Fed: a case of “travel and arrive” - tactically closing our bearish commodities view – upgrading Mining
* The eagerly awaited Fed meeting is upon us. Regardless of the actual decision,
we suggest that the market impact could end up being positive. If the Fed
does raise rates, but at the same time reassures the market that this will be a
gradual process, it would be received well. If, on the other hand, the Fed delays
the move, this could be interpreted as a signal that the Fed is aware of and is
responding to recent market concerns. A delay could dampen the link between
the DXY and commodity prices.
* Even though inaction might be seen as prolonging market anxiety, the key in
our view is that investors get to know what the new Fed’s reaction function is.
One of the main current investor concerns is over the lack of clarity from
central banks. We believe that the policymakers are still on the side of the
risky assets and will act supportively; the ECB opening the doors to QE2 is a
case in point.
* We have been cautious on commodity equities for a while, but are now advising
to tactically add exposure – upgrading Mining to OW and upgrading Energy
to Neutral.
* Specifically for Mining, we highlight the following:
1) Risk-reward is improving as the sector is by far the worst performer ytd,
down almost 30% in absolute terms.
2) Iron ore price has picked up since July, now up 30%+ from lows. From
current spot levels, JPM projections are for broadly range-bound commodity
prices next year. EPS downgrades have already been severe, with the Mining
EPS integer down 80% from highs. Unless commodity prices fall significantly
further, downside is likely limited from here.
3) Bearishness on China is omnipresent these days, but we note some improving
datapoints: Auto sales were up 12% mom for August; steel PMI is up from 37
at the lows to 45 currently; infrastructure orders appear to be bottoming out to
meet annual budget plans; and property transactions are stabilizing.
4) The Fed event could act as a positive catalyst, offering clarity. A case of
"travel and arrive".
5) The sector is clearly doing self-help. Major Miners’ capex spend has
halved over the past three years. Companies are working to improve their
balance sheet health.
6) Mining valuations have improved, with P/B relative at its lowest since 2001.
* We reiterate our call from 1st September that recent market weakness is
unlikely to be a start of a prolonged fall, but a correction which one should
use to add exposure. Regionally, we remain OW Japan and Eurozone, and stay
UW the US. We are bullish on Eurozone recovery plays – Banks, Construction
Materials, Travel & Leisure, Media and Retail. We find global consumer plays,
such as Autos, as attractive. In addition to our Mining upgrade, we close the
Energy short as the sector has performed poorly and valuations are improving.
We fund the move into commodities by downgrading Capital Goods to Neutral.
Capital Goods have held up surprisingly well ytd, to be 2% above the market.
The sector valuations are unexciting, and global capex concerns remain.