we also have concerns about those changes to the way MediCare and MedicAid in the US will treat ResMed’s products. And, if they do get an adverse ruling, the hit to earrings will be significant and the share price is likely to reflect that. 
     
    Lelde Smits: So Michael, which companies are looking cheap right now and perhaps showing some signs of value?
     
    Michael McCarthy: I like companies in transformation. And, Oil Search Limited (ASX:OSH) is for mine, a company in transformation. It’s going from being an explorer to a producer. Now, they’ve proved up their process, the chief operator, ExxonMobil in PNG [Papua New Guinea], has done a great job, they brought gas on stream early in March this year. 
     
    The market has increased Oil Search’s valuation over the years. But, I don’t believe that at current levels it reflects the real potential for cash flow in this company. And, I suspect that we’ll see double digit prices for Oil Search shares at some stage in the next 12 months. 
     
    Lelde Smits: In the first half the ASX has seen a series of takeovers emerge. Where could we see some M&A [Merger and Acquisition] action in the second half? 
     
    Michael McCarthy: Well, it could happen anywhere. Looking globally, one of the areas which is surprisingly cheap relative to the rest of the world, is consumer discretionary stocks, and in particular top line retailers. We’ve already seen David Jones Limited (ASX:DJS) taken out by Woolworths Holdings Limited (JSE:WHL) of South Africa. I would be very surprised if other global retailers are not currently running their ruler over the Australian retail sector. And, I suspect that Myer Holdings Limited (ASX:MYR) might be a candidate for an attempted takeover at some stage over the next twelve months. 
     
    Lelde Smits: Finally Michael, you’ve been involved in FX, commodity, interest rate and equity markets for more than 30 years. What are some of the biggest mistakes that you see traders make?
     
    Michael McCarthy: For investors or traders, the route to superior returns is to cut losses and run profits. It’s that simple - It’s that simple to say, it’s much harder to do. Investors in particular seem to hang on to stocks that are not performing for far too long. And so, to improve returns, it’s about efficient use of capital. And, for individual investors that means getting out of dead capital – getting out of stocks that are not performing and moving into the stocks that are performing. 
     
    I also see the problem in reverse. When stocks start to perform investors often jump out too early. Once a stock is moving in your favor, it’s worth hanging on and perhaps giving up the last few per cent once it turns rather that jumping out before the uptrend is completed. 
     
    Lelde Smits: Michael McCarthy, thank you for the outlook. 
     
    Michael McCarthy: My pleasure. Thank you Lelde. 
     
     
    Ends
 
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