Welcome to the December edition of The Burrell Blog for 2015!
US Federal Rate Decision
We awoke this morning to confirmation of the long awaited Fed rate increase of 0.25%, the first increase in 8 years. The initial reaction of the markets around the world was positive. This accords with the view in the Burrells dealing room last week that we were surprised the Australian stockmarket fell below the 5000 level and it was more than likely there would be some form of relief rally when the Fed made its decision. A 100 point increase yesterday on the Australian market was followed by a further 100 points in early trading today, Thursday 17 December.
Janet Yellen, chair of the Fed has also left open the ability to further increase the rates in 2016. Initial commentary in New York varied widely for those expecting four increases of 0.25% in 2016 i.e. 1% in total to those expecting no increase until after the next US recession! The most likely scenario is that a continuing strong US economy will continue to push the US to full employment. If the unemployment rate falls much further in the US, concerns about inflation will lead to further increases in the US Fed rate.
The broader issue is whether these rate increases will be viewed as positive or negative for valuations in the US stockmarket. This $64 question will preoccupy commentators for the next 12 months.
In the previous blog, Seek was noted as an investment outside the material/energy and banking sectors. Attached below are two slides which indicate the growth potential of the Seek business.
Source: SEEK AGM/CEO presentation 26 November 2015
The first slide shows that Seek Domestic with 135,000 monthly paid job ads in Australia whereas on the various countries where Seek operates internationally, there are 3M monthly job ads. Seek is now a major owner of Zhaopin, the market leader in China. The second slide shows that the revenue internationally has grown from $14M in 2008 to $333M in 2015, marginally exceeding the Australian revenue. Pre-tax profit (EBITDA) has grown from a loss in 2009 to a profit of $108M in 2015, around two thirds of the Australian profit. The implication is that the Seek International business has significant growth potential. Seek holds market leadership in 14 countries across Australia, China, South East Asia and Latin America.
Dividend Yield Driver v The Bears
The fall in the Australian stockmarket is not supported currently by falls in dividend yields. The income being paid by companies has not reduced, resulting in dividend yields at levels which seem not only attractive, but difficult to rationalise. For example, NAB was on a dividend yield of 7% earlier this week, a gross dividend yield including franking credits of 10%. How can this be rational pricing when compared to dividend yields in the USA at 2-3% and low US interest rates.
The answer must be either the Australian market is not only good value, but under-priced on these yield stocks or that there is a significant threat to these dividend yields going forward. While NAB is an example of a stock with a strong dividend yield, the market overall as shown by the State Street 200 index is trading on a yield of 4.05% while the Russell high dividend ETF is trading on a dividend yield of 6.22%. In the past three years, the best predictor of movements in the Australian market has been the dividend yield theme. It has dominated the other 9 themes which you diarist has included in this blog for each of those years. Sometimes the simple view is the correct one. With the current dividend yields on quality banking and industrial stocks, it is difficult to come to any other conclusion than that the Australian market should move higher in response to the strong income currently available on the market. The low interest environment in Australia also supports this conclusion.
But what about The Bears? Their view is summarised in some articles by Christopher Joye, a fixed interest specialist. Joye sees significant head winds for the Australian banking sector, or more correctly, the larger banks in Australia. He sees the capital raisings to date being followed by some further capital raisings and this excess cash leading the major banks to compete to the extent that the return on equity will fall from 15% to 11% over five years. In this scenario the major banks lose significant market share to the regional banks. Equity prices globally face head winds as the long term risk free rates trend higher 50 to 100% higher than current levels. He sees the major Australian banks becoming more price takers than price leaders and share prices declining from over 2 times book value to 1 times book value.
These views achieved wide spread publication in the Australian financial press in the week leading up to the latest testing of the 5000 level on the Australian stockmarket. The pronouncement in Basel, Switzerland of the final guidelines for banks globally for risk weighted capital indicated that the major banks would no longer be able to use their internal models to provide what are regarded as low amounts of equity against their lending book as compared to the higher amounts traditionally required from regional lenders. Simply stated, the major banks have been able to use internal models to offset say housing risks in Brisbane against house risks in Perth and overall the regulators have accepted lower capital requirements from the major banks as compared to the regional banks. A more level playing field and higher capital from the majors may well over time lead to a reduction in their return on equity. Of course it is often easy in stockmarket matters to get the strategy right, but the timing wrong. In the current environment of strong housing growth and a shortage of housing in the major markets of Sydney and Melbourne, it may be that the dividend yield driver is the more immediate influence into 2016, whereas Mr Joye on his own admission sees the headwinds he is concerned about being over 5 years.
In terms of portfolio weightings, the current changes in the Australian banking sector to capital structures suggest banks should be held to market weighting rather than carried at an overweight position. Stock acquired as a result of the recent bank capital raisings should be considered for sale into any recovery in bank share prices.
Your diarist commented previously that the best predictor of the leading mining companies was to consider the outlook for the individual minerals which they supply. BHP fell from $23 at the end of October to what may have been a bottom of $16.27 on the 15th of December. This indicates not only as a pessimistic view but a quite alarming outlook for commodity prices. Your diarist would proffer a view that in 12 months’ time, the current price for BHP may well be seen as a bargain. Relentless negative information flows on commodities of all types has filled the airwaves over the past couple of months. The truth of the matter is likely to be somewhere in between.
For example, RIO committed $US4.4B to the expansion to its copper gold project Oyu Tolgoi in Mongolia last week and further expressed the view that if any major copper projects were to come onto the market, they would be interested. The CEO of a recent Australian base medals miner had positive views on copper and zinc markets not being in surplus in 2016. It does seem likely that the copper market may also have bottomed in the past month, although time will tell.
In Iron Ore, Morgan Stanley noted that the four largest producers now account for now some 75% of seaborne Iron Ore trade and that it would not take too much of a correction in supply to obtain a price increase back towards a more sustainable level of $US60/65 as compared to the price last week of under $US40.
The recent OPEC meeting did not impose any production limits. OPEC is aware that with current oil prices under US$40, oil shale in the USA is unprofitable and about 80% of any cash received is being used for debt repayments. OPEC are intent on driving out higher cost production, particularly in the USA and also the oil sands in Canada. It seems more likely than not that in 12 months’ time the oil prices will be materially above current levels.
The USA Fed rate increase removes uncertainty and allows global stock markets to look forward.
Diversifying into non-resource non-bank sectors with companies such as SEEK is a key issue in portfolio reviews. Australian bank yields are attractive, but medium term issues suggest bank weightings should be kept under review.
Have a Merry Christmas and a Happy New Year!
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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.