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The Australian Small Industrials market retreated 2% over the week in the shadows of the ongoing Nasdaq volatility. The Small Industrials index is down only 3.7% in absolute terms since June 30, a commendable performance given the large sell off in the Nasdaq over the period and reflective of the lesser representation of high technology stocks. We continue to recommend the key themes of service companies, strong franchises and select software companies, with any Nasdaq led share price weakness representing a good buying opportunity in our preferred exposures, which we believe remain attractive on a Price-for-growth basis.

Institutions continue to adopt a cautious approach given the large number of recent profit downgrades from Australian companies (both large and small cap) across a wide range of industries over the past few months. A number of factors continue to present earnings uncertainty and consequent risk for a large number of sectors including post Olympic activity, the introduction of the GST, the low $A, the high oil price, and an uncertain retail environment.

Consequently, trading volumes remain relatively low for the Australian Growth Companies sector, with Institutions in general avoiding any company with the slightest risk of potential earnings disappointment. Consequently, a key Growth sector thematic remains identifying companies with both robust short-term EPS growth and a defensive, low risk quality to those earnings. Preferred exposures continue to include CXP, IFM, KAZ, LAC, RMD and SRV, which continue to exhibit strong absolute share price performance.

Further corporate activity, particularly from international companies utilising the weak $A, remains a distinct possibility. In the past month there have been several takeover offers at the smaller end of the Australian market. These include Australian Hospital Care, IAMA, Evans Deakin Industries and Spicers Paper. Interestingly, with the exception of Spicers Paper, these companies have been chronic under-performers over the past few years, yet offer large strategic benefits to their suitors if successful.

In an environment where positive earnings surprise is likely to be well rewarded, we continue to highlight several companies where the weak $A presents a likely boost to earnings for several Growth Companies with increasingly international business models and hence earnings derived in $US.

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