Reporting season having concluded in the last two weeks of August, the market has been in contemplation mode during September as analysts considered in further detail some of the company reporting and revised fair value estimates (FVE).
Some companies which reported well decided to take advantage of the current market with capital raisings, the largest being Macquarie with a $1B capital raising at $120. These funds were not raised for specific purposes. It appears Macquarie will be investing in infrastructure. This validates our firm’s interest in this sector and the speaker for the October market outlook breakfast, Sarah Shaw (Global Portfolio Manager and CIO – 4D Infrastructure).
Economic data was generally not positive. New car sales plunged 10% in August as car loans dried up, continuing the trend for over a year. We continue to believe the new car sales market is interrupted by the electric vehicle phenomena, also supported by the increase in used car sales. GDP numbers around the world are generally downgraded, although thankfully Australia remains positive. These poor economic numbers led to calls by governments for further cuts in interest rates. One would have thought that central banks have carried far too much of the load already and the politicians needed to adjust fiscal policy to stimulate infrastructure. In Australia the personal tax cuts should be assisting to cushion the economic blows, but as noted in last month’s blog, the federal government sees the delivery of a surplus as its number one priority and state governments are constrained by high debt. The issues are similar overseas, with the economist Paul Krugman saying Germany should borrow at its negative rates and provide fiscal stimulus to replace its aging infrastructure. There’s been no sign of this, with Germany continuing with its kitchen table economic policies.
Geopolitical issues were at the centre of the markets sentiment moves during September. The US and China continued to attempt to sooth the markets by individually saying that a deal is preferred. But harder heads including a US former trade secretary thought a breakthrough in US/China trade talks a bit optimistic, “The parties are too far apart, such a public dispute. That environment not conducive to a deal. Difficult to see the parties coming to an agreement in the near term. Multinationals with assets are generally staying in China but taking a hit to earnings, a hit to cash flow, share price and everything that goes with it”. Another expressed the view that China will never trust the US again. China will now move to establish self sufficient supply chains within the next seven years. The US will move likewise.
BREXIT saw the rather odd phenomena of the Conservative Party electing Boris Johnson, but then not supporting his stated policies. There does appear recognition that the current impasse is a lose/lose rather than a win for Europe and a lose for the UK. Perhaps the Europeans will decide they have inflicted enough pain on the European and UK economies, although it must remain tempting to let Boris Johnson have a general election, with the probability he may be replaced by a more pro-European Prime Minster. The UK Supreme Court ruling that the prorogation of the UK Parliament was null and void increases the probability Europe will again delay.
A new geopolitical risk added during the month with the drone strike on Saudi oil. The markets have reacted more to the increase in the oil price with oil companies increasing 4-9%. Markets seems to have forgotten that oil price shocks are one of the major negative impacts on stock markets over the past 40 years. The evidence also appears to suggest the attack came from Iran. It is unclear what response will be seen as appropriate by the world community. At the company level, one commentator said Raytheon may be the largest beneficiary of the drone attack with its NASAMS missile defence. Burrell is able to buy overseas stocks for client portfolios.
In the latter part of September, lower interest rates drove a switch from fixed interest to Australian equities. The TINA effect i.e. there is no other alternative given the increasing gap between fully franked dividends yields and the ten year bond rate. This is despite the warning from ING of a downgrade to its earnings due to margin pressure saying, “This impact will be significant in FYr20”. Declining interest rates are negative for banks because of margin pressure, so that the Australian banks may be closer to fair value than the market thinks. Elsewhere, an inquiry confirmed that the payment of $1B for 4G Spectrum by TPG was a strategic error, which accorded with the Burrell view at the time of our exit from that stock.
Regulatory risks continue to arise with the return on electricity networks likely to be reduced materially by the regulator in line with the decline in the long term bond rate. It is a little ironic that electricity network operators having responded to NSW politicians in particular to gold plate the networks to reduce system outages, have now been lambasted for overinvesting in their networks. Another example of why companies need to be skeptical of responding to politically driven investment decisions.
The accounting for leases standard for the accounting bodies is upon us and its impacts are just as bad as anticipated. Apparently there is now no rent paid on leases and so the rent has disappeared from profit/loss statements so that EBITDA i.e. Earnings Before Interest Tax Depreciation Amortization which would previously have been after rent, now is before amortization of a newly created asset being the service potential of the lease which happens to equal a lease liability. So this is another adjustment for analysts by reversing the amortization and including the rent in order to calculate an adjusted profit number for the purposes of company valuation.
And in line with the times of politicians tweeting sentiment, Trump tweeted he is not interested in a partial US/China trade agreement and the Chinese negotiators left Washington early. It may be thatboth BREXIT and the US/China trade agreement will be deferred until March quarter 2020.
So investment managers such as ourselves spend our hours reviewing research reports from the reporting season, looking at forecast earnings with an increasing degree of uncertainty as to their correctness, comparing high PE growth stocks to see if their growth multiples match, looking at expensive defensives such as Westfarmers and Coles focusing on maintainable dividend yields.
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