Your diarist welcomes you to the October edition of The Burrell Blog for 2015.
The September blog that was written around a month ago remains relevant in explaining the last four weeks, and is worth re-reading (click here to read
). The Australian share market continued to fluctuate just above the 5,000 level and closed on the 30th
of Sep at 5,021 being 16% below the high of 5,982 at the end of April.
While the Australian market had fallen 16%, the banks had fallen 25% with CBA falling from $96 to the low $70s and the majority of the other banks falling from high $30’s by 25% to around the $30 mark.
Some of the reasoning outlined in the September blog included issues concerning the Chinese economy and declines in commodity prices; the offshore perception that Australia has a property bubble and that larger capital raisings by the Australian banks indicated stress issues; and the falling Australian dollar with predictions by some of the merchant banks that the $US dollar/ $AU dollar might fall into the 60’s and even the 50’s. Finally the GDP growth number in the June quarter was 0.2%, although it was noted that this number seemed low and the March quarter 0.9% seemed high.
These themes have continued over the past 4 weeks. There remains quite a deal of pessimism in Australia with concern over China and commodity prices, articles about the Sydney property market, the retail short fall in the Commonwealth Bank rights issue and pessimism generally around the Australian economy. This negative view can also be found overseas with articles from the bears on why the US economy may go into recession in the next couple of years.
From your diarists point of view, this is all far too pessimistic and the more probable case is that the truth is somewhere in between.
Iron ore shipments from Port Hedland in Australia remain at record levels, with Australian production remaining a material source of long term reliable supply for overseas markets. While the China property boom is no doubt correcting, Chinese services as measured by Chinese retail sales, train travel and outbound Chinese tourism continue to show that the Chinese consumer is improving their lifestyle, as has happened in other developing economies. While in Chinese manufacturing, the lead indicator being the Purchasing Manager’s Index (PMI) remains important, the world needs to move on from simply looking at this as the only indicator of Chinese economic growth.
The global press outrage at the Chinese yuan being devalued from its peg to the US dollar was misplaced. Just imagine if Australia had been pegged to the US dollar on a 1 to 1 basis as compared to now, we have enjoyed a 30-40% devaluation against the US dollar, which offsets to a material extent the fall in commodity prices that Australian shareholders are receiving. Richard Herring believes the Australian stock market has not properly factored in the currency adjusted commodity prices. The fact is the Australian currency is a commodity currency. Australians have the same disease as the US, spending too much on average. Plus the Australian currency goes up and down with commodity prices so that the now Australian prices for commodities are not nearly as volatile as the prices in foreign currency.
The offshore perceptions concerning the Australian banks lead to further selling in September and it’s only in the past week or so that Australian investors appear to be realising the excellent value in the Australian banking sector. If we were to ask what might go right rather than what might go wrong, then the bank reporting season was generally a positive, concluding with BOQ in the past fortnight which had an excellent result. NAB, Westpac and ANZ all pay dividends in November with BOQ cum dividend on the 29th of October. Last week NAB was trading on a yield of 6.3% full franked, the equivalent of 9% gross. Where else in the western world is one to receive such a yield with interest rates in the USA around 0%. It’s not uncommon if you have a bank account in the USA for it to yield between 0% and 0.25%. While the Australian banks, no doubt have business issues to confront including the Senate inquiry on the high interest rates on credit cards; the increasing competition from non-banks such as OzForex in the foreign exchange space; and the impact of digital disruption generally, none of these factors appear material in terms of the bank outlook going forward. In last month’s blog, your diarist also commented the assumption that the additional equity capital raised by the banks will not obtain a return on equity seems unrealistic. It is much more likely the banks’ borrowers will bear part of the cost of the regulators increased capital ratios. Banks have already increased interest rates on investor loans. Westpac may be the only major bank yet to have a capital raising. In the last week we saw the Australian market move up effortlessly to 5,250. With the yields on offer, it is little wonder that Australian investors should see current prices as an attractive entry point and a case can clearly be made for recovery of part of the losses as we roll forward to Christmas 2015.
Another positive in the past month is the change in Prime Minister. John Howard held the view that one of the reasons the Australian economy did well under his Prime Ministership with Peter Costello as Treasurer is that Australians had confidence in their national government and that the national debt was under control. This made Australians feel more confident, more interested in taking risks and developing businesses and consumers more confident to spend. While it is early days, our Independent Chair Bernard Rowley makes the comment that this is the first Prime Minister who has had a business background in all of his time in business and so fingers crossed no matter what your political persuasion that greater confidence in our national government will lead to a more pragmatic approach to infrastructure spending and to building confidence generally in the Australian economy.
While the banks and a number of other yield stocks look good value e.g. Telstra, one key factor in portfolio reviews is to focus on companies with high price earnings (PE) ratios which are expensive on other valuation matrices. It is clear the Australian economy isn’t going strongly and so company earnings on average may not grow as strongly as the market expects. Investors and their advisors need to cast a critical eye on companies with high growth projections and thus high PEs. Health care area is one industry sector of concern. Disappointments of earnings per share (EPS) growth will likely lead to contraction of PE ratios.
In summary with respect to the Australian share market, current valuations appear attractive to our advising team at Burrell and we would be inclined to either hold existing positions or add selectively where value has appeared.
International exposure and international share market
In the September blog, a graph was included showing the US stock market as expensive whereas Asia x Japan, inexpensive. This issue together with the likely increase in US interest rates continues to be the focus of overseas commentary. This commentary has led to uncertainty internationally. Historically the Fed in the USA has left the increase in interest rates too long and your diarist has the view that the failure to increase the rates by 0.25% from their current 0% setting was a lost opportunity last month. One needs to remember that falling oil prices are actually stimulatory for the world economy, although they may be negative for oil producers.
This general view on US valuations does not mean that all sectors and all stocks in the USA are expensive. But it does mean that a number of companies particularly the defensives on the USA market do look expensive. It is interesting that several investors into the US market including Platinum see the technology stocks as good value, as we do with the Burrell World Equities Trust (BWET). A cautionary view on US valuations has led fund managers such as Magellan and BWET to have 20% invested in cash in US dollar and pound sterling bank accounts.
For PPS and IMP clients wishing to hold some funds in US dollars, the Burrell Stockbroking Trust account now includes a separate ANZ US dollar account where client funds may be held In US dollars. Should readers be interested in this service, please email your advisor or raise at your next review.
On a closing note, the US economy has reduced unemployment from 10% during the GFC to currently 5.5%. Talk of any recession in the US appears to convince the press to publish the article because they are attracted to negative news. However from your diarists viewpoint, it is simply noise that should be ignored. The probability of the USA going into recession in the near term is under 10%. Both domestically in Australia and internationally, be a value investor and ignore the press sentiment.
Happy investing …
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