Australian Market Summary (Issue 405) – 24 June 2016

Australian Market Summary – 24 June 2016

The British headed to the polls overnight to finally decide on whether or not to remain part of the European Union. Despite markets having priced in an 83% chance the UK would remain, it seemed clear from the outset that this vote could go either way.

In periods of uncertainty such as this, global markets tend to shy away from the riskier assets such as shares and instead settle for the perceived safety or protection within defensive assets such as bonds.

However, surprisingly investors seemed willing to the buy market early this week both locally and abroad in spite of the looming Brexit vote.

The Australian market appears likely to now close down for the week following a significant rally in the bank and energy sectors early on. Strong gains in the oil price at the backend of last week ensured our market opened strongly at the beginning of the week and this momentum seemed to transcend the expected paranoia and negativity surrounding the UK referendum.

However, panic selling has driven the market down today with the ASX200 falling 3.5% following the UK decision to exit the EU.

Bonds rallied as investors sought safety and looked to reduce their exposure whilst volatility plagued the market.

The performance of our large cap stocks drove the market this week until this morning when the likelihood of a Brexit outcome swung to favouritism and became a very real possibility.

At the risk of sounding like a broken record here, it is precisely these stocks – the top 20 whose share prices have become expensive in recent years, that have made our market (which now trades on a multiple of 16x) appear so one dimensional and subsequently coerced investors to look elsewhere in order to find growth and perceived value.

I read a note yesterday that depicted this so clearly.

Think about this…

The ASX20 has underperformed the remainder of the top 200 (ie the other 180 stocks that comprise the ASX200) by more than 30% over the past 2 years.

Portfolio favourites ANZ, CBA, NAB, WBC, BHP, RIO and TLS amongst others have underperformed the broader index by a frightening 30%.

Whilst we may have in the past made concessions on capital growth for an attractive yield, this too has now been compromised and price underperformance and PE multiple de-ratings across these “safe haven” stocks will continue until earnings growth begins to improve.

Charts convey technical information in such a simplistic manner. See below a visual display of what I have alluded to here.

ASX200vEX20

The RBA

The RBA released its minutes on Tuesday and gave little to no indication as to the likely direction of the cash rate at its upcoming meeting in two weeks time.

The general consensus is that the RBA will not follow the federal election with a rate cut in July, but expectations of a second rate cut to occur in August are gaining momentum with futures markets currently pricing in a 52% chance.

The RBA reemphasized lower than expected first quarter core inflation figures along with declines in terms of trades and some reduction in domestic prices which were responsible for their decision to cut rates last month.

Siting the unemployment rate holding steady at 5.7% and first quarter GDP growth exceeding expectations, the RBA’s underlying confidence that the economy’s transition from resource investments to service exports is progressing well.

The RBA’s concerns surrounding property markets in Sydney and Melbourne abated somewhat with tougher lending conditions, apartment oversupply and the slowing pace of credit expansion all helping to relieve property market pressures.

Yet, increasing signs of wage pressures, an expectation for inflation to remain low for a prolonged period of time and a recent bounce in the AUD (from 0.7150 to 0.7720) are restricting growth opportunities domestically. It is these factors that will lead to a further rate cut in order to ensure these service exports continue to boost and reshape the way the Australian economy functions.

To Brexit or not to Brexit?

A British exit would deny the 28 member EU of its second largest economic power not to mention the withdrawal of one of its two main military powers in a decision that could have long lasting political and economic implications.

Whilst a decision to leave supposedly protects British jobs through stricter immigration policies, it also undermines the current 650,000 British jobs which are directly attributed to their involvement with the EU.

Despite leave campaigners maintaining a Brexit would ensure long term prosperity for Britain’s economy, the short-term effects would likely cause financial chaos and weaken their economic power.

George Soros who famously broke the Bank of England in 1992 claimed that a Brexit could lead to the Pound depreciating by more than 20% against its peers – a greater rate of depreciation than when he bet against the bank.

Until now I could not envisage an exit from the EU and note at the current point in time they have not yet counted Scottish votes where polls indicated there was overwhelming support to remain in the EU.

But this is the nature of markets and the uncertainty that accompanies them is what makes this all so fascinating…

Have patience. All things are difficult before they become easy

Markets have moved every direction this morning and it was precisely this anticipated volatility that caused us to raise cash weights in our SMAs to near maximum levels.

Having ensured we took a cautious and safe approach, we continue to look ahead for potential opportunities that will generate additional alpha for the portfolios.

Stocks we have been watching for some time which we continue to monitor such as Mantra Hotels (MTR) and Blackmores (BKL) have come back a long way from their highs.

We continue to wait patiently in our best efforts to ensure this period of global uncertainty can be beneficial for us and clients. For now we remain on the sidelines but we are ready to act.

Disclaimer: This information has been prepared by Primestock Securities Limited ABN 67 089 676 068, AFSL 239180 (“Prime”). Prime accepts no obligation to correct or update the information or opinions in it. This information does not take into account your objectives, financial situation or needs. Before acting on this information, you should consider whether it is appropriate to your situation. It is recommended that you obtain financial, legal and taxation advice before making any financial investment decision. Prime is bound by the Australian Privacy Principles for the handling of personal information.

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