1

Week Commencing July 21, 2014

22

This week we look at the following topics:•Outlook on Indices•Unsettled global economy & higher energy prices•US Market outlook•German economic evolution•Forthcoming Japanese market

33

As we write this week’s report we are hearing very sad news of another Malaysian Airlines plane which has crashed on the border of the Ukraine and Russia. Reports are emerging early but it seems as though there has been a large loss of life. Any accident like this is horrific to say the least, but this crash means even more for Australia because it seems as though 27 of its citizens were on the plane. Again, things are not confirmed as of the time of writing and there will probably be a better picture which has emerged by the time you read this report.

It’s unsure how this crash will impact the current geopolitical shape of the globe – the Russians are seeking to increase their sphere of influence, the West has a huge mess on its hands in the Middle East and the emerging Asian nations are themselves looking at their own backyard and trying to exert their own territorial boundaries – China, The Philippines, Vietnam etc. in the South China Sea while Japan has made clear its territorial lines are nonnegotiable.

44

We have spoken about the very unsettling factors across the globe that all point to higher energy prices, we addressed this two weeks ago and in more detail over the past few months. We encourage you to go back and read through our research archive once you have finished going through this report.

For us, higher energy prices because of supply disruptions are the single greatest risk to global stock markets. We want to make this very clear from the outset. If energy prices rise, corporate earnings will have to absorb the pain and this will put a temporary drag on the movement in the share prices of those companies. This will only be temporary though as lower corporate earnings will soften demand which in turn will have a flow over effect on energy prices themselves. Every single market which we review below is dependent on cheap, abundant energy and the geopolitical environment suggests that the status quo in energy markets over the past decade might be about to change.

55

Our view on the various stock markets below is also a bit different. We will this week try to focus on the certain elements in each market which we think are the most important. We won’t go through the technical analysis and key levels – that will be left for Vito Henjoto who does an excellent job. In this report we will provide not on the fundamental view but the most essential factor which we think will signal market movements and price action with a medium term horizon. Remember across all of these forecast guide reports which we have provided over the past few weeks, our time horizon is around one to three years depending on each case.

US market – what many don’t see

Many are predicting a fall in the US market as it continues to ride high and hit new records. The same old argument is at hand – ‘valuations have become over stretched’. We too were of this few earlier this year, we make no mistake about that. But one of the things that we and many others had missed was the very significant structural shift which has occurred in the United States. If you don’t live in the United States, this can be difficult to see. While the United States has emerging from the financial crisis, a new manufacturing and labour force has adapted and embraced the technological change that is important to evolve the Unites States economy into its next phase.

66

We are writing this document in a Microsoft application, it will be saved in a PDF format which is licensed by Adobe and you will read it on either an Apple, Google or Microsoft operating system. If you decide the contents of this report are fantastic (which we hope you do) you will then most likely email it through your Google, Microsoft or Yahoo email account to someone who will probably first read it on their iPhone and then review on a tablet or home computer. All of the companies mentioned here are American companies, they are all pioneers of the technological change which is driving the world. All of these companies provide a service – software, hosting – things that you don’t necessarily see but services that in the modern age you will find it very difficult to live without. This is the significance of the United States economy.

What if we told you that all of the above is old news, boring news, insignificant news in terms of the savvy US investors who command huge amounts of capital? What if we told you that the next phase of the US bull market has probably not even emerged because many of the companies who will drive it are still small and emerging?

77

It will be difficult to believe, because you need to see substance behind that comment in order to start comprehending it. Well here is a short video from Elon Musk – one of the founders of Tesla Motors which we brought you last week and included a video on their manufacturing process. We said Tesla was a standout business which should help drive up the US dollar as manufacturers evolve, change and adapt new technologies. Tesla is already half the market capitalisation of General Motors. That’s old news these days, the future is in what Musk is showing in this video. Take a look.

Image: Elon Musk displaying the future of computing, printing, manufacturing

88

The US stock market might come down in the short term but we think the structural change which has occurred over the past decade – while everybody has been focusing on the financial crisis – is a major boost for future earnings growth. Many analysts, advisors and experts who constantly talk about the US market being overvalued fail to see the ability of a huge amount of smaller and emerging companies to become significant earnings contributors and key index constituents. Keep in mind that the largest company in the world and on the S&P500 – Apple – once on the brink of collapse two decades ago and reinvented itself by marketing simple consumer products and services – an mp3 player, a telephone, a tablet and a store which sells the content. Many other manufactures around the world had the ability to sell all of these things – Nokia had telephone supremacy, Sony controlled the portable entertainment market and rights to content and IBM was seen as the premier name when it came to portable computing devices. Apple overtook and dominated because of the start-up culture which thrives in US markets and the capital to back that process.

Bottom line: The US market might have a mild correction but the next three years will see more emerging technology names generating larger earnings and supporting the overall market momentum.

99

Germans will benefit from currency gains Not many predicted Germany would win the 2014 World Cup on Brazilian soil, but they did. The German football renaissance is very similar to the economic evolution in that economy. We think Germany is probably a decade or so away from where the US markets are in terms of innovation and it having an impact on corporate earnings, but they are heading in that direction. Unfortunately for German, the European Sovereign Debt crisis because a huge distraction for many companies because they had to realign their balance sheets and capital management based on political and legal issues.

The greatest benefit to German companies will come through the devaluation of the Euro. We think the Euro will continue to slide against the US dollar (reasons discussed last week) and this will have a flow on effect on German companies – multinational manufacturers, conglomerates, telecommunication companies and the finance sector. In May this year we reiterated our Buy call for the DAX – you can read the report here. This followed on from our positive call from October last year. The DAX is only about 100 or so points above the level we called in May but it did add at one stage around 400 or so points.

1010

Where the DAX goes in the next one to three years is based on how quickly the Euro slides. The top ten companies in Germany are all heavily leveraged to currency fluctuations, all of these businesses listed below have offshore earnings and they all need to have a lower Euro to boost their translated earnings when the funds are repatriated. The Euro has been a major drag on the earnings of these companies and their lobbying has provided the ECB a mandate to do “whatever it takes” to drive down the currency.

Table: Top 10 DAX index constituents weighted by market capitalisation.

1111

Bottom line: In terms of the largest index constituent Bayer, it recently reported a 5% increase in its underlying operating earnings for the first quarter of this year when compared to the prior corresponding period. Bayer’s Healthcare division sales were 3% higher which is a little to the negative side on face value but when adjusting for the higher EUR against other counter parts, sales were actually 8.9% higher in constant currency terms.

Let us reiterate that point. Bayer’s Healthcare division sales were only 3% higher in EUR terms but on a constant currency basis (stripping out the EUR’s impact) the group’s sales were actually three times that amount at 8.9%. The largest stock in Germany through this example is showing us just how much the higher EUR is hurting ordinary corporate earnings. As the Euro falls, the DAX will rise with a solid floor in place given the very loose ECB policy commitment in place.

1212

FTSE a little boring – brief reason why

In our currency review last week we wrote a bullish outlook for the GBPUSD. We think the pound or sometimes referred to as ‘cable’ has solid support and is in the early stages of a long term recovery. The UK economy is improving and the Bank of England will find it very difficult to fend off pressure to eventually start adjusting its interest rate policy. The cable will be a major beneficiary but because of the very high level of financial company exposure on the UK market, we think gains in the FTSE will be capped due to the currency rise. We think the FTSE will find it very difficult to break through and maintain a level above 7000 until the rest of Europe improves and UK financial companies start to benefit from that improvement. The type of innovation we spoke about in the US market is not completely absent from the UK market but it is nowhere near the same extent needed to propel the FTSE outside of its current trading range.

Bottom line: No point in spending too much time here. Just as the ASX200 index in Australia has basically gone nowhere for the past year or so, the FTSE in the UK is unlikely to benefit from a rising currency and interest rate environment.

1313

Japan had its run

Like the UK market, we think the Japanese market will be able and consolidate its recent gains over the next year before moving higher again in mid to late 2015. The market has priced in some very good news and recent earnings and economic data has probably disappointed slightly but there is still a lot of hope out there. The single largest factor driving the Japanese market at the moment is very cheap money and willingness by Abe to pioneer a major shift in the way Japanese business is conducting. This is excellent for Japan and excellent for Japanese stocks, but this takes time. The US structural change towards a technology savvy economy took a few decades, it didn’t happen overnight. For Japan the innovation has been coming but the corporate landscape is quickly improving.

Despite Japan’s ageing population which we spoke about last week, Japanese companies are likely to benefit from the quick expansion in wealth across the whole region. Japanese multinationals know their own backyard and despite cultural and territorial differences, Japanese companies are the best placed among any other developed nation to benefit from the huge increase in middle class wealth across the Asia Pacific region. The Japanese yen is perhaps still too high for many Japanese exporters but at least it has improved from the record highs seen a couple of years ago and there is now some sense of stability of which business can forecast and adjust their capital decisions.

1414

Bottom line: The Nikkei 225 will probably range trade between 13,000-15,000 over the coming year, before corporate earnings start to surprise higher. This will push the market towards the 20,000 level sometime later next year. We see strong support at around 13,000 given the BOJ and Abe will underwrite any downward momentum in markets with abundant, cheap money. This is a major boost.

Which brings us to Australia We’ll bring you a list of Australian listed companies which we think will do well next week. The list will be updated from that provided at the beginning of the year in our 2014 Forecast guide. We updated the performance of that list earlier this month on the Invast blog – in case you missed it, here are the performance results of the six companies which we said should do well this calendar year.

1515

On 7 July we said “Since the beginning of the year, the performance of the stocks we picked has been as follows – Leighton Holdings +31%, Newcrest mining +41%, Oz Minerals +37%, Qantas +14%, QBE Insurance -4% and Worley Parsons +12%. The average return across these six stocks has been 22% in just six months. Keep in mind that we haven’t included dividends here. Adding dividends would see the return closer to around 25%. Over the same period the ASX200 has been up by only +2.8%.” You can read the whole blog post by clicking here. The Australian market has been one of the worst performing stock markets in the developed world over the past two years in terms of index returns. This has been due to two factors – a very high currency and the complete shattering of the mining investment boom. The Australian stock market is a major source of capital for many global mining companies and there is a huge presence of resource and energy companies listed on the market.

1616

As base metal prices declined, the impact on this part of the market was profound. But we think Australia might be at the very early stages of a significant recovery in resource company stock prices. As base metals and other bulk commodities bottom and start to turn higher, the impact on the ASX200 will be very significant.

This could take some time yet with so much global uncertainty, it’s not as appealing as the structural shift in the US market but because Australia has lagged global markets for so long, the relative outperformance on the ASX200 over the S&P500 over the next year could be very significant when also taking into consideration the real prospect of a lower Australian dollar. The two key elements we would look for are: Stabilisation in the copper price, if we see copper move in the mid $3/lb level towards US$3.60’ish then this will be a major forward signal for mining stocks. When BHP hits $40 per share, the rest of the market will see it as a sign that the valuation on mining companies has been suppressed for too long.

1717

Bottom line: If we see copper continuing to do well and BHP with a 4 in front of it, there is the very real prospect of the ASX200 breaking out of the 5300-5550 range and moving higher towards 6000. There will be resistance at around the 5800 level or thereabouts but a mining led boom cannot be ignored and will have a huge impact on sentiment in Australia. The Australian market is seen as a trade on commodities and China. Should sentiment change in those two areas, the flood of capital into the Australian market form international fund managers will be profound.

Image: AUS200 stuck in narrow range for the past year. Weekly chart via Invast MT4

1818

We’ll speak about the companies we think are best placed to benefit from this next week. Some of the names we will dig deep into include BHP, Rio Tinto, BC Iron and Woodside. To reiterate, our top three picks this year from the blog post provided above have been Leighton Holdings +31%, Newcrest mining +41%, Oz Minerals +37% (as at 7 July 2014). We will also elaborate on these views in our webinar which is coming closer. Details to join are below.

Join the webinar to discuss these pointsA kindly reminder. Global markets are at all-time record highs yet some analysts are predicting a large potential fall. So what is install for the rest of 2014? Join Peter Esho, regular on CNBC, Bloomberg and host of ‘Your Money Your Call’, as he outlines his views on:

The global markets for the new financial year;Where he sees the commodity, currency and stock markets heading; andWhich ASX stocks are primed to do well over the next twelve months?

1919

Peter’s webinar will cover both the fundamental and technical outlook going forward plus the key drivers to look out for and is expected to fill fast. Q&A will be open straight after the webinar. Register now by clicking the image below.

2020

Go to www.invast.com.au/insights to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.

2121

DisclaimerPlease note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.

General Disclaimer: This newsletter contains confidential information and is intended only for the person who downloaded it. You should not disseminate, distribute or copy this newsletter. Invast does not accept liability for any errors or omissions in the contents of this newsletter which arise as a result of downloading this newsletter. This newsletter is provided for informational purposes and should not be construed as a solicitation or offer to buy or sell any financial product. Invast Financial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).

2222

Risk Warning: It's important for you to read and consider the relevant Product Disclosure Statement, and any other relevant Invast Financial Services Pty Ltd documents before you decide whether or not to acquire any financial products listed in this email. Our Financial Services Guide contains details of our fees and charges. All these documents are available here on our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange are leveraged products and carry a high level of risk and you can lose more than your initial deposit so you should ensure CFD and Foreign Exchange trading meets your personal circumstances.

General Advice Warning: Being general advice, this newsletter does not take account of your objectives, financial situation or needs. Before acting on this general advice you should therefore 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.

23

https://www.youtube.com/user/InvastInsights https://www.facebook.com/invastglobal