Australian Market Summary (Issue 429) – 9 December 2016

Don’t believe the hype.

This is important.

This week Australia’s S&P200 is up another 2%, and mortgage banks are leading the charge.

Our market continues to be fueled by optimism surrounding the new US President, and a US share-market that once again this week made new highs.

But the optimism is misplaced.

Australia is not the United States, and nor is its economy remotely positioned for anything like the positive momentum global investors seem to expect from life under a Trump presidency.

This rally in Australian banks and miners has a finite life.

The upswing in Australian shares, and banks notably, since Trump was elected President in early November has everything to do with investor positioning and very little to do with Australian economic growth nor corporate profitability.

Simply put, the outlook for Australia’s economy in the coming 12 months is about as fragile as I can remember.

Consider the following:

  • This week Australian GDP for the September Quarter fell -0.5%, making it only the 4th negative quarterly growth in 25-years. Annual growth of +1.8% is at its lowest rate in 7 years.
  • October Building Approvals fell -25% year-on-year
  • Monthly Approvals for Apartments has HALVED since July, and in absolute numbers are at a 2-year low
  • Monthly Approvals for Private House construction have fallen to their lowest level in THREE YEARS
  • Last week the major banks raised fixed-rate mortgages and investment mortgages, the latter by 0.60% – this is a whopping rise for investors, and is relevant when you consider investor loans make up 40% of all housing finance

Think this through.

Growth is already slow, but the one engine of growth, construction, is now slowly being asphyxiated by tighter credit conditions.

Australia’s ability to switch growth from mining to construction in recent years is the single reason our economy has managed to remain buoyant.

But future construction activity is now rolling over.

Excess supply in certain CBD apartment markets, credit-rationing by banks, higher funding costs for borrowers and more broadly, issues of affordability given skyrocketing house prices and faltering wage growth are all responsible for the deterioration in building approvals.

Australia’s economy needs a new catalyst in the same way markets have perceived Trump’s policies as a breath of fresh air for the US economy.

Sadly, there is little in the offing.

Australia’s politicians have been so focused on a specious tit-for-tat argument about whom is responsible for the rise in Australian government debt that the narrative in support of increased government spending is still 12 months or more away.

It’s ridiculous.

The likely downgrade to Australia’s AAA sovereign credit rating early in the new year will only further serve to ensure any agenda reliant on increased government infrastructure spending for instance, is kicked deeper into the long grass.

Falling momentum in construction and a stubbornly high Australian Dollar necessitate that the next move by the RBA will still be LOWER, but the trouble here is that it’s really unlikely to further stimulate domestic demand.

As every bank tells you, it’s not the cost of debt that is holding back corporate lending.

Furthermore, cuts to interest rates will only serve to reduce investment income for the 15% of Australian’s aged 65yo and over.

So what else picks up the slack?

The export account? I doubt it.

Though there has been a surprise resurgence in ferrous metal prices in 2016, I have to say the prospect for continued coal and iron ore price strength seems awfully slight to me. Much of this year’s commodity strength can be attributed to Chinese production restrictions, many of which are now being reversed such has been the impact on coal prices in particular.

So we lack a catalyst or stimulus.

In spite of record low interest rates, a significant household wealth effect from rising house prices, and the benefits of a 30% fall in the Australian Dollar over the last 3 years, Australia’s economy still can’t get off the canvas.

I repeat, September quarter GDP was +1.8% and the lowest pace of growth in 7 years.

Australia’s economy has SHED 75,000 full time jobs, adding only 130,000 in the 10 months to the end of October 2016.

The economy is spluttering, and now it seems the one engine of growth (construction) is beginning to stall.

What makes matters worse is that households have gorged on debt, and debt-to-income levels are now at 135% or TWICE WHAT THEY WERE IN 2000.

The chart below is hugely informative.

Where the GFC caused American households to de-risk and save, Australian households gorged on cheap debt.

The green line is Australia’s Household Debt-to-GDP ratio, and the red line is the United States equivalent.

It’s a bracing chart.


So what to do?

Having been cautious for much of the last 6 months on markets, or non-plussed is perhaps a better description, we are turning incrementally more negative.

The outlook for Australia’s economy in 2017 is poor.

We fully expect interest rates to remain on hold or lower in 2017, and we expect Australia’s currency to fall into the mid-60’s.

We feel mortgage bank share prices are fully-valued here (CBA at $80, ANZ & NAB at $29+ and WBC at $32) and we think the impact of rising funding costs will crimp profitability and bring pressure on household cash-flows.

House prices will plateau and ease during 2017 as banks ration credit and issues around serviceability of debt increase.

We continue to advocate for higher than normal cash weights, increased offshore equity exposure by way of international fund managers and domestic companies exposed to a falling AUD.

Our expectation for slowing growth and low rates domestically means that we still see excellent reason for holding Telstra (TLS) and Transurban (TCL).

A chart pack to consider

For those of you interested in further words and pictures on the topic above, the link below will take you to some presentation material I have recently spoken to.

Hopefully it makes sense and as they say, a picture tells a thousand words.

The week just gone

As I alluded to earlier, the big news in Australia should have been the weaker than expected GDP figure, but in fact the euphoric buying of global equities that continued this week swamped any potential pessimism around domestic growth.

That will change, so for now we would argue that this is a rally to be sold.

The RBA meeting shed little light on future interest rate moves, and Australia’s credit markets still forecast NO CHANGE in the 1.50% cash rate in 2017.

However, we feel by early Q1 the softening in construction activity will again see the RBA shift to an easing bias.

In stock news, the oil sector saw some restructuring news out of both SANTOS (STO) and Origin (ORG) this week, but neither impressed me materially.

Both ORG and STO are burdened by excessive debt, and though both companies this week conceded they would consider asset sales of upstream assets (ORG by way of IPO, STO by trade sale), the prospect of making material inroads into their debt (in ORG’s case $13bn) remains remote.

Though we continue to expect a progressively improving oil price, the likelihood remains that STO and ORG will be forced to tap equity markets again in 2017 to shore up balance sheets.

The Aged Care sector saw some much-needed respite this week as reports emerged that the government might water down some of the proposed cuts to Aged Care funding.

Japara Healthcare (JHC) led all-comers, rising 16% on the week and Regis Healthcare (REG) bounced a helpful 7%.

We concede we made an error in our BUY recommendation on REG north of $5.00, but feel the quality of assets and balance sheet are such that our investment will be readily recovered, just not as immediately as we had hoped. This weeks news offer some faint light at the end of the tunnel that aged-care operators like REG and JHC will be less harshly impacted by the changes to complex care payments, and hence able to eek out some modest earnings growth as the ACFI changes hit in 2017.

Next Week is the last Market Update for 2016

Next week will be the last update for 2016, and the comments from Guy and myself will resume on Friday 13th January.

I will put pen to paper on my formal thoughts for 2017 in the coming month, but hopefully my remarks above on the economy already give you a strong guide to my thinking.

It is time to become more conservative.

Have a great weekend

All Ordinaries5610+66+1.2%
S&P / ASX 2005556+70+1.3%
Property Trust Index1342+50+3.9%
Utilities Index7533+236+3.2%
Financials Index6406+120+1.9%
Materials Index9933+321+3.3%
Energy Index8970-91-1.0%

Key Dates: Australian Companies

Mon 12th December     N/A

Tue 13th December      Div Ex Date: AMPPA, ORGHA, WBCPF Div Pay Date: Incitec (IPL), National Australia Bank (NAB)

Wed 14th December     AGM: Dulux (DLX) Div Ex Date: NABPC, WBCPE Div Pay Date: CWNHA, CWNHB, Macquarie Bank (MQG), Graincorp (GNC)

Thu 15th December      Div Ex Date: G8 Education (GEM) Div Pay Date: ANZPA, CBAPC, CBAPD, CBAPE, RESMED (RMD)

Fri 16th December       AGM: ANZ (ANZ), BT Investment Management (BTT), National Australia Bank (NAB), Incitec (IPL) Div Pay Date: Betashares High-Interest ETF (AAA), ANZ (ANZ)

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