Australian Market Summary – 17 June 2016
It was an interesting week.
We saw some mean reversion occur as several ‘high-flying’ stocks began to find gravity is unavoidable – AMCOR (AMC) and Medibank (MPL) in particular.
We were particularly impressed and relieved to see the Crown Resorts (CWN) announcement of a significant restructure aimed at releasing unrecognized asset value.
The stock is up 10% on the week and we feel there is more to play for, though I will discuss it in greater detail later in the note.
It was also a week in which the Federal Reserve again made themselves unpopular with the global central banking community, by again pushing out the rate and pace of future US interest rate tightening.
Most significantly this week, the combined effects of a ‘dovish’ Federal Reserve outlook, a similarly weak outlook from the Bank of Japan and ongoing fears surrounding Britain’s exit from the EU saw global bond yields collapse again to RECORD LOWS.
German 10-year bond yields went NEGATIVE for the first time on record. More spectacularly, Swiss 30-year bond yields went NEGATIVE too – think about that, a 30-year investment on which you are committing to a ZERO OR NEGATIVE return.
We live in complicated times.
EMERGING INVESTMENT THEME – RENEWED AUSTRALIAN DOLLAR WEAKNESS
I spent two days in Perth this week seeing clients and talking through my expectations for investment markets over the next 6 to 12 months.
Consistent with my thoughts on these pages, I discussed my caution on equity assets in general and my unerring belief that Australian investment portfolios will continue to evolve away from their heavy reliance on large-cap Australian shares.
The trend of reducing exposures to Australian equities is a long-term and secular one for retail and institutional portfolios alike.
Australia remains the 4th largest national pool of retirement savings globally and yet comprises only 1.5% of world share-market value.
That our portfolio’s remain so heavily dependent on old-economy, low-growth companies such as the banks, miners, Telstra and the supermarkets is a real handicap and it needs to change.
Growth assets are held for the purposes of growth, yet much of the Australian blue-chip corporate scene is bereft of growth.
Secondly, the concentration risk of portfolios to domestic housing is and remains a scary one.
Although I expect the RBA to throw the kitchen sink at trying to alleviate any significant housing correction, being blind to the risks of failure here would be naïve.
We wholeheartedly support the idea of investors raising their GROWTH exposures to international equity markets at the expense of the domestic Australian market – a theme we have reinforced over the last year.
Further supportive of the trend towards raising offshore exposures is my RENEWED BELIEF IN A FALLING AUSTRALIAN DOLLAR.
Follow me here.
The Australian Economy Needs Fresh Stimulus
Right now, the Australian economy is in need of a fresh catalyst to spur growth. Export income is on the wane and unlikely to rebound any time soon.
Domestic demand is now being supported by lower interest costs and falling savings rates, but this is finite.
We need a new catalyst and it is vital we get it.
The reason the RBA need to keep a wind in our economic sails is a very simple one – housing.
The two drivers of house prices are interest payments and employment/wages.
Lower interest charges are helpful, but going forward will likely have diminishing impact in isolation.
What the economy needs is a growth boost that ensures employment and wages are underpinned.
See, though Australia’s housing market right now seems very well underpinned by serviceability and current asset values, the enormity of the debt rise in absolute terms is staggering.
Should Australia’s employment growth begin to stutter, real and genuine risks begin to emerge on housing that could jeopardise the 25 years of unerring economic growth this country has seen.
This is precisely why the RBA will do everything it can do to engineer a weaker Australian Dollar and interest rates will be the major policy tool.
We need a weaker AUD in this country to spur domestic economic activity. Import substitution is the single biggest reason.
A lower AUD makes domestically produced goods and services more attractive than foreign goods and thus sponsors domestic capacity utilization such as increased employment, wages and local corporate growth.
This occurrence will shift momentum in the economy from the owners of ‘capital’ to the producers of ‘labour’. Lower return on investment and a weaker currency will make life harder for older demographic groups, whilst increased domestic economic activity will improve wage growth amongst the working population.
We need to be prepared for this to come and we also need to hope a weaker Australian Dollar can be engineered on the RBA’s terms and not be an outcome of falling demand in and of itself.
The longer the Australian Dollar remains in the mid-70s, the greater the chance of a slowing in domestic economic momentum and the greater the chances the RBA loses control of the housing narrative.
This is precisely why the RBA cut rates back in May and precisely why they will cut again in July or August (and most probably they will have to again early in 2017).
The RBA need to keep housing afloat and to do that they need to keep the economy and employment afloat.
This requires a weaker Australian Dollar.
Implications for Portfolios
Over time, we expect to see portfolios again become dominated by those assets levered to lower local rates and currency.
Foreign earners like CSL (CSL), RESMED (RMD), Magellan (MFG), Blackmores (BKL) and Sonic Healthcare (SHL) alongside domestic utilities like Telstra (TLS) ought to be well sought. Banks will struggle as their earnings abilities are neutered by falling rates.
This is a longer-term trend we forsee and we will look to evolve portfolios this way in due course.
For now, our over-riding view on investment markets is one of caution in anticipation of the chance to participate in opportunities offering more attractive risk/return characteristics than currently abound.
Crown Resorts (CWN) – Significant Restructuring
As above, we were thrilled to see CWN announce their plans to split the domestic Australian gaming assets from the ‘international’ assets, alongside a likely IPO of 49% of Crown’s Australian hotels (excluding Crown Towers) into a REIT structure.
CWN also announced a revamped dividend policy, stating that they would pay out 100% of normalized profits.
Whilst we and many in the market, had anticipated a privatization by James Packer, the announcement of yesterday’s moves is equally encouraging and will upstream greater share of profit and value to shareholders, as well as increasing market transparency on asset values.
Having seen the share price rise 10% this week to $12.60, we still feel there is another 10%+ upside to go before we see the stock reach a fair value.
At $12.60 and under the new dividend policy, CWN offers a prospective 2017 dividend yield of 5.5% (50% franked) which should also underpin shares near term.
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