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Australian Market Summary  – 2 September 2016

‘At the moment risk is not paying enough of a return’.

Peter Costello, Chairman of Australia’s $120bn Future Fund said this today in the paper, after the group unveiled their June quarter returns and asset allocation.

Future Fund positioning

I don’t normally seek vindication from others as to the views I do or do not hold and Peter Costello isn’t a known investor, but those running the Future Fund are well known and proven investors. The views of Mr Costello reflect the views of the Future Fund investment committee and are reflected in their conservative asset allocation as at 30^th June.

Much like our own recent caution, the Future Fund is holding significant cash (21.7% of assets).

Australian equities remain a fraction of their international peer group at 6.2% of total assets, as against 22.5% invested in offshore share-markets.

All of this is interesting insofar as both the context on their view of investment markets and future returns (cautious and conservative), but also the Future Funds allocation to global share-markets.

The significantly higher offshore weighting is not new news and has been the case for some time.

Secondly, it is important to acknowledge that the Future Fund themselves ‘serve different masters’ to ourselves in terms of the returns they are seeking.

However, it is an interesting and timely observation to make since PRIME this week hosted a very successful presentation on global equities by Damian Craven of Magellan Funds Management.

International Equity exposures

We continue to feel that foreign equities offer local Australian investors significant portfolio benefits, amongst them an exposure to growth from industries which aren’t represented in the Australian share-market, plus diversification benefits away from the local market and its substantial leverage to Australian house prices.

On Monday we will send out a refresher note with greater detail on our recommendations for offshore equity exposures and we would encourage you to take a look.

For those that missed Tuesday’s event, the note will include Damian’s presentation, which I thought was terrific and the annual report from Magellan’s Chief Investment Officer, Hamish Douglass, as well as a terrific link to a 10-minute video presentation from Hamish.

It goes without saying that we welcome your feedback here, both in terms of the presentations and our suggestions.

Our aim is to provide you access to more outside investment professionals in the year ahead.

Property might well be the next subject.

Equally if you like what we are doing and feel that you have colleagues or friends who are interested in these matters, do please encourage them to get in touch.

We are a young and growing company and would appreciate any referrals you deem appropriate.

Market Observations

We felt just a little fragile this week, losing a couple of percent in spite of international markets being largely flat.

Now the impetus from reporting season is over and companies have laid it bare in terms of business conditions, it’s no surprise to me that we have seen selling.

As Costello above remarked, there really is very little reward offered from markets at current levels.

So I thought I would share with you a few observations of my own from recent markets and economic data.

I think you’ll find them interesting.

On Banks…

• ANZ Bank (ANZ) has OUTPERFORMED Commonwealth Bank (CBA) by 20% since January and this in spite of cutting its dividend 10%. This is a huge move.
• Both CBA and Westpac (WBC) have UNDERPERFORMED ANZ and National Australia Bank (NAB) by 10-12% in 6 weeks. That’s a huge move. The reason in my mind is simple: the market is recognizing the peak in the housing market is upon us, so it is de-rating the premium multiples afforded to CBA and WBC and arguably rewarding ANZ and NAB for their lesser exposure to Australian mortgages.
• CBA is now at its lowest point relative to the ASX200 since Q1 2013. What this means is that you could have simply owned the market for the last 5 years and done just as well.
• In fact, CBA has UNDERPERFORMED the ASX200 by 18% year-to-date! That is enormous, more so because it is the biggest stock in the market.

These facts with reference to CBA dispel the notion that there is one stock ‘for all seasons’.

CBA might be a good company, but it isn’t ALWAYS a good share.

• BHP (BHP) is the 2^nd best-performing large-cap share year-to-date, rising 11% and outperforming CBA by 30%. This is despite falling under $14 in early January during the China currency panic.

Markets regularly over-react and under-react as demonstrated by BHP’s rebound from its panic lows and CBA’s fall from its undeserved peaks.

The recent recommendations in Blackmores (BKL) and Mantra Group (MTR) are examples of where we are hoping to uncover long-term corporate value after heavy share price falls from unwarranted and dizzying heights.

Wesfarmers (WES) and Woolworths (WOW) have the potential to be a similar reversal of previous investor perceptions, with WES disappointingly cutting its dividend whilst WOW is now finally seeing positive growth in its core supermarket business.

On the economy…

• Australian Manufacturing in August fell off a cliff. The AIG survey on manufacturing activity cited a heavy reduction in orders and employment during the month, with a notable reference to food & beverage producers and textile and clothing manufacturers.
• Australia’s savings ratio of 8.1% is at an 8-year low and down from a peak of 12% in the months post the GFC
• Australian household leverage is the highest on record in terms of debt to income (187%)
• Fortunately for now, household assets to income is also at a peak, but it is only at the peak it reached in 2007 before national house prices peaked and fell a modest 5%
• However, on this last point, RBA cash rates in December 2007 were 6.75% and then fell to 3% by mid-2009 shielding house prices.

Goes without saying that RBA cash-rates are now only 1.5% and far less capable of offering the house price ballast than they were post GFC.

Managed Account (SMA) performance update

Fortunately, the equity managed accounts have begun to arrest their decline of recent months, with strong relative gains made in August.

We feel confident in our ability to recoup the modest underperformance in the equity accounts, but are proud to say that in spite of an indifferent 2016, our 3 year compound annual growth rate for the PRIME Australian Equity Growth is +9.53% to the end of August 2016 as against the ASX200 Accumulation’s 6.49% annual gain.

Fortunately, the PRIME Defensive Income portfolio has gone from strength to strength this year on the back of its bank-hybrid exposure and is +4.43% year-to-end-August.

It was good to see so many of you on Tuesday at our event. Thanks for attending and hope you got as much out of it as we did.

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