“I believe we can avert the fiscal cliff.”

North American equity indexes almost immediately turned positive when Speaker of the House John Boehner (R-OH) uttered those words following a meeting of Congressional leadership and President Obama at the White House on Friday, and eventually US stocks posted their biggest daily gain since the presidential election after principals generally agreed that the opening round of budget talks were constructive.

Speaker Boehner noted in his remarks, “To show our seriousness, we’ve put revenue on the table, as long as it’s accompanied by significant spending cuts.” Senate Majority Leader Harry Reid said, “I feel very good about what we were able to talk about.” And Senate Minority Leader Mitch McConnell echoed Mr. Boehner, noting, “We’re prepared to put revenue on the table.”

The S&P 500 Index added 6.55 points Friday, or 0.5 percent, to close at 1,359.88. But the world’s most widely followed equity index was off 1.4 percent on the week. The S&P had closed lower for five out of seven post-election sessions heading into today’s action.

The Dow Jones Industrial Average rose 45.93 points, or 0.4 percent, to 12,588.31, reversing a morning slide of as much as 71 points. But it declined for the fourth consecutive week, the longest such slump since August 2011. The Dow was off 1.8 percent on the week.

The Nasdaq Composite Index climbed 16.19 points, or 0.6 percent, to 2,853.13. But it was down for the five days ending Friday, too, by 1.8 percent, its sixth straight down week. This is its longest losing streak since July 2008.

The S&P/Toronto Stock Exchange Composite Index posted its first positive close all week, gaining 66.34 points, or 0.56 percent, to 11,877.72. But the main Canadian equity index is off 3.9 percent since the close of trading on Tuesday, Nov. 6, the day of the US election.

US Treasury Secretary Timothy Geithner may have made the most salient point, however, when he admitted on Bloomberg TV that negotiators “have the hard stuff ahead.”

Politics have always impacted markets, but never so much in recent history is they do now, not only in the US but in Europe and Asia as well.

Until the second decade of the 21st century political was generally a background issue for investors in developed markets. Since 1980 broad trends–lower taxes, rolled-back regulations, more open trade among nations, less protection for workers–have generally favored investors.

Company earnings and equity valuations benefitted from these trends. But developed-world governments–save, among the world’s major markets, Canada and Australia–are facing solvency crises. And that means some costs are likely to shift from the public to the private sector.

We’re only at the beginning of the process of identifying which of and how these costs will be imposed. As much as the instinct for self-preservation among Washington’s leaders may argue in favor of a deal to avert the fiscal cliff, so too does this instinct to minimize political pain suggest that economic and financial discomfort may result from an agreement.

Markets have been temporarily soothed by the initial sounds of compromise. But there are many notes to play in this symphony.

Turning from the fiscal cliff to the monetary escarpment, US Federal Reserve Vice-Chairman Janet Yellen stated that short-term rates should remain around zero until 2016. Ms. Yellen also proposed adopting inflation and employment targets to set Fed rate policy.

What this means is that one highly placed monetary policymaker seems prepared to accept higher inflation to reduce unemployment. Ms. Yellen is mentioned prominently among candidates to replace Fed Chairman Ben Bernanke when he retires at the end of 2013.

Ms. Yellen’s comments during a speech at the University of California, Berkeley, on Tuesday, Nov. 13, reflect sentiments expressed in the minutes of the Federal Open Market Committee’s October meeting.

According to these minutes many members of the FOMC expressed the view that lower rates “were providing support to aggregate spending, most notably” in housing, autos and other consumer durables. And “a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of” operation twist “in order to achieve a substantial improvement in the labor market.”

This is QE4, another round of quantitative easing. And that means further support for the Australian dollar versus the US dollar.

Portfolio Update

Our first objective in the AE Portfolio is to establish long-term positions in strong companies–and to hold on through market ups and downs as they build value as businesses. That means if there is a violent pullback in this market between now and the resolution of the fiscal cliff, we’re going to mostly ride it out.

The only exceptions we’ll make will be if one of our Portfolio stocks really begins to come apart as a business under the strain. In that case we’ll move on to find better values, just as we do in other markets.

Our guide for making these moves won’t be price swings in the stock market. These occur for many reasons. Most near-term moves, however, have a lot more to do with opinion and mass selling than anything to do with a company’s ability to build long-term value. We’ll always want to know what’s up when a stock falls, and we will give you our view on why when a drop is significant. But so long as the underlying business is healthy and growing, we won’t budge from a position.

What makes us so confident we can outlast a global pullback that spreads to Australia? Simply, it’s the strong underlying health of the companies in the AE Portfolio.

Here’s the latest on our Conservative and Aggressive Holdings.

In Focus

CSR Ltd (ASX: CSR, OTC: CSRLF), a supplier of residential and commercial building products with a significant investment interest in aluminum production, has posted a 48.3 percent rally since hitting its all-time low of AUD1.17 on the Australian Securities Exchange on Jul. 18, 2012.

We made our CSR our “stock of the month” in the July Big Yield Hunting, the ultra-aggressive advisory I also co-edit with Roger Conrad, because we felt at the time that it had hit bottom, a “Big Bottom,” which was how we headlined that issue.

CSR has had a solid run, much of it based on a rebound in aluminum prices, and we’ve advised subscribers to Big Yield Hunting to close out their positions. We first recommended it at USD1.25, and it closed on Friday, Nov. 16, at AUD1.82.

The half-dozen stocks profiled in this month’s In Focus feature are all trading well off their 2012 highs. None are plumbing the relative depths CSR was seeing at the time we picked it for Big Yield Hunting. But it’s fair to say operating prospects for these six companies are better than those for CSR, what with its exposure to a struggling Australian construction market and a still-cloudy outlook for aluminum.

CSR has met rather low expectations, even as it cut its interim dividend in half on Nov. 13. And the market is rewarding it for clearing a low bar.

These stocks have been punished in recent weeks. But the companies and businesses underlying them are solid. We’re not looking for anything like the near 50 percent, four-month bounce out of the stocks below that CSR produced. They are similarly though not as speculative as that recommendation.

These are picks for investors who’d like to look for bargains amid the recent panic-driven carnage in global markets.

Sector Spotlight

What is now Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY) began its existence as a tiny farmers’ cooperative in the West Australian wheat belt in 1914.

It’s now the eighth-largest publicly traded company Down Under, its AUD39.03 billion market capitalization as of Nov. 15, 2012, trailing only mining giants BHP Billiton Ltd (ASX: BHP, NYSE: BHP) and Rio Tinto Ltd (ASX: RIO, NYSE: RIO), Australia’s “Four Pillar” banks, including Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) and dominant telecom Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY).

The largest private-sector employer in Australia with almost 200,000 employees across the country, Wesfarmers is a broadly diversified conglomerate with numerous and varied assets and interests, including food, liquor, office supplies, discount department stores, home improvement and hardware, hotels and leisure, natural resources, industrial products and insurance.

Its solid cash flow, strong balance sheet and record of dividend growth recommending it, Wesfarmers is a new member of the AE Portfolio Conservative Holdings. Read more about it in one of this month’s Sector Spotlights.

We first recommended Amalgamated Holdings Ltd (ASX: AHD) in a December 2011 In Focus on Australia-based consumer-focused stocks. Since that article, “The Australian Consumer and Picking Apart a Shopworn Sector,” was published on Dec. 16, 2011, Amalgamated has generated a total return in US dollar terms of 31.08 percent.

We boosted our buy-under target on the stock to USD6.50 in the July In Focus feature and then raised it to USD7 in August.

The stock hit a closing high of AUD7.10 on the Australian Securities Exchange (ASX) on Oct. 19, 2012, but has since backed off to AUD6.67, which puts it back below our recommended buy-under target of USD7. At these levels the stock is yielding 5.9 percent.

We’re taking advantage of the recent selloff to add Amalgamated Holdings to the AE Portfolio Aggressive Holdings as a buy under USD7.

The primary reason we’re adding Amalgamated to the Aggressive Holding and not the Conservative Holdings is that it doesn’t trade on a US exchange. Its ordinary share is listed on the Australian Securities Exchange (ASX) under the symbol AHD, while it’s also listed on the Frankfurt Stock Exchange under the symbol AQH. There’s more on Amalgamated Holdings in the second of this month’s Sector Spotlights.

News & Notes

The Affluent Revolution: According to a recent study by Boston Consulting Group (BCG) China’s population of “affluent consumers” is expected to more than double by 2020 from 120 million to 280 million.

By comparison, as of the 2010 census the US was home to 308,745,538 total people.

This explosive growth in affluent consumers will certainly help drive the Middle Kingdom’s transition from an export-dependent economy to domestic consumption-led growth.

The Continent, the US and the Middle Kingdom: Eurostat reported Nov. 15, 2012, that the still-evolving debt crisis on the Continent had finally dragged the eurozone into a double-dip recession.

Gross domestic product (GDP) in the eurozone contracted by 0.1 percent in the third quarter, or 0.4 percent on an annualized basis. This follows a 0.2 percent quarterly contraction during the previous three months.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced dividend cuts during the recently concluded earnings reporting season Down Under, lowered earnings guidance in recent weeks as well as those that cut payouts during their most recent reporting period.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

Here’s a list of those companies, along with an explanation of what these ADRs represent.

How They Rate

How They Rate now includes 111 individual Australian companies–with the addition this month of iron ore producer Atlas Iron Ltd (ASX: AGO, OTC: ATLGF)–organized according to the following sector/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business.

We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

I’m notified almost instantly via e-mail when (or if) you post a comment after you read an article. I can provide nearly real-time answers to your questions, provided the subject matter can be disposed of in such manner. If I can’t answer your question, chances are that my co-editor Roger Conrad can, and I know how to find him.

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David Dittman
Co-Editor, Australian Edge

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