Welcome to the May issue of the blog for 2019.
The Stockbrokers and Financial Advisers Association (SAFAA) conference was held in Sydney on the 22–23 May 2019. This blog includes observations from speakers at SAFAA, together with some of the writer’s views.
The overseas markets are late cycle, not end of cycle. This is an important observation as it indicates that sections of the overseas markets are likely to be over priced and that care is required in stock selection. It is generally not a time for index exposure, but a time for careful analysis based on research and active managers.
Industrial production globally fell in the December 2018 quarter, it was rescued by the Federal Reserve’s decision to not increase interest rates and the impact was dramatic. The central case remains for no recession but steady as she goes for the USA economy.
The Eurozone remains on the brink of recession. Readers who will recall Mario Draghi from the European Central Bank (ECB) downgrading growth in the Euro zone substantially to 1.1%. A key factor is the failure to reach agreement on Brexit, which Europe had been approaching as a win/lose to the UK, whereas Mr Draghi was pointing out it is a lose/lose. The other factor impacting on the Eurozone is that exports from the Eurozone to Asia have been soft.
A major impact of the US/China Trade War is that domestically the Chinese have seen sentiment turn negative. This is of concern because China sets growth for the world. The Chinese have moved to a stimulus of 2 trillion yuan, equal to $US300B. The last time that China moved to stimulate their economy, this was successful. And so this move by China is seen as responsible.
The US/China Trade War increasingly has a central case that there will not be an agreement anytime soon. In fact the geopolitical risks of Brexit and the US/China Trade War won’t be solved in the near term. While this may lead to some useful buying opportunities over the next quarter, the view of Alva
Devoy, Managing Director, Fidelity Australia is that the failure to solve these geopolitical risks will not lead to crisis.
In Japan, Abenomics has worked after a long lead time. The Bank of Japan has been stealth tapering ie not particularly targeting its punches. Japan has finally seen an increase in AHE (Average Hourly Earnings) and inflation is up, after Japan suffering a long period of stagflation.
The re-election of the Modi Government in India is seen as positive, as anyone who can lead 1B people in a positive direction deserves respect. Emerging market valuations are generally positive.
Growth stocks in the US are expensive, whereas US industrials and cyclicals have had price/earnings (P/E) compression leading to value. The US/China Trade War is impacting unevenly on US listed companies with stocks such as 3M which derive a deal of their input and trade from China suffering, whereas Cisco being least exposed to China has held up.
Australian growth stocks are overpriced. The average valuation P/E multiple of growth stocks in Australia was reported by one of the speakers as being 30x as compared to China at 22x. For example, Baidu, the Google of China 17.5x Ali Baba 26x. The Australian Financial Review on the 31st May published similar chart looking at the 12 month forward P/E of stocks forecast to grow earnings per share at over 20% per annum in the next 3 years. The Australian multiple was a 39.8x, which compared to the global average of 23.5x and ahead of number two, the USA on 31.5x. The sample included not only the Australian WAAXA stocks ie. Wisetech, Afterpay, Altium, Xero and APEN but also household names such as Newscorp, Breville, A2Milk, Bellamys, Blackmores, Seek, Cochlear, CSL, REA Group and Domain. Such PE stocks are likely to suffer price corrections if the growth is not delivered or earnings do not materialise at what are likely unrealistic expectations. These valuations are the reasons that small to mid-cap growth has consistency disappointed in Australia.
In terms of the economy, both major political parties announced a raft of Infrastructure expenditure during the recent election campaign. And so it might be reasonable to conclude that there could be bi-partisan support for the rotation of resources, particularly by government into infrastructure. Infrastructure spending has relatively long lead times, but NSW and Victoria have already seen a deal of infrastructure spending. Such fiscal stimulus is seen by some economists as sustaining the Australian economy and reducing the need for further interest rate cuts. However the Reserve Bank governor gave a paper in Brisbane on the Tuesday before SAFAA which was widely interpreted as foreshadowing a rate cut (refer Bruce McLeary’s detailed consideration). More importantly for the valuation of stocks and businesses generally, the 10 year bond rate has moved from expectations of rising prior to Christmas 2018 to having now fallen by 1%. To even seasoned investors, this fall in the 10 year bond rate is dramatic and was not generally expected.
Reflecting the global and domestic issues above, the Australian Equities market was down 10% in the 6 months to Christmas Eve 2018 with the ASX 200 reaching a low of 5467. Since then, Australia equities have rallied by 18.3% off the low to 6452 (27 May 2019). The short covering rally after the election looked overdone, just as the selloff pre-Hayne in February looked overdone on the downside. The banks continue to face a number of headwinds in the post-Hayne era and increased competition.
Resources are somewhat China dependent, but to date commodities prices have held up well. Iron ore has been buoyed by the unfortunate safety issues in South America, but also by China shutting in low quality iron ore. Similarly China has shut in low quality coal containing high ash because of pollution concerns and safety issues in coal mines in China with high methane. The result is that while China has shown some weakness, it has not been reflected in prices or quality of iron ore coal exported from Australia. Likewise, geopolitical issues in the Middle East, Libya and Venezuela have kept oil prices relatively firm.
For the last two years there has been considerable focus by Burrell on non-bank non-resources stocks to deliver risk/return outcomes. This strategy has been successful including portfolios on average falling by a half to two thirds of the fall in the market at Christmas Eve 2018, but participating in most if not all of the upside to date. As noted above, care is required for Australian growth stocks and small-mid caps.
Listed property in Australia appears overpriced with a number of major property trusts trading above net tangible assets. However, this is somewhat dependent on the 10 year bond rate, because if the bond rate continues at such low levels, then cap rates will fall again resulting in increased valuations for office, industrial and retail property assets.
All of this has made fixed interest difficult in a low rate environment with careful assessment of risks/return options. Some clients will come to the conclusion of Wayne Matthews, head of Burrell’s fixed interest desk, that we may add some exposure to global high yield predominantly in the US, probably not in Australia as the market is not sufficiently developed. Finally, the G20 is being held of the last weekend in June. Fingers crossed that this does not result in adverse market movements in the last few days of the financial year, as happened in 2016 when the Brexit vote was 3 days before year end. In a difficult year, portfolio returns are satisfactory after 11 months.
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This document contains general securities advice only. In accordance with Section 949A of the Corporations Act, in preparing this document, Burrell Stockbroking did not take into account the investment objectives, financial situation and particular needs ('relevant personal circumstances') of any particular person. Accordingly, before acting on any advice contained in this document you should assess whether the advice is appropriate in the light of your own relevant personal circumstances or contact your Burrell Stockbroking advisor. If the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure Statement relating to the product and consider the Statement before making any decision about whether to acquire the product.
Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.