Your diarist welcomes you back for a combined August/September edition of The Burrell Blog for 2015.
Australian Share Market
About a month ago on 11th August, the S&P/ASX 200 index had fallen from 5,982 on 27th April to 5,473 i.e. by 8.5%. In the 4 weeks since, the index has continued to fall to around 5,000 being 16% since April.
|27 April||11 August||4 September|
|S&P/ASX 200 Index||5,982||5,473 (â 8.5%)||5,040 (â 16%)|
True it was that the April prices particularly for the banks looked high, CBA trading at $96 and the other banks in the high $30s, there were commentators referring to CBA as the world’s most expensive bank. Thus the adjustment to 11th August looked reasonable, but what is the justification for the falls continuing?
What has the markets attention?
- Perception the Chinese economy is growing at 3-5% per annum not 7%
- Chinese intervention in the stock market
- Chinese devaluation of the yuan
- Dramatic declines in commodity prices
- Offshore perception Australia has a property bubble
- Australian short term interest rates falling
- Large capital raisings by Australian banks
- $US / $AUD falling to 70¢
- Deutsche predicting $US / $AUD may fall into 50s
- GDP growth of 0.2% in the June quarter
There has been debate for over 12 months as to what the real GNP growth rate is China. The official figures from the Chinese government have continued to support the 7% growth target, but the global community is sceptical. As the Chinese stock market has flat lined over the past couple of years, the Chinese stock market appreciated strongly in what several commentators saw as a bubble. Russell Investments noted that this Chinese bubble was fraught with risk as it did not reflect their underlying economy. To the extent that the Chinese stock market has corrected to reflect the economic reality, this is a normal market adjustment process. The Chinese intervention in this process might not seem remarkable to the Chinese, but to the rest of the world, government intervention in stock markets is an anathema.
The Chinese yuan is pegged to the USD. Imagine what would have happened to the Australian economy if our dollar was pegged to the USD at 1:1? As it is, Australia has now had a 30-40% devaluation against the USD while the Chinese currency continued to appreciate against its trading partners. In this context, the modest devaluation of the yuan is again unexceptional.
Dramatic declines in commodity prices have more to do with perceptions of oversupply in key markets including iron ore and coking coal. In fact lower commodity prices are good for global economic growth, although bad for commodity producing economies such as Australia and for the producing companies. However in terms of volumes, iron ore shipments from Port Hedland last month remained at record levels. Rio had its briefing last week and stated that they did not agree with the view that Chinese steel had peaked, but rather saw China continuing to become an exporter of steel and steel products with the result that export volumes would continue to grow through to 2030.
The truth as usual is probably somewhere in between. The Chinese economy is exiting a period of strong property development and becoming increasingly consumer and export driven. These transitions tend to result in periods of economic consolidation. The Chinese government are unlikely to allow their growth rate to slip too far, with projects already underway including the recently announced replacement of an ageing underground pipework system in China, a very large project in itself. Overseas investors may well be overreacting to the Chinese stock market adjustment in the perceptions above.
Offshore perceptions of Australia have also contributed to the Australian stock market performance in recent times. Learned visitors from overseas commented that in London there was a perception that Australia has a property bubble, particularly in Sydney. Australian short term interest rates have been falling. Then APRA, the Australian Prudential Regulatory Authority announced a shorter timetable for capital raisings than had previously been anticipated. This resulted in capital raisings by NAB, ANZ and CBA to take the Australian banks into the upper echelon of capital coverage globally. Whether these large capital raisings are necessary is the subject of considerable debate. Regulators have an incentive to have high capital ratios and do not bear the costs involved. Shareholders who have contributed the capital will be seeking competitive returns on equity. We have already seen non-residential loan rates rise, which may be justified by ensuring Australia does not develop a housing bubble, but will also provide increased profits to provide return for the equity capital currently being raised. It is unlikely the market will shift all of the cost of the additional equity to reducing shareholder returns. It is much more likely that bank borrowers will bear part of the cost of the regulators increased capital ratios.
Capital raisings by large banks overseas were conducted in the context of the global financial crisis and failed stress tests. One wonders to what extent some offshore investors might not understand the context of these Australian capital raisings.
Offshore investors may count for as much as 45% of the Australian stock market according to some commentators who have analysed the ABS statistics. The fall in the Australian dollar to 70 cents means the $AUD/$USD is most likely the key factor in the continuing sell off of Australian banks over the past 4 weeks. It appears as though selling is largely driven from offshore. Institutional brokers have commented that the level of offshore bank flows have confirmed a high level of offshore selling of Australian banks. Domestic Australian stockbrokers have reported buying, including by Burrell clients.
And why wouldn’t one consider topping up on Australian banks with yields on 7th September as follows: NAB 6.6%, WBC 6.2%, ANZ 6.7% and CBA 5.8%. The 6.6% fully franked yield equates to 9.4% gross. Little wonder that Australian investors see current prices as an attractive entry point with CBA trading around $72.50 and the 3 banks all trading under $30.
That is not to say that there are some head winds for the Australian economy. The GDP growth number for the June quarter was 0.2%. Your diarist has commented previously about the prospect of a negative growth quarter during this period of transition from the mining investment boom to a more normal economy, with housing growth picking up a deal of the capacity. It should be noted that the GDP growth number in the March quarter at 0.9% seemed too high, while the June number appears too low. Again the truth of the matter appears somewhere in between with the Australian economy growing around 2.3% in current year, a mediocre number but not a disaster.
One key factor in portfolio reviews for this month is to focus on companies with high price / earnings ratios or which are expensive on other valuation metrics. It is clear that the Australian economy is not growing strongly and so company earnings on average may also not grow as strongly as the market has expected. Thus investors and their advisers need to cast a critical eye at companies with high growth projections and thus high PEs. Disappointments on EPS growth will likely lead to contraction of PE ratios.
International share markets
The comments in the preceding paragraph apply even more so to the US stock market. The chart below indicates that there is general scepticism about valuation metrics in the US stock market. While the US economy is stronger than most in the world today, PE ratios over 20 times require sceptical analysis based on likely EPS growth rates.
Both domestically and globally, a number of the defensive companies are trading on high PEs. This includes health care both in Australia and internationally. It may be that the correction we’ve seen in the Australian share market since April is a preview for further US adjustment. Investors should be wary however of lumping all international stock markets together. While during the GFC which was a global credit event, all markets moved down together, stock markets tend to react more commonly to their underlying economies. The US economy is stronger while Europe is weaker. Thus a stronger stock market in the US and a weaker one in Europe is not surprising. What your diarist is raising here is the potential for stocks within those markets to have PE contraction in the event that the EPS growth falls. This may well provide and has already provided some excellent buying in the US.
For example in the Burrell World Equities Trust (BWET), we currently have 20% invested in cash in US dollar bank accounts. The technology stocks in the US do not appear overpriced and in the past month we have added to holdings in Apple, Cisco and Intel.
Following the corrections, several analysts see Asia as offering good investment opportunities, with Kerr Nielsen delighted that the fall in Asian markets coincides with his IPO for Platinum Asia Investments Limited.
Source: Bloomberg, May 2015. Price to earnings are current, not projected numbers.
Happy investing …
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