Themes for 2016
↗ Dividend yield driver
↗ Interest rate cycle headwind
o Central banks in different parts of the cycle
↗ Segment stocks in Burrell Universe into four segments
o Other high yield, but steady/lower growth
o High growth & sound business model, management, Balance Sheet, ROE > 10%
↗ Adopt a realistic view on China, not a sentiment view
o Markets wholly reactive to China as a proxy to demand growth for energy & mineral resources. There is relatively well developed themes so looking for inflection points in calendar 2016.
↗ US economy and the USD
↗ Digital disruption and competition
↗ Australia innovation stocks: medical appliances; global champions
↗ Weaker resources sector = lower A$ = Mergers & Acquisitions (M&A)
↗ Deloitte Fantastic Five: agribusiness, gas, tourism, international education and wealth management
↗ Property: more positive moves driven by low interest rates, demand and low valuations
↗ Possible X factors
A. US stock market valuations and possible correction
B. $20 oil
Dividend yield driver
In the month to Easter 2016, the ides of March which have plagued several recent years were nowhere to be seen. Rather, the dividend yield driver being the difference between the high yields on leading Australian banking and industrial stocks and the low fixed interest rates have seen those stocks recover from un realistic lows and the market advance from 4854 on the 25th of February to over 5200 on several occasions in the last week. This continues the see-sawing since September 2015 where various overseas concerns have pushed the market down whilst the dividend yield driver has then in turn seen domestic investors buying stocks at attractive yields. Where else in the western world are AA rated banks available of the same quality on fully franked yields of 6%+?
Interest rate cycle headwind
This theme is the counter to the dividend yield driver such that if long term bond rates recover from their current lows, this will act as a headwind to the equities and bond markets. That there will be losses on longer term bonds at some point in the cycle seems certain, so shorter term fixed interest securities are recommended. However, “lower for longer” was the message from Japan with negative yields on inter-bank debt, the US Fed declined to raise short term rates during the month as did the Australian Reserve Bank. Those visiting our offices observe that it seems likely it will be 2017 before there is any expectation of material rises in the long term rates.
Segment stocks in Burrell Universe into four segments
↗ Other high yield, but steady/lower growth
↗ High growth & sound business model, management, Balance Sheet, ROE > 10%
This segmentation has continued to be useful in analysing portfolios and considering stock selection. During the month, many companies reported their December half year results. Overall the market took those results in its stride, although there are always those companies that exceed expectations and those that disappoint the market. The Telstra results for the December 2015 period disappointed the market, with the stock falling to $5 in early March. Analysts blame the larger than expected decline in fixed line connections as the reason for this negative view, although mobile and broadband services continue to expand. The market has since recovered in Telstra to $5.25. This represents a yield of 5.9% full franked. Looking at US statistics on broadband, the move to streaming will continue to see broadband services increase. Mobiles are an essential item now for many of us who increasingly use them for all sorts of functions from news to quotes from the ASX site etc. Burrells saw the selling in early March was an overreaction and we’re not surprised by the recovery in stock market price.
Adopt a realistic view on China – not a sentiment view
The five yearly China plan was in full view of the world during the month. The plan appears sensible and commercially positive, whilst at the same time being environmentally responsible. The revised growth rate is 6.5% for the current year, which again appears realistic.
This was the most interesting sector during the month.
In the February blog we commented that markets are highly reactive to China as a proxy to demand growth for energy and mineral resources. This is a relatively well developed theme so looking for inflection points in calendars 2016 and 2017. The inflection points are likely identified by considering the supply/demand balance for individual commodities. Copper for example may well be in balance in 2016 as the services sector in China requires copper & new copper mines post GFC were few & far between, with any greenfields high in sulphur unlikely to receive World Bank funding. Both RIO & BHP have confirmed the view that copper may be one of the first base metals to be positively viewed, with RIO further committing to Oyu Tolgu and BHP expressing interest in buying any quality copper mines put up for sale by distressed majors. IRON ORE rebounded to the $US 60/65 range during the month.
This is the level that a senior executive from the Chinese metallurgical association spoke of at the May 2015 Australian Stockbrokers Conference. The rationale is that China wants to see an IRON ORE price in this range, because it guarantees the survival of Fortescues and Vale as long term IRON ORE producers. The Chinese believe the IRON ORE market requires this stability. Perhaps the most interesting dynamic was that the President of China visited the iron and steel area of China during the month. He noted that there was a surplus of steel production and announced a billion dollar fund to shut in the excess production and re-train workers into other areas of the economy. What is unclear but perhaps implied, is that China has high cost IRON ORE mines with the IRON ORE costs thought to be in the vicinity of over $100US equivalent. If this production were to be shut in, then a more stable Iron Ore market with RIO and BHP continuing to sell their production at a price $65US maybe the more probable scenario.
The OIL market was also fascinating during the month. Glenn Stevens, Governor of the Reserve Bank of Australia gave a paper at the ASIC conference in Sydney this week. He noted that virtually no one had predicted the move by Saudi Arabia in November 2014 to flood the market to increase the production of oil so as to reduce the price below the $60US cost of US oil shale production. The oil price fell to the twenties and has since recovered to around $40US. Coincidentally this was the level predicted by Chris Probyn, Chief Economist, State Street Global Advisors in his annual pilgrimage to Brisbane on Friday the 5th of February. The decision by the USA to allow exports of oil is a further change in the dynamic, with the first shipment by Exxon Mobile to its refinery in Italy and shipments since to ten countries. One can understand why Europe would be interested in receiving crude from parties other than Russia so as to reduce their dependence.
An immediate consequence is that the $10 difference between a West Texas crude in the US and the price of Brent crude in the UK had all but disappeared as traders are now able to arbitrage between these markets. The USA has some 500 mmbbl of oil in strategic storage. As an aside Australia seems to have none and does not think we even need refining capacity! The conversion of coal fired power stations in the USA to low priced gas and now the ability to export oil and gas means the oil market is truly returning to one international market. Also during the month Russia joined with Saudi Arabia in initial steps to reform a cartel. The cartel has in fact run stronger in terms of membership, because Russia has never been a member and although it has not formally joined, Indonesia did do so and so going forward the USA may well be dealing with a stronger OPEC block, once the supply/demand balance returns to the oil market. If readers are looking for a trigger, it will be that the members of OPEC believe that the supply of oil has fallen sufficiently that they can again bring a disciplined approach to their members and thus bring the market back into balance. The most likely price going forward will be somewhere between the current $40US and the coal shale price at $60US.
The reason for spending some paragraphs on these matters is that it is likely we have seen the bottom of the resources prices and further positive moves in reducing supply imbalances are likely to see further appreciation. It seems likely that BHP bottomed at $14.21 on the 21st of January and is currently trading in the $17/18 range. Further positive moves as noted above should see BHP above $20.
US economy and the USD
The purchasing manager indices for both manufacturing and services continue to show expansion in the USA. The case for a stronger US$ appears intact.
Possible X factors
↗ US stock market valuations and possible correction
↗ $20 oil
↗ Lower global growth than forecast i.e. risk is to the downside
Last month, the blog noted some of the high PE’s in the FANG stocks in the USA. While we do not think Google is fairly included in this list, there are some over valuations in the tech sector for stocks chasing revenue without profit such as Facebook, Amazon and Netflix. These stocks seem overdue for some correction and are reminiscent of the 2000 tech bubble. However the US market is far from uniformly overvalued, particularly given the strength of the economy. In Chris Probyn’s presentation, the head line for the US market was “Too early to call time”. Thus at 76cents, the exchange rate is relatively attractive for selected overseas investment, but indices are not recommended at this time. The US stock market valuations and a possible correction remain a possibility as an X factor. The political situation in the USA is a likely trigger for some adjustment in the US market, be it from Democrats whose plans seems to be to soak the rich with additional taxes or the Donald Trump card. In terms of other possible X factors, $20 oil, China and lower global growth forecast moved down a notch during the month in terms of disruptors.
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