Welcome to the March edition of the Burrell Blog for 2017.
Twelve months ago ten themes were proposed in accordance with our usual practice. Let’s see whether these themes assisted us in explaining market movements over the past 12 months. The ten themes were as follows:
↗ Dividend yield driver
↗ Interest rate cycle headwind
- Central banks in different parts of the cycle
↗ 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%
↗ Adopt a realistic view on China, not a sentiment view
- Markets whollyreactiveto 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.
↗ $US economy and the USD
↗ Digital disruption and competition
↗ Australia innovation stocks: medical appliances; commercial biotech
↗ Weaker resources sector = lower A$ = Mergers& acquisitions (M&A)
↗ Deloitte Fantastic Five: agribusiness, gas, tourism, international education and wealth management
↗ Possible X factors
- US stock market valuations and possible correction
- $20 oil
The Dividend yield driver theme sees Australia with materially higher dividend yields than most western world countries as assisting positive valuations, particularly in a low interest environment. Over recent years we have seen external events responsible for market downward corrections, to then be followed by recoveries which Burrell attribute due in no small part to the dividend yield driver. The same effect occurred during 2016 with BREXIT causing a low in June 2016, to be subsequently followed by a recovery particularly in the banks in the six months to 31 December 2016. As a significant explainer of market movements, the dividend yield driver should remain a theme for 2017.
The interest rate cycle headwind was seen as a possible offset to the dividend yield driver ie. with both short and long term interest rates at record lows, it was thought that we may have seen recovery particularly in the 10 year bond rate. In fact against most forecasts, both the Australian and US 10 year bond rates fell during the first half of the 2016 calendar year, with the Australian 10 year bond at 1.8% and the US 10 year bond at 1.4%. Towards the end of 2016, both rates recovered quite quickly by approximately 1%. However they remain a long way below long term averages of 6.5% for the Australian 10 year bond and 5.5% for the US 10 year bond. Going forward, the US economy with a likely fiscal stimulus is forecast to result in higher interest rates. There remains some doubt as to the impact on Australia with some commentators predicting a retraction from current levels while others see the Australian 10 year bond moving up a little in sympathy with the US. The interest rate cycle headwind remains a theme for 2017, perhaps 5 knots for Australia and 10-15 knots for the USA.
In explaining resources, the theme was that markets were wholly reactive to China as a proxy to demand growth for energy & mineral resources. This was a relatively well-developed theme so looking for inflection points in calendar 2016. The resources index bottomed around this time 12 months ago and has since recovered from 3000 to 4800. BHP has recovered from under $15 to over $25, Brent Crude fell by 40% from April 2015 and has recovered half of that fall with energy stocks moving in sympathy. Going forward, in understanding resource stocks in 2017, the theme for resources remains with markets wholly reactive to China as a proxy to demand growth for energy & mineral resources.
Adopt a realistic view on China not a sentiment view was the 2016 theme. Sentiment was negative 12 months ago coinciding with the major fall in resources stocks. Burrells thought this was overdone as economic growth in China remained and remains above 6%. Another positive is the second year of economic rationalism in curtailing high cost coal and steel over-supply. Comments by the Chinese President to instruct administrators to be mindful of systemic risk are also positive, although in the short term this may result in shadow banking debt being more honestly reflected on the books of Chinese banks. The National People’s Congress 5 yearly elections take place in November 2017. Positive ‘steady as she goes’ comments have been made in recent days. China/US trade issues have been raised, but this seems more a negotiating tactic in terms of “fair trade” so the central case is steady as she goes but there is risk to the downside. The synopsis above is consistent with the confirmation as a theme for 2017: Adopt a realistic view on China not a sentiment view.
The next 2016 theme was a fizzer in that the weaker resources sector and lower Australian dollar would result in a number of overseas merges and acquisitions (M&A). While there was some M&A activity in the resources sector in 2nd tier assets overall the lower Australian dollar has not resulted in material listed M&A activity. This is perhaps more difficult to understand given the large increase in Coal, Iron Ore and Copper prices in the last quarter of calendar 2016. Going forward, into 2017, it should be remembered the $A is a commodities currency and a (relative) interest rate currency. It is not a strong currency perse as Australians in aggregate don’t save sufficient and our economy has a number of concerns.
The Deloitte Fantastic Five was a theme for 2016 based on work by Deloitte and CSIRO on the basis Australia should focus on its strengths and what it is good at. The five industries were agribusiness, gas, tourism, international education and wealth management. There is no doubt that Australian universities have done well from international education, but the listed company exposure to this sector is limited. In agribusiness, clients buying Select Harvests on the theme of breakfast cereal including more muesli and nuts resulted in some gains. In 2016, gas was difficult given the fall in the price of oil has a proportional effect on LNG prices. Tourism and wealth management are themes which are worthy of detailed analysis and we will look at these in a later blog.
An ongoing theme for 2016 and 2017 is Digital Disruption v Digital Adaptors. For 2017 we add Competition and Industry Restructure as these four taken together explain a deal of underlying value movement in the Australian stock market. Twelve months ago detailed papers were given at a Burrell Market Outlook Breakfast distinguishing between sustaining/adapting digitisation which is technology for a better customer experience as compared to disrupting digitisation which includes new entrants taking advantage of new technology which can collapse traditional and cannibalise markets. This theme is a good explainer of movements in the past 12 months, both positive and negative in stocks such a Woolworths, Corporate Travel, carsales.com, realestate.com, Seek, challenger brands such as Bingle (Suncorp) and AHM (Medibank), Fairfax etc.
During the period when banks and resources had both suffered major falls in the 2015/2016 year, Burrell portfolios often performed better than the market by focusing on two other segments:
↗ Other high yield, but steady/lower growth
↗ High growth & sound business model, management, Balance Sheet, roe > 10%
Stocks such as Challenger, Resmed, Macquarie and CSL were successful under this theme, as were Iluka and Orocobre (Lithium). In the high dividend but lower growth space there has been a significant correction in Telstra and the other telcos due to the impact of high wholesale NBN connection costs. Jamie Elgar considers some aspects of this matter in this month’s Bourse.
The US economy and the USD was a theme for 2016 and dominated the airwaves in recent months. Trumponomics to the extent it encompasses tax cuts, infrastructure spending and Navy ships may result in a positive fiscal stimulus. But there is similarity to the first year of the Reagan era where after an initial rally, the US market fell 20% as the reality of achieving such measures was contrasted with lofty market expectations.
Burrells remain cautious on the current high level of the US stock market and this remains a possible Xfactor for 2016. Other Xfactors include actions from the Trump presidency together with wider geopolitical issues especially in Europe. The European issues include hard BREXIT, elections in the Netherland, France and Germany and possible default by Greece.
In summary, the 2016 themes were useful in understanding drivers for a number of sectors and stock prices. The majority of those themes remain current for the 2017 year, albeit with some refinements noted above.
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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.
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