Australian Market Summary (Issue 424) – 4 November 2016

 Man this can be a frustrating gig sometimes.

One step forward, one step back.

This week saw the market fall just under 2% and continue the weakness of late October.

The US election next week is unlikely to offer any respite to markets either in my opinion since it now looks likely to be neck and neck, meaning that even if HRC wins, Trump seemingly has a mandate (at least in his own mind), to contest the legitimacy of the result.

I fear the worst.

Where we hoped the election of a new President would serve as a catalyst to look forward, I expect that whatever the result, the US looks set to be an ever more divided country in the months and years ahead.

That isn’t good for consumer confidence and the economy.

It remains really tricky…

There are land-mines everywhere you look – this week market favorites like Mayne Pharma (MYX) & NEXT-DC (NXT) imploded, and can be added to a list as long as your arm of 20%+ share price falls in recent months.

Two hours ago Flight Centre (FLT) announced a further downgrade to 2017 profit expectations and is down 7% to near $30 as I type.

On this one at least we were fortunate to have acknowledged the changing circumstances and called a SELL north of $37.

But the point is that it is hard to hide in this market.

For every obstacle we feel self-congratulatory for avoiding, we find ourselves bumping into another unexpectedly.

The market is as tricky as I have seen it in the past 3 years, and genuinely behaving like we are set for a shift to a lower trading range.

Valuations remain full, earnings outlooks are mixed and investors still own too many Australian shares in their portfolios relative to international shares & stable commercial property.

Our sustained caution on markets is proving vindicated, and yet my stock-picking has been tawdry in 2016 and is a genuine source of disappointment and frustration.

Mea-culpa …

This is a mea culpa of sorts and an acknowledgement to you that I haven’t had the same degree of success with our Australian stock-picks in 2016 as we have had in the previous 2 years.

It hurts and is confidence sapping, but all the same we feel that at some point the logic and reason behind our stock views will find a natural settling point and we will ‘get our eye back in’.

It further serves to highlight the importance of a well-diversified portfolio, and having other assets there to protect against a rainy day.

Australian Income Pressures …

I’ll say it ‘til I am blue in the face, Australian equities are not your retirement savior.

We are facing far trickier times in the coming years, and the Australian share-market will echo these economic difficulties.

To this end, I have been doing some presentations lately on the ‘income crunch’ underway in Australia, so if you would like a copy of the presentation slides do please ask.

In short we feel that Australia is increasingly asset-rich and cash-flow poor, and this will soon become a problem for the economy.

Investment income has collapsed, export incomes have weakened, corporate profitability is pressured and wage growth is at its lowest in 20+ years.

Interest rates are assuaging these fundamental problems, but not curing them.

It is palliative care only for now.

And this is why our share-market is going nowhere.

Observations from the market this week…

You’ll note we felt we missed an opportunity when much of the mid-cap and small-cap universe went on a bull run during the first half of 2016.

We acknowledge we missed the re-rating on several stocks, but would point out that both the ASX Mid-Cap 50 and Small Ordinaries have now fallen by 10% from their August highs.

Miners continue to beat all-comers and remained outperformers again this week, underpinned by the stubborn resilience of Chinese coal and iron ore prices.

Whilst it’s been my opinion for several months now that iron ore prices will roll over soon enough, the reality is such that BHP (BHP) in particular has been driven by the stupendous rise in coking coal prices.

As a guide, Australian export coking coal prices have risen 200% since June, and as one of the world’s largest coking coal producers, BHP is creaming excess cash-flows right now.

The jump has taken everybody by surprise, and will almost certainly be short-lived since the price spike has its origins in Chinese policies designed to curtail excess steel and coal production and to improve air quality.

At over $250/ton for coking coal (was $90/t at end June) few Chinese steel producers are making any money, and the possibilities of them being able to pass these prices on by way of higher steel prices are limited as well.

What I’m saying is that at some point this is all going to come unstuck.

Sonic Healthcare (SHL) had a solid end to the week after announcing the e120m acquisition of German laboratory group Staber.

The best thing about this acquisition is that in spite of its small size, it will be earnings accretive by as much as 3-4% in the first year.

SHL is a bona fide Australian equity rock-star, and continues to look great value for the medium term.

Fairfax (FXJ) and REA Group (REA) had a torrid week again this week after FXJ disclosed that its Domain online real-estate business had been impacted by the weaker trend in property listings in recent months.

FXJ is down 20% and REA is down nearly 30% from its highs, and though better value than before, I can’t see any reason to want to prematurely expose myself to the softening property market.

We have flagged REA as being an ‘at risk’ stock for much of 2016, and it is finally coming home to roost.

I would flag very strongly that the next stock on this list you should be wary of is Medibank (MPL).

Following the disclosure from hospital-provider Healthscope (HSO) a fortnight ago that hospital admissions and case-mix had been softer than expected, it gives me huge reason to question the ability of health insurance companies able to continue forcing through 5%-type annual premium increases.

The government is working to reduce healthcare inefficiencies by reducing unnecessary procedures, which in turn reduces claims experience for the health insurance industry.

Given the government similarly wants to encourage greater private health cover, it seems incongruous to expect Medibank (MPL) and the like to be able to profit from higher premiums at a time when they are paying out less in claims.

A clampdown on premiums is coming and it won’t be pretty.

I think MPL will be low $2’s by end of 2017.

Magellan Financial Group (MFG) showed its class again this week by announcing another whopping month of fund inflows. MFG took in $550m of new funds in October and disclosed that in the first week of November they had already received a further $786m in committed funds.

This is miles ahead of analyst forecasts.

Mark my words we will be buyers of this stock soon.

The company is on fire and has come back to trade just over a market multiple on P/E terms.

We love the trend for offshore investment, and we love the way Magellan go about their business.

The clock is ticking and post the US election result I feel convinced we will be adding this name to portfolios.

Finally, a word on the banks …

ANZ (ANZ) & National Australia Bank (NAB) both reported full year profit figures this week that were kinda OK.

NAB managed to hold net interest margins stable, and its internal capital generation was also surprisingly good which allowed the bank to hold its 99c final dividend – a good result.

We would however expect NAB to cut its dividend during 2017 to reflect the increasing capital pressures being experienced across the sector.

ANZ figures were OK, but lacked any revenue growth and for choice saw a decline in provisions for bad loans (lower buffer for future coverage) and an uptick in impaired loans, the latter two being potential issues for future profitability.

Both ANZ and NAB are doing good things internally under new CEO’s, and ANZ’s decision this week to sell off its sub-scale Asian wealth management unit is further evidence of this.

ANZ further confirmed it was reviewing its ownership of its Australian life and wealth business, and could look to offload this in the coming 6-12 months too.

The trouble however for the banks is that there is simply no growth in lending volumes, the regulators are forcing them to hold more capital and most importantly, the housing cycle has peaked.

Interestingly Genworth Australia (GMA), who are Australia’s leading mortgage insurance provider, disclosed a reasonably significant deterioration in mortgage delinquencies across key Western Australian and Queensland markets.

The slowdown in resource-focused population centres is having a notable uptick in mortgage delinquencies in those two states, and this is most likely to impact Commonwealth Bank (CBA) given its Bankwest ownership, and Bank of Queensland (BOQ) and Suncorp (SUN) given their QLD focus.

Let’s leave it at that.

Have a terrific weekend folks.

All Ordinaries5267-94-1.8%
S&P / ASX 2005185-90-1.7%
Property Trust Index1311+13+1.0%
Utilities Index7083+84+1.2%
Financials Index5754-179-3.0%
Materials Index9069+11+0.1%
Energy Index7961-218-2.7%


Key Dates: Australian Companies

Mon 7th November                AGM: Dominos Pizza (DMP) Earnings: Westpac Bank (WBC)  Div-Ex Date: Freedom Foods (FNP), Harvey Norman (HVN)

Tue 8th November                 AGM: Newcrest (NCM), REA Group (REA) Earnings: Dulux (DLX) Div Ex-Date: Macquarie Group (MQG)  Trading Update: Commonwealth Bank (CBA)

Wed 9th November                AGM: Flight Centre (FLT), Fortescue (FMG), Medibank (MPL), Commonwealth Bank (CBA), Ramsay Healthcare (RHC), Seven West Media (SWM) Div Ex-Date:   RESMED (RMD)

Thu 10th November              AGM: Treasury Wine (TWE), Wesfarmers (WES)

Fri 11th November                 AGM: Lend Lease (LLC)Div Ex-Date: WBCHB


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