Average Monthly Long/Short Return Jul-96 Feb-97 Sep-97 Apr-98 Nov-98 Jun-99 Jan-00 Aug-00 Mar-01 Oct-01 May-02 Dec-02 Jul-03 Feb-04 Sep-04 Apr-05 Nov-05 Jun-06 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12 Nov-12 Jun-13 Jan-14 Aug-14 Mar-15 12m average Correlation AUSTRALIA Stocks that rise during currency depreciation with low volatility and a strong Quant alpha score Security Description Analyst Rec CSL CSL Limited Outperform RHC Ramsay Health Cr Neutral AMC Amcor Limited Outperform AST AusNet Services Neutral TLS Telstra Corporation. Neutral CCL Coca-Cola Amatil Neutral SHL Sonic Healthcare Outperform BXB Brambles Limited Neutral DUE Duet Group Neutral CPU Computershare Ltd Outperform Stocks that fall during currency depreciation with high volatility and a weak Quant alpha score Security Description Analyst Rec FLT Flight Centre Travel Neutral TPI Transpacific Indust. Neutral CGF Challenger Limited Outperform FMG Fortescue Metals Neutral BSL BlueScope Steel Neutral SGM Sims Metal Mgmt Outperform SEK Seek Limited Outperform WOR WorleyParsons Ltd Neutral ALQ ALS Ltd Underperform RIO Rio Tinto Limited Neutral Correlation between Commodities and AUD has returned 10 8 6 4 2-2 -4 Dislocation driven by carry trade Return correlation between AUDUSD and S&P GSCI Correlation has normalised Living with uncertainty Event Volatility has returned to markets as investors await the fallout from the Greek debt crisis and negative velocity in Chinese equities builds. We examine what a high risk environment means for style returns and also update our Macro Distance model. The year has seen a number of rotations; however the one constant has been the downward pressure on the currency. We identify stocks that will survive the volatility and benefit from a falling currency. Impact Stocks that historically performed well when the Australian dollar is falling, have low volatility and a strong Quant score include CSL Limited (CSL), Ramsay Health Care (RHC), Amcor (AMC), AusNet Services (AST) and Telstra (TLS). Stocks that historically performed poorly when the Australian dollar is falling, have high volatility and a poor Quant score include Flight Centre (FLT), Transpacific (TPI), Challenger (CGF), Fortescue Metals (FMG) and Bluescope Steel (BSL). The correlation between the currency and commodity prices has also normalised to high levels after a dislocation driven by the carry trade (see chart on left). Outlook The Macquarie Risk Index (MFRI) is a global cross-asset risk index which provides a holistic view of overall risk within the economy. Risk in bond markets is building and beginning to spread to other asset classes. The index currently shows medium levels of risk. In a higher risk environment investors reward defensive factors. Large cap stocks outperform along with those with stable earnings, strong profitability and supportive valuations. Style returns in different risk regime: High Risk = Defence! 4% 3% 2% 1% -1% -2% 10 July 2015 Macquarie Securities (Australia) Limited -3% Earnings Dividend Book Volatility (high) 12m Momentum 3m Momentum 3m EPS Revisions ROIC Size Earnings Certainty Low Medium High Please refer to page 7 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.
The year to date... Mixed signals The first six months of 2015 came to a disappointing end for investors with a sharp sell-off in the Australian market in June. Weakness in the Chinese equity markets and commodity prices weighed heavily on the Australian market along with uncertainty around a Greek debt resolution. The uncertainty was evident in returns to different investment styles which have been mixed through the end of June. These can be observed in Fig 1 below. Fig 1 Average Monthly long-short returns to different factors (ASX 200) 5. 4. 3. 2. 1. 0. -1. -2. -3. -4. Earnings Dividend Volatility (high) 12m Momentum 3m EPS Revisions ROIC Size Earnings Certainty Last 12M 2015 Q1 2015 April & May June Defensive stocks started the year strongly but April and May saw investors embrace risk with strong returns to high volatility and Small Caps. Expectations of a FED lift-off helped drive this style shift as well as a rebound in commodity prices. Evidence of this is clear looking at fund flow data for ETFs (Fig 2). Investors voted with their feet as early as February with negative fund flow into yielding ETFs. Fig 2 Investors began to rotate out of high yielding products (ETF Fund flow) Flows US$bn 3.0 Dividend, REIT & Utilities ETFs Estimated From Average Month End Prices Assets US$bn 120 2.0 100 1.0 80 0.0 60-1.0 40-2.0 20-3.0 0 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 ETF Inflows (US$bn/mth, left) ETF Assets (US$bn, right) This caused a sharp sell-off in Momentum which we discussed in an earlier note and suggested this was more of a correction than a regime shift. The optimism disappeared in June and has continued to do so through the beginning of July driven by the aforementioned Greek debt situation and Chinese market selloff. 10 July 2015 2
Risky Business Macquarie Financial Risk Index In September 2011 we launched the Macquarie Financial Risk Index 1. The Macquarie Risk Index (MFRI) is a global cross-asset risk index which provides a holistic view of overall risk within the economy. We focus on Equity, Sovereign and Corporate Bonds, FX and Commodity asset classes. This provides a useful framework to understand risk and its drivers throughout global financial markets We can see below that the risk in Bond markets is starting to spread to equity markets and other asset classes. Fig 3 Macquarie Financial Risk Index (MFRI) FX Equity Asset Class Sovereign Bonds Corp Bond Commodity 08 Jul 14 15 Jul 14 22 Jul 14 29 Jul 14 05 Aug 14 12 Aug 14 19 Aug 14 26 Aug 14 02 Sep 14 09 Sep 14 16 Sep 14 23 Sep 14 30 Sep 14 07 Oct 14 14 Oct 14 21 Oct 14 28 Oct 14 04 Nov 14 11 Nov 14 18 Nov 14 25 Nov 14 02 Dec 14 09 Dec 14 16 Dec 14 23 Dec 14 30 Dec 14 06 Jan 15 13 Jan 15 20 Jan 15 27 Jan 15 03 Feb 15 10 Feb 15 17 Feb 15 24 Feb 15 03 Mar 15 10 Mar 15 17 Mar 15 24 Mar 15 31 Mar 15 07 Apr 15 14 Apr 15 21 Apr 15 28 Apr 15 05 May 15 12 May 15 19 May 15 26 May 15 02 Jun 15 09 Jun 15 16 Jun 15 23 Jun 15 30 Jun 15 07 Jul 15 Average Monthly Long/Short Return MFRI Equity Sovereign Bonds Corporate Bonds Commodity FX Economics US Equity EU Equity EM Equity UK Equity Japan Equity Asia ex Equity US Sovereign Bonds EU Sovereign Bonds UK Sovereign Bonds EM Sovereign Bonds Japan Sovereign Bonds Asia Ex Sovereign Bonds High Investment Grade Energy Agriculturals Base Metals Precious Metals EU FX UK FX Asia Ex FX Japan FX EM FX US FX Green signals low risk (higher risk appetite), Red signals high risk (lower risk appetite) and Amber signals normal risk environment Source: Macquarie Research, Bloomberg, July 2015 Uncertainty ultimately creates volatility which has a strong chance of persisting in the current macro environment. So what does this mean for style returns? We show below the average return to investment styles grouped by risk regime since 2010. Defence dominates in high risk regimes with investors turning to companies with strong earnings certainty, low volatility, supportive valuations and strong profitability. Fig 4 Style returns in different risk regime (MSCI world since 2010) 4% 3% 2% 1% -1% -2% -3% Earnings Dividend Book Volatility (high) 12m 3m Momentum Momentum 3m EPS Revisions ROIC Size Earnings Certainty Low Medium High Source: Macquarie Research, Bloomberg, July 2015 1 See Risky Business Stressing about risk, Macquarie Quantitative Research, September 2011. 10 July 2015 3
Jul-96 Feb-97 Sep-97 Apr-98 Nov-98 Jun-99 Jan-00 Aug-00 Mar-01 Oct-01 May-02 Dec-02 Jul-03 Feb-04 Sep-04 Apr-05 Nov-05 Jun-06 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12 Nov-12 Jun-13 Jan-14 Aug-14 Mar-15 12m average Correlation Cumulative Returns Cumulative Returns Macquarie Wealth Management While factor returns have been volatile over the last 6 months the one constant has been the steady decline of the Australian Dollar. We show below a cumulative return of the S&P GSCI (commodity index), the AUD/USD exchange rate and the MSCI China A equity market. The relationship between the AUD returns and commodity returns is strong whilst the Chinese equity market (MSCI China A) has no apparent correlation. Fig 5 Cumulative returns to Commodities, Currency and China 4.0 3.5 3.0 Currency and commodities continue to fall 2.5 2 2.5 1.5 2.0 1.5 1 1.0 0.5 0.5 0.0 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 S&P GSCI (Commodites) - Spot Price (LHS) MSCI China A (LHS) AUDUSD (RHS) 0 Historically the Australian dollar has had a strong correlation to commodity prices; however there are periods where this relationship diverges. See Fig 6. 2012 to 2014 was one of these periods with Australian interest rates offering a significant premium to global peers during a period of commodity price weakness. This dislocation has proven to be temporary and correlations have returned to higher levels. Fig 6 Correlation between the AUDUSD and commodity prices (S&P GSCI) has normalised back to high levels 10 8 Correlation has normalised 6 4 2-2 -4 Dislocation driven by carry trade Our economics team currently forecast future deterioration in the Australian dollar as a weak economic outlook drives possible further rate cuts and the terms of trade continue to deteriorate. With this outlook we examine stocks that are most sensitive to movements in the currency. To account for the increased risk and volatility in markets we include a volatility rank for stocks plus our latest Alpha ranking. 10 July 2015 4
Stock level currency sensitivity In a note earlier in the year we highlighted the importance of paying attention to your currency exposure, especially in an environment where the exchange rate is facing significant pressure in one direction. Our currency beta is calculated using monthly excess stock returns of stocks and returns to the AUD/USD pair. Figure 1: Negative Beta Stocks Outperform when the currency depreciates Security Description Beta (2010+) Corr (2010+) Alpha Rank Volatility Rank RMD ResMed Inc. -1.03-58% 39% 81% CSL CSL Limited -0.83-61% 78% 23% WFD Westfield Corp -0.65-49% 45% 45% RHC Ramsay Health Care -0.63-42% 64% 26% WOW Woolworths Limited -0.62-6 11% 42% AMC Amcor Limited -0.59-51% 9 25% AST AusNet Services Ltd -0.55-48% 65% 22% SKI Spark Infrastructure -0.55-44% 46% 16% ANN Ansell Limited -0.50-38% 16% 44% TLS Telstra Corporation. -0.50-42% 99% 2% CCL Coca-Cola Amatil -0.47-39% 77% 2 TCL Transurban Group -0.46-35% 19% 8% NVT Navitas Limited -0.44-21% 26% 79% MTS Metcash Limited -0.43-33% 4% 96% TTS Tatts Group Ltd -0.42-38% 38% 37% SHL Sonic Healthcare -0.41-29% 85% 11% BXB Brambles Limited -0.40-3 93% 12% ALL Aristocrat Leisure -0.37-17% 48% 7 DUE Duet Group -0.33-25% 89% QBE QBE Insurance Group -0.30-17% 61% 71% CPU Computershare Ltd -0.28-18% 53% 27% ASX ASX Limited -0.25-22% 58% 1% DMP Domino Pizza Enterpr -0.25-17% 9% 93% APA APA Group -0.25-25% 56% 39% BEN Bendigo and Adelaide -0.25-12% 42% 9% AZJ Aurizon Holdings Ltd -0.22-19% 72% 36% *Stocks are highlighted where they have a below average volatility and above average Alpha rank Figure 2: Positive Beta Stocks Underperform when the currency depreciates Security Description Beta (2010+) Corr (2010+) Alpha Rank Volatility Rank FLT Flight Centre Travel 0.80 39% 13% 83% TPI Transpacific Indust. 0.77 31% 21% 88% CGF Challenger Limited 0.75 36% 27% 73% FMG Fortescue Metals Grp 0.64 23% 10 DOW Downer EDI Limited 0.61 26% 97% 77% BSL BlueScope Steel Ltd 0.60 23% 3% 97% SGM Sims Metal Mgmt Ltd 0.56 27% 34% 74% SEK Seek Limited 0.45 24% 14% 65% IFL IOOF Holdings Ltd 0.45 34% 79% 58% FXJ Fairfax Media Ltd 0.43 23% 52% 84% GMG Goodman Group 0.36 19% 82% 38% WOR WorleyParsons Ltd 0.36 2 5% 94% BLD Boral Limited 0.35 2 32% 18% ABC Adelaide Brighton 0.34 25% 68% 48% ALQ ALS Ltd 0.31 15% 98% QAN Qantas Airways 0.29 17% 10 92% LLC Lend Lease Group 0.28 21% 75% 29% RIO Rio Tinto Limited 0.28 2 36% 54% IPL Incitec Pivot 0.27 14% 63% WPL Woodside Petroleum 0.22 19% 2 51% NCM Newcrest Mining 0.20 9% 18% 91% NAB National Aust. Bank 0.20 24% 67% 3% AWC Alumina Limited 0.19 11% 81% 87% BOQ Bank of Queensland. 0.17 12% 47% 17% MGR Mirvac Group 0.17 4% 91% 21% *Stocks are highlighted where they have a above average volatility and below average Alpha rank 10 July 2015 5
Jun-92 Jun-93 Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 GOLD ( Current Value = 1191.400 ) ISM_INV ( Current Value = 51.500 ) MSCI_AU_M12M ( Current Value = -0.100 ) MSCI_WORLD_M12M ( Current Value = 0.063 ) MSCI_WORLD_M3M ( Current Value = 0.013 ) OECD_AU ( Current Value = 100.664 ) OECD6 ( Current Value = 99.435 ) US_YLD_10YR ( Current Value = 2.120 ) US_YLD_3M ( Current Value = 0.010 ) USDAUD ( Current Value = 1.306 ) US_YLD_SPREAD ( Current Value = 2.110 ) US_YLD_SPREAD_M6M ( Current Value = -0.023 ) ISM_INV_M6M ( Current Value = 0.000 ) USDAUD_M6M ( Current Value = 0.115 ) Macquarie Wealth Management Macro Distance model Our favoured approach to style timing involves the use of a broad range of macro-economic inputs, and places more emphasis on realised style returns at points in time that are closer (macro-economically speaking) to the current point in time. The macroeconomic factors used in the Australian model are shown below along with their current score and the score at the most and least similar time in history. Fig 7 Macro factors used in distance calculation and current z-score (Australian Model) Least Similar ( 2009-05-29 ) Most Similar ( 2015-04-30 ) Current Period ( 2015-06-30 ) 3 2 1 0-1 -2-3 -4 We show below (fig 8) the similarity of the current point in time, measured by our distance model, to history and which periods are most similar. The similarity remains higher to recovery periods such as the mid 2000 s and the mid 1990 s and dissimilar to the distress periods at the depth of the GFC and the tech wreck. It is through these periods when we see the most risk of severe turning points. Fig 8 Current macro similarity index Fig 9 Active style weights of the model 10 9 8 High Similarity to current macro environment VALUE MOMENTUM Current Active Weights 7 6 Similarity to periods of market strength ANALYST RISK 5 PROFITABILITY 4 GROWTH 3 TECHNICAL 2 LIQUIDITY 1 Low Similarity to current macro environment Crisis periods least similar QUALITY CAPITAL -8% -6% -4% -2% 2% 4% 6% Active Weight Our distance model forecasts style returns by weighting observed factor returns experienced historically by using the macroeconomic distance of each specific date point from today s date. The style returns on closer dates (macro-economically speaking) get more weight in the forecast than dates that are distant. This results in a model that produces forecasts of style returns that are dynamic. We then produce recommended style weights in our model which reflect a pro-rating of the forecasts. These style weights are compared to the long term average style weights to give a feel for the favoured styles. The current style recommendations (Fig 9) of the model continue to remain reasonably mild; however the model continues to favour Analyst and Capital factors at the expense of Valuation. Despite the macro volatility our distance model continues to indicate a regular environment for investment strategies. 10 July 2015 6
Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+1 Neutral expected return from -1 to +1 Underperform expected return <-1 Macquarie First South - South Africa Outperform expected return >+1 Neutral expected return from -1 to +1 Underperform expected return <-1 Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 60 10 in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 6 in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 4 in a year. Low medium stock should be expected to move up or down at least 25 3 in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2015 AU/NZ Asia RSA USA CA EUR Outperform 46.23% 58.36% 47.27% 44.2 60.65% 43.01% (for US coverage by MCUSA, 9.68% of stocks followed are investment banking clients) Neutral 37.67% 25.65% 29.09% 49.29% 34.19% 40.93% (for US coverage by MCUSA, 5.53% of stocks followed are investment banking clients) Underperform 16.1 15.99% 23.64% 6.52% 5.16% 16.06% (for US coverage by MCUSA, 1.38% of stocks followed are investment banking clients) Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 318062) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 002 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 002 574 923, AFSL No. 237504) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 008 583 542, AFSL No. 237502) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return e-mail and delete the document. We do not guarantee the integrity of any e-mails or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. 10 July 2015 7