ASX CLOSE: Market dips as traders look to reduce China exposure

Wednesday 13th January 2010

Across the Asian region, equity markets are all lower this Wednesday after China raised the amount its banks have to hold in reserves in an effort to cool inflation and prevent asset bubbles. The Shanghai Composite is the biggest faller, down 2.7% while the Hang Seng is lower by 2.3%. The Kospi and Nikkei are down 1.4% and 0.9% respectively.

Further south, the ASX 200 closed down 0.6% at 4868.1, slightly off morning lows of 4852.9. The energy, materials and industrial sectors detracted the most points as traders looked to reduce their exposure to riskier assets in light of the moves by China.

A few weeks ago there was a rotation to riskier assets. Now we're beginning to see that unwind with money looking for more defensively positioned sectors.

Anything from stocks to currencies exposed to China was sold. There has been talk around for sometime that the Chinese would look to slow their economic expansion but the market wasn't expecting the measures so soon.

The move has raised concerns the pace of global recovery will slow, which is the main reason why equity markets across the globe are lower.

However, we only expect it to have a short-term impact on sentiment. Once the markets realise that the Chinese are doing it for the long-term health of their economy, the buyers should return.

They're trying to prevent inflation becoming too much of a problem and asset bubbles developing. Surely this is a positive for global markets and their prospects in the long run. It's short term pain for long term gain.

The energy sector was the biggest decliner today, losing 1.6%. WorleyParsons was by far the worst performer, slumping 11.5% after issuing a significant downgrade for FY10 net profit. A weaker market for services in the US refining space and some underperforming regions (since October) forced the firm to downgrade net profit to between $280 - $320 million from $320 - $350 million. On a mid-point basis, the downgrade is approximately 10%. The market seemed surprised by this announcement given recent strength in the stock. Since its 27 November low, the stock was up more than 20% with the majority of brokers fairly positive on WorleyParsons. Despite the company saying its medium and long-term prospects remain very good, it's likely we'll see a number of broker downgrades and may see some switching to the likes of Downer EDI and Bradken.

Santos, Paladin Energy and Origin Energy were the other major detractors, all finishing down between 1% and 2.9%.

The materials sector was another big decliner, falling 1.3% as the likes of BlueScope Steel (-3.8%), Alumina (-3.1%), Lihir Gold (-2.3%), Fortescue Metals Group (-1.9%) and Rio Tinto (-1.6%) all detracted on the back of sharply weaker commodity prices.

Interestingly, in a commodities report from Deutsche Bank, they predict 2010 should see the return of real physical demand for commodities but expect volatility with fluctuating quarter-on-quarter GDP growth. They remain most bullish on bulk commodities and expect 2010-11 iron ore prices for Japan's financial year to rise 35%. Thermal and coking coal is expected to rise to US$85/ton and $175/ton respectively, up 36% vs previous expectations. They also upgraded 2010 forecasts for aluminium by 21% to $1/lb, copper by 15% to $3.00/lb, zinc by 33% to $1.05/lb, and nickel by 11% to $8.25/lb. They remain positive on gold and expect prices to average $1,150/oz in 2010. Despite the completion of global restocking and a slowdown in China's strategic purchasing, we expect physical demand in the US and Europe to improve in 2010. Base metals however, together with mining equities, are likely to peak and then weaken in 2Q and 3Q due to seasonally lower Chinese imports and the bottoming of China's GDP growth mid-2010. This will likely offset the physical demand recovery in the US and Europe in the short term, but by late 2010, we forecast stronger demand from China.

Elsewhere, the industrials sector lost 1.2% with Downer EDI the biggest faller, down 3.8% on fears it maybe facing the same headwinds as WorleyParsons. Toll Holding, United Group and Macquarie Infrastructure Group were all down more than 3% also.

Following yesterday's approach from China's Bright Food, a number of different analysts have said they don't have strong opinions on Bright Food's surprise announcement yesterday that it was interested in CSR's sugar operations, given the lack of detail and preliminary nature of the talks. Bright Food said it was keen in discussing an up to $1.5 billion all-cash offer, but CSR said it wasn't a proposal capable of being considered. A note from Credit Suisse analysts said the timing of the expression of interest appeared "coincidental" given there is a court hearing on Friday regarding the demerger of CSR's sugar unit. Credit Suisse believe the demerger "does not create significant value" but that it may establish options for the future, like improved takeover prospects. In a different report from Citigroup, they said it seems unrealistic to expect a better bid, unless the sugar unit is materially undervalued by the market. Macquarie Group also expressed their opinion, adding the potential Bright Food offer represents a 29% premium to its current valuation for the business.

The financials sector also weighed, losing 0.3% as three of the big four banks finished in the red. ANZ managed a gain of 0.2% while Westfield Group led the group, rising 0.6%.

In a report from UBS, the broker believes National Australia Bank should take a close look at an acquisition of Northern Rock's "good bank" operations in the UK. UBS feels that Northern Rock offers a number of attractions to NAB's underperforming UK business, including its very strong deposit base (which would address NAB's UK funding issues) and the substantial synergies. A deal could significantly improve NAB's UK financial position if it's able to acquire the assets at a slight premium to book value, or around GBP1.6 billion. UBS adds a deal would put NAB in a much better position to eventually exit its UK operations once the acquisition is bedded down. We believe that a profitable, well funded and capitalised UK regional bank would attract significant interest (either via a trade sale or IPO) as the UK economy eventually recovers. Adding a deal could generate large returns.

On the upside, the typically defensive sectors like telecommunications, property trusts and utilities all rose between 0.2% and 0.7%. Also, the retailers had a good session with Harvey Norman, JBFi Hi, David Jones and Billabong International all up between 1.4% and 2.6%.

Prices are in AUD unless otherwise stated.
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