Australian Market Summary – 22 July 2016
A fellow market-watcher observed to me this week that the ‘FOMO has begun’ and so it has.
FOMO – fear of missing out.
In truth there’s been evidence of it in recent weeks, but this week some moves in particular did more than raise an eyebrow.
This observation is important because it is animal spirits, as much as anything, that dictates price action and when the evidence starts to emerge of increasingly irrational behaviour, we should begin to take notice.
I have spoken of the need to be fearful when others are greedy and the need to be brave when others are fearful on many an occasion, so looking at some of the moves this week I must admit to more than my usual skepticism.
A couple of remarks.
This week the market is higher by about +1.5%, with every major sector, barring Materials, higher.
We have spoken at length about the need to purge portfolios of unnecessary miners bets at much improved prices of late and this move again vindicates our calls. BHP (BHP) is still 10% below our SELL call and any attempts to push above $20 should be sold.
But where my interest lay this week was in the +4.5% gain in the healthcare space. Each of CSL (CSL), Ramsay Healthcare (RHC) and Healthscope (HSO) rose another 5% this week, as the upward spiral continued.
All of these shares are businesses you ‘want to own’, in the sense that they have large scale, cash-generative earnings streams that are unaffected by the whims of economic momentum.
But at what price do you buy them? CSL is perhaps the least offensive of the three given its balance sheet and R&D pipeline, but you are still paying 27x 2018 (2 years forward) cash earnings.
RHC and HSO on the other hand are getting a little nuts.
Only five (5) months ago, the market was in a tizz about the Government’s deliberate decision to reduce unnecessary surgery procedures and the impact this would have on hospital utilization.
At the time we felt concerns were a little overwrought and in fact used the opportunity provided by similar concerns to BUY Sonic Healthcare (SHL) at $17.20, but circle forward to the here and now and RHC is some 37% higher and trading at well over 30x cash earnings.
Healthscope (HSO) is even more egregious, particularly since its debt level is materially higher than RHC’s and it makes no dent into this debt until 2019+.
To pay 30x for something by default means you earn back your principal in 30 years.
I fully comprehend and have at times been a strong advocate for the idea that with record low bond yields, equity valuations should rise. But this isn’t infinite, particularly when the underlying earnings or cash-flow fails to grow.
And on that front, make no mistake, hospitals claims growth IS at a 15-year low (March quarter +3%, against 10-year average growth of +8.7%).
See, the usual argument for paying a higher multiple is the idea of ‘earnings growth’, not the opposite.
Ordinarily you would be prepared to pay a higher initial price if you knew that the earnings would be growing fast enough to make what looks expensive now, cheaper in the not-too-distant future.
And it’s here that this contentious and fragile argument for higher equity valuations becomes a tricky one.
How high can valuations go without any kick to earnings before the deck of cards falls?
From my standpoint, it’s simply not a game I am prepared to play because you don’t get second chances if you’re wrong.
This is my greatest concern with the equity market right now.
The lack of underlying cash-flow growth makes valuations all the more tenuous lest we get a hit to that cash-flow.
The Rise of Trump, Rejection of the Status Quo & Why as an Investor You Should be Concerned
In looking ahead, I have come to think that the single biggest risk to this market run and the global economy is the election of Donald Trump as President.
This is not a political statement and in truth I think much of the success of Trump comes down to a hubris and arrogance within the Western political elite.
But a Trump presidency would surely be less tempered, considered, predictable and planned. And investment markets and businesses alike like certainty.
This is without considering his anti-globalisation, anti-Wall Street politics.
Trump as a President effectively kicks the globalization movement in the guts.
And to think it impossible is I think naïve.
As many of you may have seen, Trump won more primary votes in the Republican candidate race than any other contender in history and won the highest percentage of votes on record in spite of a record 17 initial contenders for the Republican candidacy.
He’s far from the fringe politician he was dismissed as earlier in the year.
Watch this space team and the closer we draw towards the 8th November election date, the more this will prove to be a market fear.
I could talk at length about the changing politics we are witnessing globally as I find it fascinating and it will surely have a bearing on the market.
The Italian Referendum scheduled for October is a nearer term, but equally as relevant a political point for markets and the future of Europe, as the US Federal Election.
Elsewhere in the market this week
QUBE Holdings (QUB) had a good 5% bounce this week, driven in large part by the ACCC’s acceptance of its bid terms for fellow port & logistics operator Asciano (AIO).
This is good news, but far more interesting to me is further progress on the development of the substantial Moorebank site in south-west Sydney.
Oil Search (OSH) and Woolworths (WOW) both had good weeks for us, with OSH being trumped in its bid for Interoil by oil-major Exxon (XOM).
This is no bad thing and now cements the co-operation between the two competing LNG projects in PNG, which for a major equity holder in both like OSH is, is wonderful news.
OSH CEO Peter Botten suggested synergies from combining the two projects could number US$3bn, which in highly simplistic terms for a ~20% and 29% shareholder in each could be worth 20-30% of OSH’s current market value.
WOW was stronger on press reports that it was drawing closer to the sale of its beleaguered home improvement business.
Looking forward – RBA in a fortnight & Earnings Season
The RBA will cut interest rates in 10 days’ time and that as far as I am concerned is a given.
Secondly, you should be preparing yourself for reporting season.
As per my remark above about corporate earnings and my concerns for the lack of growth, this is confession season for many corporates, so expect some wild moves.
My hope is that more opportunity emerges than risks are created.
One final point on Mortgages & Banks
This week the RBNZ gave us a glimpse of where Australian monetary policy is headed when it extended its restrictions on lending into Auckland housing to the entire country.
The RBNZ chose to restrict bank mortgage lending to only those owner occupiers capable of making a 40% deposit and to those owner-occupiers with a 20% deposit.
Bank lending is set to tighten further in the coming 12 months principally because, just like the RBNZ, the RBA need to lower domestic interest rates further to get the AUD down. But whilst that is a goal, they don’t want the lower interest rates to further inflate an already expensive domestic property market.
This isn’t great news for the banks because it takes away their ability to grow lending volumes, all the while their ability to earn a spread is being diminished by the interest rate cuts.
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