August 2015 – ASX200: Worst month since the GFC!

A quick note to surmise the drivers of this month’s downfall, and a simple conclusion for investors to take away from here.

SUMMARY THOUGHTS

  • August worst month since GFC
  • Chinese economic weakness the root cause
  • Australian share valuations looking more interesting
    • PRIME advocate for selectively raising equity ownership

    If it feels bad, it’s because it has been.

    August month-to-date performance for the ASX200 is down over 14% this morning, making it a worse month for Australian shares than either September or October 2008, in the depths of the GFC.

    See the sector performance month-to-date below.

    THE CAUSE …

    Undeniably the single catalyst for Australian and global share-market weakness is China’s economy, but more particularly the decision taken two weeks ago by the Peoples Bank of China (PBOC) to devalue its long-standing link to the US-dollar.

    In truth, the decision to devalue the Chinese Yuan is a productive one for Chinese exports and a belated response to the money-printing policies effected by US, European, British and Japanese central banks in the wake of the GFC. China’s economy is laboring under a lack of export competitiveness, excess industrial capacity and waning household confidence. Attempts by the Chinese authorities to engineer renewed consumer confidence by way of a stronger stock-market now looks ham-fisted.

    In short, the devaluation was a necessity.

    However the ‘perceived’ negative for all of us is manifold –

    a) if China is devaluing to regain export competitiveness, this will sap volume and margin from Western world corporates operating in China, and

    b) create deflationary pressures on global goods prices.

    After 8 years of so-called Quantitative Easing (QE) in the US and other G7 countries, aimed specifically at warding off deflationary forces, it seems the possibility that China’s devaluation could snuff out that aspiration without drawing breath has been enough to cause panic in global investment markets.

    Further, the ‘admission’ of economic fragility by the Chinese authorities is another perceived negative, coming from a country and economy in which the omnipotence of the Communist party and central government is unquestioned. Sino-watchers love to debate any conspiracy theory that might suggest the potential downfall of the Chinese Communist system.

    So the moves in China are central to this move, but made all the more pronounced by the elevated levels of global share-markets and by the elevated expectations on corporate profits. US corporate profits as a % of GDP are at record highs, and much of this has been driven by incremental Chinese demand. If China’s economy is slowing, ergo, incremental profitability is weakened.

    But this is not the end of the world as we know it. This is not to my mind, the start of another GFC. This is a rap over the knuckles for the slightly myopic optimism reflected in share prices for much of the last 2 years, and a reminder that share prices can and do fall.

     

    US economic growth is strong and the collapsing oil price is offering up a very effective consumer subsidy to most Western nations. European growth is improving in spite of the Greek troubles (albeit still unresolved). Interest rates remain low and conducive to investment.

    WHERE TO NOW…

    We are now selective buyers.

    We have run near maximum cash levels in both the PRIME Australian Equity Growth & PRIME Australian Equity Income portfolio for the last few months in anticipation of opportunity, and we believe that time is emerging.

    We will be adding to equity positions today.

    We believe the best bets remain our recent recommendations in each of Crown Resorts (CWN), Carsales.com (CAR), Insurance Australia Group (IAG), Oil Search (OSH) and RESMED (RMD).

    We have long advocated against raising weights to Australian bank shares simply because history shows few clients ever sell! Many portfolios are hence very overweight banks (ASX bank sector weight is ~28% currently). However, make no bones about it, National Australia Bank (NAB) and ANZ Bank (ANZ) currently look cheap at today’s prices, offering 7% fully-franked yields (10% grossed for franking) and 10-15% capital appreciation in the coming 12 months.

    We remain confident that the global economy will continue its recovery. The US service sector is growing at its fastest rate in 10 years (see chart below), the unemployment rate has halved since the GFC (from 10%+ to 5.3% currently) and wages growth and ‘hours worked’ in the US economy continue to build.

    The collapse in the oil price might well cause some angst in emerging markets like Brazil and Russia and create some US energy-sector bankruptcies, but make no mistake, the collapsing oil price is a de-facto tax cut for the vast majority of western world economies.

    In Australia, the economy continues to improve – whether you choose to believe it or not. Like the US, service sector activity is picking up and so too is employment.

    The weaker Australian dollar and 2% interest rates are assisting our economy to build capacity and regain competitiveness. It isn’t a bed of roses, but it’s also not the end of the line.

    CONCLUSION

    Now is the time to be more constructive.

    Valuations look more compelling than they have done in months in several quality companies.

    Stick to quality – both in terms of balance sheet, brand name and management.

    Remember to think of shares and broader asset markets in an absolute AND relative sense – note that part of our increasingly constructive view-point is driven by the 25% underperformance of Australian shares relative to Australian government bonds in the past 2 months.

    Remember to SELL shares and to rotate portfolio positions as and when appropriate to ensure portfolio vitality and ‘freshness’.

    WATCH VIDEO: Mohamed El-Erian, Allianz Chief Economic Adviser, and a Bloomberg View columnist, comments on the selloff in stocks. He speaks during an interview with Bloomberg’s Olivia Sterns and Alix Steel on “Bloomberg Markets.” (Source: Bloomberg)

    Disclaimer: The information contained in this presentation is for informational purposes only and is not intended to be exhaustive or complete. This information does NOT constitute financial advice and should NOT serve as the basis for any decision by you. The information does not take into account the objectives and circumstances of the individual investor and we recommend that you consult a financial adviser should you have questions regarding the information contained in this presentation.

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