Australian Market Summary (Issue 355) – 12 June 2015

Funny little week this.

This week I want to focus on a speech made by the RBA Governor, Glenn Stevens this week, in particular since I think it is an excellent discussion of Australia’s current climate and outlook.

I also have several remarks to make on the HYBRID sector, which many of you will find pertinent.

In the remaining text I will give a brief summary of the market.

MARKETS…

I think we learned a lot more about the domestic economy and policy-maker intentions than the underlying market move may have implied.

As it happens, the ASX200 rose just under 1% this week, but is still down 4% for the month of June.

Energy and banks led the gains interestingly – oil stocks rose 4% on some modest oil price gains post the OPEC meeting last Friday, and banks bounced just under 2% as the 15%+ fall from top to tail dragged in some bottom-fishing buyers.

None of this is overly controversial nor interesting really.

Oil stocks are still too high to buy aggressively given continued excess supply and the threat (and likely reality) of a repeal in US legislation prohibiting oil exports at some point in the year ahead.

Oil Search (OSH) is and remains on our radar, but frankly hasn’t gotten cheap enough yet. On the broader sector we will continue to hold our WPL position, but keep our powder dry elsewhere.

On banks, as discussed last week, these things are getting ‘cheaper’ and now offer up some merit relative to cash – NAB particularly. But with higher bond yields, increased regulatory oversight of investor lending and the impost of higher capital charges, we see minimal earnings and dividend growth for the sector in the coming 18 months.

We upgraded Insurance Australia Group (IAG) to a BUY as you all will have seen. This is a very simple story, and offers investors an alternate equity income stream to the Banks and Telstra, at a reasonably attractive level. We have seen good take-up on the recommendation, but are a little annoyed at the strong bounce in the stock so quickly.

Iron ore prices pushed up to a 3-month high this week, above $60/ton, driven by falling Chinese inventory – see the chart below. Recall the low seen was around $45/ton in early April, coinciding with the vast capitulation of the financial press on miners.

Like most things in life and the market, extremes never last for long. That’s why they are called extremes.

For now miners, like the remarks on banks and oil shares above, are in a middle-ground where valuation and momentum is neither good nor bad enough to be overly active.

Australian consumer stocks probably were the worst this week. Nine Entertainment (NEC) copped a hiding, falling 15% on the week after warning that May and June trading had been soft. This news took Seven West Media (SWM) down 15% alongside it, but interestingly Ten Network (TEN) rose against the grain in the belief that part of Nine’s weaker trading was due to lost market share to TEN (see Masterchef).

Woolworths (WOW) and REA Group (REA) both considered their underperformance this week, with neither share yet cheap enough to make a contrarian bet against.

THE RBA GOVERNORS REMARKS & STRONGER ECONOMIC DATA…

Though the market may have been uneventful, the comments made by the RBA Governor this week alongside the May unemployment figures do deserve closer consideration.

On the whole, they back up my view (one made very firmly again last week) that WE HAVE SEEN THE LAST INTEREST RATE CUT IN AUSTRALIA for this cycle.

The RBA Governor made a terrific speech to the Economic Society of Australia in Brisbane on Wednesday.

Typically, the headlines across newswires and in the financial press focused predominantly on the admission from the Governor that the RBA ‘remain open to the possibility of further policy easing’.

It’s what people want to hear, and frankly, it’s what he is duty-bound to say if he ever wants to get the Australian dollar back to 70c.

But it totally misrepresents the subtext of his speech.

Core to the speech was the Governors remarks insofar as the diminishing impact of easier monetary policy on the economy at such low rates. He remarked of monetary policy that:

..‘its marginal effect may be smaller, and the associated risks greater, the lower interest rates go from already very low levels’.

He also remarked of current policy:

‘I think it has been about right for the circumstances’.

The balance of the speech speaks to the high leverage households have built up in the past 15 years and how it would be inappropriate to expect the consumer economy to lift growth from here. That it is business investment and improved productivity that will set this nation on the path for the future, and to this extent Stevens again spoke strongly about the need for a committed infrastructure plan, and the need for ‘other policies to coalesce around a narrative for growth’.

This is as overt a remark as you will get from a central bank Governor as to remove the burden of expectation that monetary policy is the saviour to all our problems. It is not.

I have to say, for those of you seeking context surrounding Australia’s economic outlook, I would urge you to see the link below and spend 10 minutes reading these remarks.

I happen to agree wholeheartedly, and feel that this is a very strong signal that rates have bottomed here for now.

http://www.rba.gov.au/speeches/2015/sp-gov-2015-06-10.html

This week was a good one for economic data too.

The May employment report surprised all with a strong jobs gain and a resulting 12-month low in the unemployment rate (6%).

The NAB Business Confidence survey also jumped to a 6-month high, though Consumer Confidence eased back after a strong jump last month with the associated halo from an expansionary Budget report.

These are the sorts of figures we want to be seeing, but like most data locally of late, they ebb and flow from month to month with no real, discernible trend.

Australia’s economy has its issues, but low rates and a weaker currency are providing modest ballast.

BANK HYBRIDS…

I wanted to briefly focus on the value currently on offer in the Tier-1 capital instruments issued by much of the banking sector in recent years.

The bank ‘hybrid’ sector has been much maligned for the past 12 months or more, and in some reasons deservedly. When I first returned from overseas and took a look at the sector 2 years ago, it seemed quite apparent this was a sector in which the risks were misunderstood by advisers and investors alike.

However more recently, a strong education process has gone on within the industry to avail investors of the various risks associated with bank converting preference shares and the like, which is a very good thing. But I would say right now, that that education process has now gone to the point of undue criticism, which leaves a lot of this sector now offering up really good risk/reward.

The move by bank regulators to force the major banks to hold more capital reserves makes this sector look stronger. As banks raise equity capital, the risks associated with so-called ‘non-viability’ diminish.

Three securities that now offer reasonably attractive income characteristics with an appropriate degree of risk are – NABPC, CBAPD and ANZPF. All three securities are of 5-7 years before they will likely be ‘called’ by their issuers, offer a cash yield of ~5.5-6% in annual income, but in fact offer a 6.8-7.25% total return over the next 5-7 years since each of the securities are now trading under their issued and likely redemption prices.

To get 7% type returns from investments of these lower-risk nature is actually good buying in my opinion.

I would happily talk to any of you on this should you like to have a longer chat.

I’ll leave at that for this week.

Key Dates: Australian Companies

Mon 15th June 
N/A
Tue 16th June 
N/A
Wed 17th June 
Div Pay Date: Betashares High Interest ETF
Div Ex Date: Fisher & Paykel Healthcare (FPH)
Thu 18th June 
Div Pay Date: NABHB, RESMED (RMD)
Fri 19th June  
N/A

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