Australian Market Summary (Issue 410) – 29 July 2016

Another strong, if slightly odd, week of performance from the Australian share-market.

The ASX200 is up almost +6% for July and at its highest in a year, whilst the S&P500 and NASDAQ indices in the U.S are at record highs.

The German DAX index is back above levels it sat at only a month ago when the British public chose to vote for BREXIT.

It’s all a little surreal, but I can understand why.

I’m definitely not alone in my caution and perhaps that’s precisely the point – when everyone’s already a bear it leaves nothing but buyers!

But for now I think it’s a sound and sensible position to hold. Australian shares trade at 17x earnings, a 15+ year high and the underlying earnings momentum is worsening not improving.

As I outlined last week, buying shares at ever-increasing multiples without the support of solid earnings is a recipe for disaster and akin to financial snakes and ladders.

Asaleo (AHY) last week demonstrated precisely this risk. Early in 2016 Ansell (ANN) was much the same.

Given that Australian reporting season kicks off next week properly with the likes of NAVITAS (NVT), Rio Tinto (RIO) and TabCorp (TAH), we feel now is not the ideal time to throw caution to the wind

The week just gone …

Share-markets this week remained in constructive mode.

The major global event this week was the US Federal Reserve meeting. Though the Fed acknowledged the US economy had rebounded through the early northern summer, there was little concern from markets that there would be an escalation in the pace of tightening.

All quiet on the western front. Least it seems.

Woolworths (WOW) saw a nice 5% pop on the week after the company posted a confident and forward-looking statement detailing plans for a reduction in store openings, a withdrawal from underperforming stores and a renewed focus on return on capital.

Additionally the company affirmed market expectations for 2016 profits (broadly) and played down any need for a capital raising.

Encouragingly the group spoke of continued improvement in consumer satisfaction and increasing ‘basket size’.

Results in late August should post little surprise now and we feel increasingly certain that WOW is taking the right steps towards righting its core food franchise.

We remain BUYERS ~$23.

IOOF (IFL) posted a reasonable set of fund flow figures for the June quarter, which was encouraging.

Again, we feel IFL is a solid, cheap domestic financial services play and worth nearer $10.00 in the current environment.

Macquarie Group (MQG) and Henderson Group (HGG) posted a trading statement and results respectively. MQG reiterated guidance for flat profits year-on-year, which was no surprise.

HGG, on the other hand, were modestly disappointing in their results, with some moderate margin contraction leading to a disappointing profit figure. That said, with the stock off -25% since the BREXIT decision, investors weren’t prepared to penalize the stock any further and HGG shares managed to grind higher on the week.

RESMED (RMD) posted quarterly profit figures on Thursday night which the market seems to like.

You’ll notice we published our TAKE PROFIT research on Insurance Australia Group (IAG) this week and we feel it’s an opportune time to lighten the load there given strong performance and some creeping concerns on underlying profitability.

Our Equity Separately Managed Accounts (SMA’s) sold down positions on Thursday but retain modest holdings simply because both SMA’s are bumping up against MAXIMUM cash and we need to find something new to buy before we are able to fully exit these positions.

Watch this space in the days and weeks ahead.

In the coming week …

The RBA will surely CUT domestic interest rates to a record low of 1.5% when it meets next Tuesday.

In doing this, the aim is less about the impact of lower interest rates on domestic demand and more about lessening the attraction of Australian assets to foreigners and hence driving the Australian Dollar lower.

Sadly, the RBA faces an uphill battle in achieving a weaker domestic currency since every other major global central bank is endeavouring to engineer the same.

For this reason we remain pretty convinced that next week’s rate cut won’t be the last.

Also next week, Australian reporting season kicks off with the likes of NAVITAS (NVT), Rio Tinto (RIO) and TabCorp (TAH).

With much of the Australian industrial sector trading on inflated multiples (ex-banks and miners the market is on 19x), it seems many share prices are about the ‘travelling and not the arriving’.

I remain wary.

To finish …

Having turned cautious in April with the ASX200 in mid-May at 5380 we stated we felt risks were beginning to outweigh prospective reward.

We felt the ASX200 was likely capped around 5500 (now 5550) and the downside over time was potentially to 4800-4900.

From our seat, nothing has changed in this regard, though we feel we must stress this is not an overnight call.

The prospect of a tricky earnings season, likely fears over the impact of BREXIT on European growth, our still material concerns over China’s bad debt problems, emerging fears over a Trump presidency and the nose-bleedingly high valuations across a swathe of asset classes (negative bond yields and 15-year P/E valuations in Australian shares) simply make us pause.

If you’re not being rewarded for your investment risk with a suitable return, why play?

The world’s largest bond investor Jeffrey Gundlach (Doubleline Capital) remarked about the negative yields in global bond markets recently, ‘I don’t like investing in assets where if I get it right, I still lose money’.

To that I say ‘touche’.

Now is a good time to take stock and re-appraise and this what we are constructively advising to do.

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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