As we note in News & Notes, Chinese policymakers appear to have engineered a soft landing and gentle takeoff for the world’s second-largest economy. China’s exports resoundingly beat expectations in December, and the HSBC China Manufacturing Purchasing Managers Index (PMI) for the final month of 2012 posted its best reading, 51.5, since May 2011.

But, as is the case with the US federal government and the recent detour from a “fiscal cliff,” the Middle Kingdom’s rebound is merely an interlude–perhaps a long, refreshing pause–before serious work on rebalancing the economy in favor of domestic demand gets underway.

The challenge for China’s incoming leadership group is to restructure four main aspects of the domestic economy, including the current urbanization process, the current investment/financial model, the relationship between the government and the services economy and government’s role as both growth facilitator and interventionist.

The economy of the Middle Kingdom is now running at a reasonable pace as 2013 gets underway. That gives Xi Jinping, the successor to Hu Jintao as the General Secretary of the Communist Party, and the presumptive prime minister Li Keqiang breathing space to work out what is essentially a political problem.

Potential for consensus revolves around two major poles, one a focus on establishing a serviceable social safety net and improving the quality of public services, including health and education, the other a pro-market emphasis on allowing the private sector more room to grow, letting the market set prices in order to direct resources more efficiently and reducing opportunities for rent-seeking by diminishing administrative power.

It sounds a lot more elegant than the reality is likely to be, much as the euphoria surrounding the recent deal in Washington, DC, was something of an illusion in the face of yet another rapidly approaching and potentially destructive debate about “sequestered” spending cuts that was put off until March and is likely to become intertwined with what is a mess all on its own, the next extension of the US federal borrowing limit.

That’s to say nothing of Europe, where four years after the sovereign debt crisis broke policymakers are just now establishing the mechanisms and institutions to address structural problems with what remains a deeply flawed economic union. The threat of dissolution is no longer acute, and bond yields for “peripheral” nations are drifting lower.

But the eurozone remains a key constraint on global growth, and fixing its problems will still take a long time from here. Italy and Germany are holding federal elections this year, which will likely limit appetite for significant new initiatives to boost growth on the Continent in 2013.

Elsewhere in Asia, Shinzo Ab’’s government will pour JPY10.3 trillion of economic gasoline on the dimming embers of Japan’s economy with a new stimulus package the Japanese Prime Minister claims will create 600,000 jobs and boost GDP by 2 percent.

The Japanese leader is betting heavily on new construction spending and the prospect of further easing from the central bank to keep the economy out of recession ahead of elections in July.

The Australian dollar, meanwhile, continues to defy gravity as well as central bank efforts to rein it in. The Reserve Bank of Australia (RBA) has cut its cash rate target a total of 175 basis points since November 2011, the last 25 basis-point move taking the benchmark once again to its all-time low of 3 percent, a level previously reached during the depths of the Great Financial Crisis in April 2009.

And Wall Street is back to fresh, five-year highs, even as American policymakers stand ready for another game of chicken, with Uncle Sam’s full faith and credit in the balance. And a Bank of America Merrill Lynch report found that USD19 billion flowed into US equity funds during the first trading week of 2013, the biggest surge since June 2008 and the fourth-biggest since 2000. US equities have seen positive fund flows during each of the last seven weeks.

As Roger Conrad notes in this month’s Portfolio Update, more than half of our current Holdings, including 11 of 14 on the Conservative side, are trading above recommended buy-under targets. Stay tuned and remain patient. With this many politicians in this many jurisdictions exerting so much influence on short-, medium- and long-term growth prospects there will be a correction that brings our high-quality companies back closer to buying range.

This month’s How They Rate table, in addition to the regular news or commentary of note, includes updated 2012 total return figures in US dollar terms for all 116 companies and funds in the AE coverage universe.

You’ll note the numbers are generally better than the ones we reported last month.

Portfolio Update

Not every Australian Edge Portfolio Holding was a winner in 2012. But the current lineup’s average total return of 25.8 percent certainly was.

Not surprisingly, Conservative Holdings led the way in a year marked by high volatility and mostly down-trending prices for key natural resources. These companies’ earnings have little direct exposure to commodity prices, and the 14 current recommendations were up 37.5 percent for the full year.

More surprising was the fact that even the Aggressive Holdings were up 7.9 percent. These companies are chosen precisely for their exposure to the resource business. Dodging big losses with the kind of headwinds they faced all year from global economic worries was definitely no mean feat.

The Australian dollar also managed gains last year, a welcome surprise as the currency has long traded as a proxy for natural resource prices.

We owe the bulk of our 2012 returns to positive developments at individual companies. That’s reflected in the divergence in the performance among the holdings.

And there is a way to get some immediate exposure to Australian stocks, including recommended AE Portfolio picks, without overpaying or over-reaching on risk. That’s to buy a first-rate mutual fund that holds them.

Portfolio Update takes a look at 2012 performance–including what to do with winners and how to treat losers–and summarizes the four funds we track in How They Rate.

In Focus

The Australian real estate investment trust (A-REIT) market has a history dating back to 1971, when the first property trust was listed on the Australian Securities Exchange (ASX). It’s now very large, well established and sophisticated, with approximately 70 percent of investment-grade properties Down Under securitized.

There are also several A-REITs of global significance, including the world’s largest industrial developer and one of its biggest shopping mall owners.

The sector has also seen its share of significant ups and precipitous downs.

The S&P/Australian Securities Exchange 200 A-REIT Index established its all-time closing high of 2,575.6 on Feb. 22, 2007. It finished 2007 at 2111.2 after trending lower to 2419.7 by Dec. 11 then collapsing into 2008. By Dec. 31, 2008, the index measured 899.5. It finally bottomed on Mar. 9, 2009, at 546.9.

Most A-REITs are in a stronger financial position than they were entering the 2007-to-2009 period, though memories of their steep losses during the global recession and financial crisis continue to linger. Falling debt costs support REIT performance both through a reduced interest cost and by potentially driving compression of capitalization rates. “Cap rates” are determined by dividing a property’s net operating income by its purchase price.

And most A-REITs have gone back to basics by concentrating on clearly defined sectors of the market that complement their core competencies and generate reliable income streams, mainly from rentals.

A-REITs have yet to win back the full trust of the investor community and many of their shares continue to trade at discounts to net asset value (NAV). In general, however, A-REITs are better capitalized, have more financing options, own higher-quality assets and have less risk exposure than they did five years ago.

In Focus identifies value among the A-REITs we track in How They Rate and also profiles two new additions to coverage from the sector.

Sector Spotlight

AE Portfolio Aggressive Holding Mineral Resources Ltd (ASX: MIN, OTC: MALRF, ADR: MALRY) is Australia’s largest specialist contract crushing, materials handling and mining services provider, with a combined installed capacity of more than 110 million metric tons per annum for its roster of blue-chip external customers. It’s also a mid-tier iron ore and manganese producer and mine operator, with more than 4 million metric tons of output exported in fiscal 2012.

Mineral Resources produced a negative total return in US dollar terms of 6.03 percent in 2012 and is down 3.53 percent since our initial recommendation in December 2011. The 2012 performance makes it one of just five current Portfolio Holdings to post a negative annual total return.

The stock surged after our initial recommendation, closing as high as AUD13.33 on the Australian Securities Exchange (ASX) on Feb. 29, 2012. Concern about the global economy as the eurozone nearly came apart and China slowed from double-digit growth to around 8 percent reined in mining exploration and expansion plans as well as commodities prices, including iron ore, and by Sept. 5, 2012, Mineral Resources stock was closing at AUD6.19.

We’ve enjoyed a solid uptrend since then, however, as Europe has at least managed to stick together and make progress on forming a more perfect monetary and fiscal union and China has engineered a soft landing and a nascent turnaround. And iron ore posted the biggest quarterly gain on record during the final three months of 2012, rising 39 percent.

As of the Jan. 8, 2012, close on the ASX Mineral Resources stock was priced at AUD9.99, 61.4 percent above its 12-month low but still 33.4 percent below its 12-month high. At these levels the stock is yielding 4.6 percent and trades at a price-to-book value ratio of 2.05 and a price-to-earnings ratio of 7.5.

The first of this month’s Sector Spotlight features focuses on a solid value from the Basic Materials group.

Expectations are low for Australia’s biggest integrated energy company.

AE Portfolio Aggressive Holding Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY) recently revised downward its earnings guidance for fiscal 2013, this after the stock has already suffered a slow decline from AUD13.34 per share on the Australian Securities Exchange (ASX) to start 2012 to AUD11.19 on Nov. 7, 2012, the day before it cut its forecast.

The stock slumped to as low as AUD9.84 by Nov. 16. The stock’s 12-month closing high of AUD14.15 was set nearly a year ago, on Jan. 27, 2012.

Origin closed at AUD11.73 on the ASX on Jan. 8, as it’s benefitted from the general bullish mood lifting equities markets around the world. But there are particular reasons to like Origin, such as the ability of its assets to generate cash flow and build wealth over the long term.

At these levels it’s yielding 4.3 percent. Impressively, Origin has no dividend cuts over the past five years, though dividend growth has been only very modest. For fiscal 2012 the company paid AUD0.50 per share, split evenly between interim and final payments, after it paid AUD0.49 per share for fiscal 2011 and AUD0.48 for fiscal 2010. The payout ratio for fiscal 2012 was 55.5 percent, well within reason for a company with Origin’s cash-generation capabilities.

Debt-to-assets is just 21 percent, and the company has no major maturities until an AUD1.8 billion revolving loan facility comes up for rollover in April 2015.

With a price-to-book value of 0.98 and a price-to-earnings multiple of 12.91 the stock represents a compelling bargain.

Read more about Origin Energy, a member of the Utilities group in How They Rate, in this month’s second Sector Spotlight.

News & Notes

The First Name in Earnings: Alumina Ltd (ASX: AWC, NYSE: AWC) surged on strong volume on Jan. 9 after its partner in the Alcoa World Alumina & Chemicals (AWAC) joint venture, Alcoa Inc (NYSE: AA), posted expectations-beating results for the fourth quarter of 2012. Alcoa’s revenue for the three months ended Dec. 31, 2012, surpassed estimates, and management forecast a 7 percent increase in aluminum demand in 2013.

China Is Growing Again: The National Bureau of Statistics of China reported this week that Chinese exports increased 14.1 percent from a year earlier, the biggest gain since May and up from 2.9 percent in November.

RBA’s Index of Commodity Prices Ticks Higher: The Reserve Bank of Australia (RBA) reported Jan. 2 that preliminary estimates for December indicate that its Index of Commodity Prices rose by 0.8 percent on a monthly average basis in special drawing rights (SDR) terms after rising by a revised 1.7 percent in November.

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 includes 116 individual companies funds organized according to the following sectors/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

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