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Analyst report - shares
2008 sector and stock outlook part 2 - sector & stock picks
January 7, 2008
Simon Guzowski, Senior Equities Analyst, wise-owl.com
 Sectors and stocks poised for out-performance
While credit markets are likely to generate volatile trading conditions and uncertainty over 2008, and high oil prices are a risk factor for some businesses, we still see plenty of opportunities in the Australian market. Overall the global economy remains strong, and global growth is above historical averages.
As an investor it does of course help to be backing the right stocks that can continue to perform in this challenging environment. The hottest sectors are shaping up to be IT, mining services and infrastructure. Sectors most likely to underperform are manufacturing and US housing.
Mid-Tier IT
The trend for businesses to build an online presence and boost their IT capability remains as strong as ever. While in the past, businesses focussed on using IT systems to cut costs, today businesses are increasingly looking to IT as a way to grow sales, especially online.
Another important shift in the IT sector has been the tendency for large IT contracts to be broken down into smaller component parts. This has meant that the very large contracts that were once the domain of multinational IT groups are now open to medium size players. Most importantly, the medium sized or mid-tier IT players have been increasingly winning these contracts and growing their businesses on the back of them. We expect this trend to continue into 2008.
Mining and engineering services
We all know that the commodities boom has delivered some impressive share price gains to our mining companies. The good news is the spoils from booming commodity prices are spilling over to the industries that offer services or support to them.
What makes these support companies particularly exciting is that they are not directly exposed to minor falls in commodity prices, yet can share in the upside of rising commodity prices. If commodity prices were to fall from here it would immediately impact most miners through lower profits and lower share prices. However, as long as these mines keep operational, the companies who service mining operations will enjoy business as usual.
Miners
We expect the miners to continue their run of out-performance as production rates drive higher earnings and merger and acquisition activity encourages prices to heat up. BHP has positioned itself as a purchaser of RIO, and several industry majors have large cash balances and undergeared balance sheets that could support mergers. On the global front, mining giants Xtrata and CVRD have expressed intentions to expand via acquisitions and locally there are very few miners who are not putting the ruler over their peers.
Needless to say the environment is ripe for a merger and acquisition frenzy, especially as junior explorers make the transition to producer status.
The ASX200 resources index has staged an impressive record of out-performance.
Soft Commodities
More mouths to feed, a booming biofuel industry and rising levels of prosperity in developing nations such as China and India are placing upward pressure on soft commodity prices. Understandably, as people become wealthier, one of the first things they do is buy more and better food. To compound this further, a well known drought here at home has contributed to lower supplies of many soft commodities such as wheat.
Opportunities to gain exposure to growth in soft commodities are few and far between on the Australian market, and many of them are trading at levels that even the most imaginative soul would struggle to justify. Fortunately there are always exceptions to the rule as some stocks in this sector still represent good buying.
Infrastructure
Following years of underinvestment, public infrastructure is gaining more public attention and bigger government budgets. The Minneapolis bridge collapse in August could also form a trigger for substantially higher levels of spending on public infrastructure in the US. Once again the developing economies of China, India and the Middle East are also playing a key role.
Mining ventures also require infrastructure expansion to support higher rates of commodity production locally, while offshore booming economies and oil wealth is resulting in high levels of infrastructure spend.
SECTORS AND STOCKS TO AVOID
Manufacturing
Many manufacturing companies find themselves on the ‘other side’ of the commodities boom. In other words, it is the manufacturers that are paying record commodity prices and in turn delivering record profits to the mining sector. These record commodity prices are raising manufacturer’s costs and lowering profits. Many of our local manufacturers are also exposed to a strong Australian dollar which is hurting profits further.
US housing
At the heart of the US sub-prime crises is an American property market in free fall. Companies exposed to this are facing an uphill battle that is likely to continue in 2008, so we are inclined to avoid these.
2008 sector and stock outlook part 1 - global markets overview
Simon Guzowski is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
More articles from the latest edition of CompareShares:
Stock picks: Fund Manager Stock Picks - Siemens and Standard Chartered Bank
Stocks: 2008 sector & stock outlook part 1 - global markets overview
Stocks: 2008 sector & stock outlook part 2 - sector and stock picks
Investing: Gangbuster returns from Aussie microcaps
Superannuation:Borrowing in a SMSF
Commodities: Still bullish on global commodities story
SMSFs: Be wary of promoters - instalment warrants in SMSFs
Markets: Wall St skids amid recession fears
Rates: Major banks may follow NAB rate rise
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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