Bull's Roar

Sydney Morning Herald

Wednesday February 16, 2005

Barbara Drury

Some stocks will benefit from a strong currency while others won't, reports Barbara Drury.

The Australian sharemarket is now two years into a record-breaking run when everything that could go right did go right. As with most bull markets, no one knows when or how it will end. But it will end and, like good boy scouts, investors need to be prepared.

One way to do this is to look at potential risks. One is the overpriced Australian dollar. At current levels of about US77c and 63.5 on the trade-weighted index, the Aussie dollar is well above its average since the dollar was floated of US70.8c and a TWI of 57.9. (The TWI compares the Australian dollar with the currencies of our major trading partners.)

Chris Richardson, a director of Access Economics, is concerned that financial markets have not been paying enough attention to Australia's current account deficit and its potential to undermine the local currency. Markets, like people, tend to focus on one factor and ignore any signs that conflict with the prevailing view.

Richardson says that a year ago the markets were concentrating on interest rates, and Australia's relatively attractive rates helped push the dollar up. More recently the focus has been on rising commodity prices, their positive impact on corporate profits and the popular perception in global markets of the Aussie dollar as a commodity currency.

"I think the next trend will be to look at the current account deficit," says Richardson. He says part of the reason the US dollar has been bid down is concern about its budget and current account deficits and the seeming lack of any plan from the Bush Administration to rein them in.

Australia's current account deficit is headed for 7 per cent of GDP, larger than any other developed nation - including the US, with its estimated deficit of 5.7 per cent. And this has happened when prices for our exports are their highest in decades.

Macquarie Equities' head of strategy, Neale Goldston-Morris, says the market has been willing to see through the current account deficit because of infrastructure and capacity constraints which mean companies can't deliver the increased volumes the market is demanding.

Goldston-Morris argues that investors are willing to take on a certain amount of risk while global interest rates are low. He says that even if rates rise here, as now appears likely to happen within months, the gap between Australian and US rates is likely to close further because the US has been lifting rates faster. "If there was some shock they would focus on the current account," he says.

Richardson is less sanguine. "Soon people will realise the current account deficit is shocking and not likely to get better," he says. Richardson forecasts an Aussie dollar of US71.4c a year from now, bottoming out at US64c in mid-2007, and a TWI of 58.3 next year on the way to 54.4 the following year.

Yet if the US dollar is pushed much lower due to a worsening of its twin deficits, Richardson concedes our dollar would rise as a result.

Goldston-Morris also believes our currency is overvalued but thinks it could press higher before falling back to what he regards as fair value in the mid-'60s.

Whereas Goldston-Morris says he doesn't get too worked up about the dollar, others believe it is worth giving some thought to the impact of a big shift in the Australian dollar either way and being prepared to adjust your portfolio when it becomes clear what the next trend will be.

Godfrey Pembroke has taken the bull by the horns and looked at the impact on local companies and market sectors of a rise in the Aussie dollar to US80c by the end of this year, and further rises to parity with the greenback by the end of 2007 (see box).

Companies with US dollar costs would benefit most from a rise in the Australian dollar and hence an increase in profit margins. The transport sector, especially airlines such as Qantas and Virgin Blue, would be winners. So would retailers, due to the reduced cost of imported goods and resources stocks with overseas assets.

Conversely, companies with US dollar sales but costs in Australian dollars would experience a fall in profit margins. Sectors with a predominantly domestic asset base would suffer most, especially resources groups with little or no currency hedging. Companies in industries such as steel and paper and packaging that are forced to compete with lower cost imports would also be put under pressure.

Another group likely to feel the pinch are Australian companies with US-based operations due to the translation impact of converting earnings back into Australian dollars. Some of those likely to be affected are insurers, property and infrastructure groups.

However, Godfrey Pembroke's head of broking services, Cavil Singh, stresses that the currency factor should not be viewed in isolation and investors need to balance the risks of a rising dollar with other factors.

"It is ludicrous to say because miners are Australian-based and the dollar is up they will be hit," says Singh, who points out that rising commodity prices have outweighed the currency impact.

The major banks would remain relatively unscathed by any rise in the value of the local currency, as would Telstra and Telecom NZ, and service companies would feel no impact.

Goldston-Morris prefers to focus on the corporate profit cycle, money pouring into equities from housing and interest rate risk down the track. He says cyclical stocks leveraged to the growing economy have seen their best and advises investors to look at sectors with long-term prospects and less sensitivity to the economic cycle such as health care, food retailers and banks.

THE RISING $A

Boosted by rising $

Pacific Brands

David Jones

Billabong

Coles Myer

Qantas

Virgin Blue

Woolworths

PRK

BHP

Rio Tinto

Lihir Gold

Hit by rising $

WMC Resources

Iluka Resources

Southcorp

Newcrest Mining

Sims Group

Alumina

Bluescope Steel

Paperlinx

Cochlear

CSL

Woodside

AXA

SOURCE: GODFREY PEMBROKE

© 2005 Sydney Morning Herald

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