Australian Market Summary – 4 March 2016
A better week, and a better week for some good reasons.
The ASX200 is up around 4.5% as I type, taking the losses for the year back under 4%.
Where the big end of the market had been extremely weak for much of the year-to-date, it sprung back into action this week with the likes of BHP (BHP, +13%), ANZ (ANZ, +12%), Rio Tinto (RIO, +11%), Westpac (WBC, 11%) and National Australia Bank (NAB, +11%) leading the charge.
At the heart of the bounce was the sensible realization that fears of a housing market collapse were incredibly excitable (see last week’s remarks) and this helped banks.
Equally, an ongoing rebound in iron ore prices has left many of the resource sector bears worried that the likes of BHP and RIO could be prone to moderate upgrades if sustained.
In addition to these factors, an over-arching positive is looming over the market in the form of potential interest rate cuts.
This is an ace in the hole we have here in Australia that few other developed economies have – the ability to further lower interest rates as necessary.
The continued bounce in the Australian Dollar this year puts increasing potential on the RBA to further lower interest rates to provide monetary ballast to the local economy.
Some important points of context …
Since corporate reporting season is winding down, there is less need for me to speak to how profit figures looked and more an opportunity to touch on some bigger picture issues of context for markets and portfolios.
The aim with these following remarks is to give you a sense for how things look from outside the fish-bowl of a purely ‘Australian equities’ stand-point.
Context #1 – Australian shares in a global sense
Believe it or not, the ASX200 is one of the better performing indices year-to-date when considered in constant currency (in other words taking FX changes into account).
This is an important way to consider the market since we live in a global investment community and this is the way foreign investors consider our shares and bonds – remember, Australia is only 1.5% of the world share-market by value.
The ASX200 is down -3% year-to-date in US-dollars, in-line with the S&P500 but significantly better than the NASDAQ (-6%), most of Europe (-3-8%), Japan (-6%) and China (-20%).
Of the major markets, only Canada (+4%) and Brazil (flat) are ahead of us.
Context #2 – Australian shares big and small
Whilst it has been a horrible market thus far, it’s important to understand that it has felt so much worse for most individual investors since so many private portfolios are concentrated at ‘the big end of town’.
We have rabbited on about the need for diversity on more occasions than I remember, but still get hit with the oft-repeated ‘I’m never selling my banks’ quote.
As a guide for the sector performance by size, do note that ASX200 is down 3.8% in 2016, but that the ASX 20 Leaders is down 6.3%.
The Mid-cap 50 index and the Small Ordinaries indices are however down only -1% and -1.4% respectively.
For reasons of size and liquidity, small-caps are never going to be the heart and soul of most investment portfolios, but it is important to strongly consider the opportunity set beyond the well known, blue-chip favourites.
The economy is changing and this means opportunities will more often than not arise in less well-known and trusted shares.
For those who do want to talk small-caps with us, please do ask as we have an excellent fund manager we would happily recommend.
Context #3 – Australian shares against bonds and property
Australian shares have underperformed the 10-year government bond by ~17-18% since mid-2015.
This is a trend that has been global, no doubt, as investors re-appraise their views for economic growth in light of the Chinese currency devaluation.
However it’s important to understand this relative performance because no asset class sits in isolation.
At some point (certainly this past week), investors will seek to rotate from one asset to the other to take advantage of improved risk/return characteristics.
With Australian 10-year bonds now offering only 2.5% interest, but growth still steady if not spectacular, AND the prospect of potential interest rate cuts, Australian equities look far better value now than they have done in much of the past 12 months to my thinking.
Again, this is not a call to buy shares en-masse since I think investment markets remain clouded by events overseas AND the fact most investors are still too heavily concentrated in Australian blue-chips.
But it does, and should, make you feel more comforted by equity valuations after what has been a torrid start to the year.
Context #4 – Oil & Mining shares
The materials sectors are 20% off the lows seen in early January and somewhat deserving of this.
The iron ore price in particular is up 25% and pushing on $50/tonne. Most analysts have taken their expectations down into the mid-$40/t range, so quite oddly a sustenance of this bounce could well lead to modest upgrades of mining earnings estimates.
However, don’t be too taken by the bounce.
Forward contracts for iron ore are still 10% lower than the current ‘spot’ price, indicating an expectation that prices will fall away during 2016.
Furthermore, I see little respite for iron ore volumes ex-Australia and into China as many Chinese steel mills continue to reduce capacity amid falling demand for steel.
Remember, once you build a highway, office building, train track, water-works, power-plant or airport, you don’t build it again next year.
Steel is not a commodity that perishes.
Demand will slow for Australian iron ore in the coming years, undeniably. Working in the Australian producers favour is that they are the lowest cost and highest quality, which means they will take market share.
However, the endgame for miners in my mind is to sell the strength as it arises in situations not unlike the current rally.
We are watching this mining bounce with a critical eye and would be looking to make some sales should our targets be reached.
Neither BHP nor RIO nor Woodside (WPL) offer an overly compelling investment case on a 2-year view, despite our belief to the contrary on occasion in the past (in WPL in particular, but to a lesser extent recently in BHP), and so we are very much looking for the opportunity to cut our losses as appropriate.
In the case of oil, despite the massive supply issues presently, things look moderately more constructive.
It would seem the chances of some supply curbs are increasing.
The need for oil back above $50/barrel is far more acute than the need for iron ore at $50/tonne.
We feel very strongly that our Oil Search (OSH) pick will make investors excellent returns in a $50/barrel world and the stock has actually been very strong in a weaker market this past few months despite the commodity price weakness and the fact WPL walked away from its bid.
To round the week out with a few additional points I would highlight the following:
a) Magellan Financial (MFG) a former holding of ours saw its first monthly net outflow of funds since 2010 in February.
We think they are an incredibly good fund manager and a key holding for many of our portfolios, and still an excellent ‘share’, but we think the ‘share’ still looks too rich for our blood up here.
We really would like to see it nearer $18 at which point we would reconsider buying back positions in MFG.
b) Economic data this week in Australia was actually pretty good and this helped push the Australian dollar to the cusp of 74c. The February activity indicators all improved on January, which is encouraging, and the Q4 GDP figure (something I am loathe to use as guidance for the economy) also surprised favourably with a 2.6% growth rate (ask me why I hate the GDP figures another time).
c) The RBA sat this week and left rates alone, however the rhetoric out post the meeting was very much dedicated to their belief that though accommodative already, there was still room to lower rates if necessary. As above, I think the rising Australian Dollar will force their hand as soon as Q2.
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