Market Matters Report / Market Matters Weekend Report Sunday 26th August 2018

By Market Matters 26 August 18

Market Matters Weekend Report Sunday 26th August 2018

Market Matters Weekend Report Sunday 26th August 2018

A volatile week for Australian equities as a confluence of factors conspired to keep the market on edge. Clearly the Australian  political landscape changed dramatically with Scott Morrison becoming the 30th Prime Minister of Australia after a bloody, self-indulgent battle inside the Liberal Party, while we’ve also had a significant amount of companies reporting results – certainly a busy week on the desk. Overall, the ASX 200 ended down -1.45% for the week weighed by a sell-off in the banks, Westpac the worst of the big 4 after delivering a quarterly trading update that showed a big drop in margins – the stock losing -8.8% for the week.

So far this August the ASX200 has lost 33-points or -0.45%, however that probably downplays the significant variance across the sectors, the Materials for instance are down -6.84% on the month while the much maligned Telco Sector is up +13.45%, simply huge outperformance at the sector level and importantly it shows how critical it is to get your sector calls right. Only a month or so ago the resources were the ‘go to’ place to invest while there was a complete distaste for companies such as Telstra (TLS), how the tide turns and a good reminder to keep an open mind.

Company reporting underpinned some large moves last week while we also had news that TPG Telecom may shack up with Vodafone Hutchinson Australia which proved a strong catalyst to see buyers flock back to the beaten up telco names. Any tie up between TPG and Vodafone would likely mean TPGs well documented plans for super cheap deals and an outright pricing war may not eventuate.

Undoubtedly the combination of reporting season and to a lesser extent sector rotation has been the focus of the local market with the below stocks catching our eye over the last 5 days.

Winners: TPG Telecom (TPM) +29.26%,  Altium (ALU) +27.53%, WiseTech Global (WTC) +26.20%, IRESS (IRE) +11.33%, A2 Milk (A2M) +10.33%, Mineral Resources (MIN) +8.80%.

Losers: Flight Centre (FLT) -15.31%, Western Areas (WSA) -11.26%, Ansell (ANN) -8.81%, Westpac (WBC) -8.80%, Origin Energy (ORG) -7.31%, Medibank (MPL) -3.10%

Without a lot of fanfare last week, the U.S. bull market became the longest on record. 3,453 days since the market hit bottom in March 2009, surpassing the run that began in October 1990 and ended when the dot-com bubble burst in March 2000. As Charlie Aitken suggested last time I interviewed him, without stating the obvious, we’ve got to be closer to the end than the beginning!

S&P 500 Chart

The availability and cost of money has been a significant driver of this bull market for stocks. Low interest rates coupled with quantitative easing (central banks printing money to buy assets) has been a driving force behind asset prices. As we came out of the GFC, the ‘Bernanke Put’ was a term often used to describe the then US Federal Reserve Chairman Ben Bernanke’s 1-wood approach to supporting the market. By aggressively printing money and purchasing bonds he increased overall liquidity (availability of $$) and ensured interest rates (bond yields) stayed low, meaning money was cheap. The notion that as  long as markets had a free put option from central banks, then buying assets made sense, and the bull market gained steam. The S&P 500 has now rallied 330% excluding dividends, hitting another record high on Friday night. Quantitative Easing has now been wound back while interest rates have bottomed. The US 10 year yield has increased from a low of 1.31% to high of 3.12%, and settled on Friday at 2.81%. The move lower in US rates over the last three weeks has helped to support US stocks, however ultimately we view this as a counter trend pullback as rates generally go higher until ultimately, interest rates will create a headwind for stocks.

US 10 Year Bond Yields Chart

Last week, the local market made a new high on Monday at 6358 before giving back -111pts to close the week at 6247. While we continue to anticipate a pullback in stocks no outright sell signals have been generated locally, or in the US, at this point in time

ASX200 Index Chart

1 Reporting – key themes & our take so far

A normal rule of thumb for Australian Reporting season is that about half the companies will meet expectations, a quarter will miss and a quarter will beat, and that’s been fairly accurate this reporting season to date. To be more precise, of the 135 main companies that have delivered results,46% have been inline, 29% have missed and 25% have beaten expectations. We’ve seen more than twice as many downgrades to upgrades from analysts post results however given we generally roll forward valuations at full year results we get upward price target revisions in aggregate, this year we’ve see an average of +3% in terms of net target price change.

So, a reasonable reporting without being spectacular. A number of key themes have become obvious

  1. Growth in sales over and above growth in profits has been rewarded. This is particularly relevant in the small tech sector in Australia where investors seem happy to pay huge prices for revenue growth. A juggernaut that has trampled many shorts in its wake, however, ultimately bottom line earnings will become important at some point, and its very hard to reconcile how valuations can be maintained at such high levels. WiseTech (WTC) & Afterpay (APT) are examples in the tech space while CSL is a larger cap example where revenue is growing strongly, however higher costs dampened profit expectations, however the market didn’t seem to care.  
  2. Stocks trading at a cheap and cheerful valuation have typically done well by meeting / beating low expectations. The retail sector has been a good example of this where although there are obvious headwinds from increasing competition (Amazon), rising interest rates and high household debt, a number of stocks simply became too cheap. JB Hi-Fi (JBH) for instance with the stock trading on a forward PE of just 10x leading into a result that was okay. It’s now rallied ~20% and still trades on just 12.2x. Nick Scali (NCK) was on 11x leading into its result before delivering strong numbers. The stock rallied but still now trades on just 11.9x.
  3. On the flipside, optimism was high for the mining sector leading into results and we’ve seen a clear example of buy the rumour, sell the fact. Large, looming capital management initiatives have been discussed, but actual details have proven scarce. We are heavily underweight the miners, looking to buy further weakness. We expect this will be an area of focus in the coming weeks.  
  4. The lower AUD will continue to support the overseas earners such as Amcor, Ansell, Aristocrat, Brambles, Boral,  Cochlear, CSL, James Hardie,  Macquarie, Resmed, QBE, Treasury Wines to name a few.  MM is targeting a buy in Aristocrat (ALL) around $29.

Aristocrat (ALL) Chart

2 Impact of a likely Labor Government

The Liberals are now less likely to win the next election than they were at the start of last week according to the betting agencies, with Sportsbet offering just $1.20 for Labor and $4.00 for the Coalition. One of the main consequences of a Labor Government centres around the treatment of cash franking credits.

Franking credits are attached to most Australian dividend payments. They avoid company profits being taxed twice, once by the company itself and then by the taxpayer who receives the dividend from the company’s profit. The franking credit reduces the tax owed by the taxpayer, or in some instances, causes a tax refund to occur (when the franking credit is more than the tax owed by the taxpayer).

Labor are proposing that when the franking credit generates a refund for the taxpayer, the cash refund is ignored, however there is now a carveout for those who are on the aged Pension.

Clearly fully franked shares and other securities such as Hybrids that have imbedded franking credits will be impacted if Labor are successful at the next election and the policy is implemented. Furthermore, the recent May 2017 budget released by the then Treasurer Scott Morrison was meant to reduce the pressure of housing affordability while it seems to proposed plan of Shorten’s may in fact add to it by reducing the appeal of fully franked shares for income, and improving the appeal of property which typically provides unfranked yields. This would also be true for listed property stocks.

That said, tweaking the composition of franking is not all negative - it’s very clear that our current taxation system makes the domestic share market less appealing to overseas investors, simply because our imputation rules create distortions around the value of the same stream of earnings from an ASX-listed company. In short, franked dividends are more valuable to an Australian investor than to foreign investors and with about 30% of the ASX owned by foreigners, a change to the structure could feed a bigger appetite for 1. Offshore investors to focus more on Australia & 2. Australians to invest offshore, a possible silver lining to an ill thought our policy.

ANZ Capital Notes (ANZPD) Chart

3 Our recent portfolio moves and intentions from here

We made some amendments to the Platinum Portfolio last week, simply enacting the plans we’ve had in place for some time.

IRESS (IRE); We sold IRE for a ~17% profit during the week. This was always a shorter term positional trade, and although it looks good for a test of $15, we locked in a good short term profit in a little over a month

BBUS; We added to the Betshares ETF that provides a leveraged short exposure to the S&P 500. We bought this as the S&P traded to new highs. This is a leveraged product and by holding 5% in the portfolio, this equates to a 10%-13.75% short exposure on the US market. Along with the 5% weighting to the BEAR fund which is an unlevered instrument, the Platinum Portfolio now has a short exposure of between 15% & 18.75%, along with a 20% cash position. We’re clearly getting reasonably defensive here.

QBE Insurance (QBE); While we believe QBE trades higher overall, we trimmed our position by ~3% leaving a ~4% weighting in the portfolio. Given we hold Suncorp and QBE, trimming QBE into strength now gives us more flexibility in the Insurance sector going forward.

We remain committed to our view that local stocks, especially the “boring old fashioned blue chips”, will outperform the US over the next 6-months hence we are comfortable increasing our BBUS position as opposed to significantly increasing our cash position as we have in the past e.g. before stocks fell over 20% in 2015/6 MM moved to over 50% in cash, this time we are looking to improve on that excellent result with a combination of high cash levels and negative facing ETF’s.

Likely actions in the next few weeks:

  1. Casinos; Star Entertainment (SGR) reported well on Friday and importunately, guidance (and trends this FY to date) were strong. Crown (CWN) has been on our radar to buy around $14. The trends seem to be improving for VIP gambling while the renovations made by Star last year are starting to pay off. This is a sector we are watching closely, looking to add CWN and/ or Star (SGR) to the portfolio
  2. We remain keen to add Aristocrat around $29, MFG into a $1.50 pullback, Rio Tinto (RIO) below $71 and BHP below $30

QBE Insurance (QBE) Chart

4 Bond yields (interest rates) & the economic / market cycle **An update**

In the past week the spread between US 10 year bond yields and US 2 year bond yields has narrowed to just 0.18%, the tightest spread since before the GFC.

  • Historically stocks will fall when / if the US yield curve inverts i.e. the move will probably become self-fulfilling because so many market players are conscious of it.

The contraction of the bond yield differential implies to us that the US is heading towards a recession in around 2020, hence our phrase that the global asset / equity bull market since the GFC is very mature feels on the money. We reiterate investors should be looking for “late cycle positions” in stocks / sectors, 

When we consider history one of the standout messages for this stage of the cycle is be extremely careful paying up for growth i.e. We want GARP (growth at reasonable price) not GAAP (growth at any price).

To keep things simple (KISS) its time for the below:

Seek – solid / predictable profitability (ROE – return on equity) with relatively low debt levels at of course a reasonable price / valuation.

Avoid – high valuation growth stocks who are often unlikely to live up to expectations / hopes if the economy becomes a major headwind.

MM believes the time has arrived for the “boring quality blue chips” compared to the growth stories that have excelled over the last few years – although clearly, the market was not listening to us last week!

US 2/ 10-year yield curve Chart

Conclusion

Again no major changes.

·        We are now neutral (just) while the ASX200 can remain above 6240 while we have seen the US market (S&P 500) make fresh all-time highs on Friday.

·        We remain comfortable sellers of strength but not weakness, just yet.

·        We will continue to slowly increase our cash / short ETF positions and are still firmly wearing our “sellers hat”.

Standout technical chart (s) of the week

A2 Milk (A2M) reported well last week and looks strong technically on a break and close over $11

  • A break of $11 brings the ~$13.50 upside target back into play

A2 Milk (A2M) Chart

Trading Opportunities on our radar

Mineral Resources (MIN) is a stock we own in the Platinum Portfolio. We’re down on the position however a few interesting aspects now playing out. MinRes is in the final stages of a process to sell up to 49% of the Wodgina lithium project in the Pilbara. There is speculation in the news that a Chinese Lithium player is keen to pay a strong price while last week the MD and MINs No 1 shareholder Chris Ellison bought another 38k shares at an average price of $15.02, spending about $570k. Interesting timing given the outcome of the sale process is imminent.

  • MM are bullish MIN targeting a move towards $20

Mineral Resources (MIN) Chart

Investing on our radar

Crown (CWN) looks bullish whilst it can stay above $14 while the trends in VIP gaming outlined in Star’s result on Friday provide a positive read through for Crown.

Star Entertainment (SGR) provides a good risk / reward buy around $5.20

  • We remain buyers of Crown (CWN) around $14 and Star Entertainment (SGR) around $5.20

Crown (CWN) Chart

Star Entertainment (SFR) Chart

Our Holdings

Our positions as of Friday. All past activity can also be viewed on the website through this link

Weekend Chart Pack

The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.

Have a great Sunday!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 25/08/2018

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