Securities mentioned this week

• Pendal (PDL), Westpac (WBC), National Australia Bank (NAB)

Key market themes

Trade tensions >

• A positive week with both sides confirming that progress is being made on a ‘phase one’ trade deal and that any deal is likely to see tariffs on the products associated rolled back.
• This does not infer a wider repeal of the over US$550bn worth of Chinese imports currently being tariffed nor the US$185bn in goods China has tariffed in retaliation, but is a small step in the right direction towards detente

Economic data released

Australian October Australian Industry Group service sector activity rebounded to an 11-month high, and lending support to our argument that the Australian economy is in the process of bottoming out.

The headline ‘sales’ sub-index jumped to its highest level since June 2018 indicating a renewed uptick in general service sector activity.

US job opening data continues to ease with September openings falling to an 18-month low and indicating that the US has reached peak employment with the unemployment rate near its 50-year low of 3.6%

Observations from the past week

Westpac (WBC) posted disappointing earnings for 2019 and gave soft guidance that things were unlikely to get any better in 2020 or even 2021.

• Analysts now expect earnings to decline modestly in the coming 2 years as the burden of higher expenses bristle against the secular erosion of core profitability with collapsing local interest rates.
• WBC cut its 2H dividend to 80c and the company also announced a surprise $2.5bn capital raising at $25.32 which bolsters its tier 1 capital to 11.25%.
• Like the rest of the sector, WBC looks challenged by falling interest rates and the prospect of further earnings deterioration the longer Australian interest rates remain this low.
• Already year-to-date the major bank earnings estimates for 2020 have fallen by -12% to -15%.

National Australia (NAB) results weren’t as disappointing as their peer group in large part because the bank benefited from improved lending with its business and corporate bank alongside strong cost controls.

• However, in the medium-term analysts have concerns that the NAB are drawing to the end of their cost-cutting program which leaves future earnings vulnerable to ongoing net interest margin deterioration with record low interest rates.
• NAB’s tier 1 capital position looks a touch on the light side however this could be in part redressed by the proposed sale of the MLC wealth management business in the coming 12 months.

Pendal (PDL) shares have bounced +12% thus far this week after having reported FY19 profits that were largely in-line with analyst forecasts.

• Whilst the profit figures were far from spectacular, we were encouraged by PDL’s confirmation that fund flows had become to improve in the last few months.
• Our view on PDL has been that it was just an incredibly cheap stock and with the potential for a turnaround in earnings momentum as and when several of its larger equity strategies begin to outperform their respective benchmarks.
• We believe investors would do well to look back at Magellan (MFG) only 3 years ago and how PDL are now arguably in a similar position with indifferent performance, but the potential for significant earnings momentum as and when that changes.
• Even after the substantial share price bounce PDL still screens cheap on only 15x earnings with zero performance fee revenues forecast, but with almost 15% of its market value held in cash or invested in its own funds.
• PDL will continue higher we believe but were encouraged by the recent strength.

What’s interesting?

We have made much of our belief that Australia’s economy is set to bottom out before Christmas and that by early 2020 activity will be on the improve.

With that in mind we were encouraged to see the first visible green shoots of recovery emerge in the local economy last month as evidenced by the bounce in the Australian Industry Group service sector reading to an 11-month high, and the sales component jumping to its highest level since June of 2018. The combination of interest rate cuts and rebounding housing markets, the rising share-market and current and prospective income tax cuts should be making Australian households feel increasingly flush. We think the data is set to turn and we believe good exposures for Australian portfolio’s including small company exposures, housing and construction plays such as Boral (BLD) and Reliance Worldwide (RWC) and consumer travel group Webjet (WEB).

Australian Service Sector Sales activity rebounded to near 18-month high last month

Looking ahead

• Monday – AU ANZ Job Advertisements (Oct),
• Tuesday – AU NAB Business Confidence (Oct), US NFIB Small Business Confidence (Oct)
• Wednesday – AU Westpac Consumer Confidence (Oct), AU Wage Price Index (Q3)
• Thursday – AU Employment (Oct)
• Friday – US Empire Manufacturing (Nov)

This week investors will look towards the latest Australian consumer and business confidence figures, whilst we will be paying close attention to Afterpay’s (APT) trading statement due on Wednesday.

Regards,
Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Securities mentioned this week

• ANZ Bank (ANZ), Afterpay (APT), Pendal (PDL)

Key market themes

Trade tensions

• The US and China continue to progress towards completion of ‘phase one’ of their trade deal and both sides have made soothing remarks as indication to the milestones achieved
• Remarks out of unnamed officials in China did surface last week that indicated however that the Chinese side felt less inclined to be so confident insofar as to striking a longer-term arrangement that would encompass issues of government subsidies and enforcement of intellectual property rights
• For now, it would seem likely that both sides have a vested interest to progress ‘phase one’ (largely Chinese agricultural purchases), but that markets should feel less certain of further agreement, particularly as we draw closer to the next scheduled tariff hike in mid-December

U.S. Politics

• The closer we draw to the initial Democrat primaries in early February, the more likely domestic US politics will begin to have a bearing on financial markets and individual stocks and sectors exposed to potential legislative change
• We flagged up our caution for 2020 on this front several weeks ago, specifically highlighting the surging poll numbers for Senator Elizabeth Warren in the race for the Democratic nomination
• Warren is a left-leaning, consumer advocate with keynote policies on Medicare-for-all, a wealth tax’ and regulation of large monopolies in technology and the financial system
• Last week celebrated hedge fund investor Paul Tudor Jones was quoted as saying that US equity markets would fall -25% if Senator Warren was elected President in November 2020

Economic data released

Australian September Building Approvals bounced +7.6% month on month, which we think has the potential to be encouraging.

Continued high auction clearance rates will lead to a strong national house price rebound in the months to come and this will be substantial tailwind for consumer activity in 2020.

US employment gains remained strong in October with a further 130,000 jobs added and a 3.6% unemployment rate The US Federal Reserve cut interest rates to 1.50% as expected last week, but signalled that the economy was in a sound position and unlikely to need further adjustment lower in the near term

Observations from the past week

ANZ Bank (ANZ) shares fell over -6% last week after the company reported disappointing FY2019 profit figures that included a surprise reduction in the level of franking on its final dividend.

• Falling interest margins caused cash profits to miss analyst estimates by -3-5% and the lack of Australian profitability meant the company could not fully frank its second half dividend (franked at 70% only)
• Since the start of the year ANZ profit estimates have fallen by over -12% and it is hard to see the trend changing any time soon, particularly with the impact of falling RBA cash rates yet to be fully reflected in group earnings (the bank hedges interest rates ahead of time meaning that it can protect profits for a limited period of time through hedge gains).
• Investors should expect a further 12 months of bank earnings disappointment and the potential for additional dividend cuts in 2020 and 2021 as low interest rates erode the domestic business model.
• We remain significantly underweight Australian banks in our recommended portfolios.

Afterpay (APT) shares have fallen over $10 from a high above $37 mid way through October to be near $27 today and we believe there is increasing merit in adding to positions around these levels.

• Whilst the UBS research report that called APT a SELL last month has many merits, we believe the ongoing operational momentum within APT will continue to outperform broker forecasts and that the next news-flow from the company will likely be very strong.
• Google trend’s points to exceptionally strong search engine activity for APT in the United States, which augers well for activity on the platform over the high-volume Thanksgiving and Christmas sales period in that country.
• APT will hold their AGM next week on the 13th of November and its quite likely the company could further update the market on recent operational performance.

Pendal (PDL) will report full year 2019 profit on Wednesday and whilst we know the year has been a weak one from the group, we are hopeful that the company can provide grounds for greater optimism looking into 2020.

• The valuation on the group is increasingly undemanding at 13x current earnings, alongside a net cash balance sheet and 7% partially franked annual dividend yield.
• Any sign that core UK, European and Global equity franchises are beginning to outperform their benchmarks and PDL shares will be quickly +10-15% higher.

What’s interesting?

Whilst far from comprehensive, the bounce in Chinese manufacturing activity over the last quarter – by one measure at least – gives markets reason to speculate that after 18 months of industrial weakness brought on by the trade war, China’s manufacturing sector could finally be stabilising.

The Caixin survey released on Friday saw the headline manufacturing index rise to its highest level since early 2017, and the new order sub-index jumped to its best level since as far back as 2013. It is hard to get to carried away as indicators on activity remain well down, but in recent months there has definitely been a stabilization in monetary aggregates (M2 remains in the low 8% annual growth rate range) and in annual electricity production (an excellent guide on real activity). Our portfolios are overweight emerging markets and have suffered modestly on account of this in 2019, but we are hopeful that if signs improve on the economic front in China, investment performance from several of our key funds should similarly improve.

China October Caixin Manufacturing rebounding

Looking ahead

• Monday – AU ANZ Job Advertisements (Oct), AU Retail Sales (Sep), Westpac (WBC) earnings
• Tuesday – AU Australian Industry Group Service sector activity (Oct), CBA Service sector activity (Oct), RBA Meeting, US Markit Service sector PMI (Oct), US JOLT Job Openings (Sep), US ISM Service sector activity (Oct)
• Wednesday –Pendal (PDL) FY19 earnings, Boral (BLD) AGM
• Thursday – AU Australian Industry Group Construction sector activity (Oct), AU Trade Balance (Sep), National Australia Bank (NAB) earnings, BHP (BHP) AGM
• Friday – AU RBA Statement on Monetary Policy, AU Home loans (Sep), US Michigan Consumer Sentiment (Nov)

This week our focus will be on the new economic data out from October, both locally and abroad, but also the Pendal (PDL) earnings numbers due Wednesday, the Boral (BLD) AGM statements on Wednesday. Both Westpac (WBC) and National Australia Bank (NAB) will report full-year earnings this week, but we think the outcomes here will mirror those of ANZ (ANZ) last week and likely disappoint investors.

Regards,
Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Securities mentioned this week

• Costa Group (CGC), Woolworths (WOW)

Key market themes

Trade tensions

• Markets seem comfortable with the progress being made towards a ‘phase one’ deal between China and the U.S, which both sides hope will be able to be signed and sealed by Trump and Xi on the sideline to the APEC summit in Chile in mid-November
• The deal largely addresses agricultural trade which benefits both sides, particularly the Chinese, who are being faced with skyrocketing pork prices as stocks across Asia have been decimated by the African swine fever
• China have agreed to buy US$40-50bn of US primary exports assuming the US continues to withhold the mid-October tariff rise, however, plans for the December US tariff hike remain unknown

Economic data released

• Australian September skilled vacancies fell again last month, taking the 12mth fall to -7% annually and marking the 9^th straight month of declines.
• US manufacturing in October has definitely flattened out, with the Richmond Fed manufacturing survey bouncing and the provisional US Manufacturing PMI similarly posting a small gain

Observations from the past week

Costa Group (CGC) shares were suspended last week pending an update to FY2019 earnings guidance.

• A likely earnings downgrade is sure to come, which will be its 4^th in the space of 12 months, and its more likely than not, that CGC will seek to repair its balance sheet by way of equity raising.
• CGC earnings forecasts have fallen well over -20% in the past year, impacted by a variety of issues across both its local and African operations, but the group do have excellent greenfield growth ahead of them in the coming years given heavy investment since their 2015 IPO.
• Having risen 4x-fold since its 2015 IPO to reach a share price peak above $8 during 2018, its highly likely that the impending news from CGC will see the stock back under $3.00.
• Depending on the content of the outlook and the size of any raising, we might finally take a serious look at investing in the company for significant long term upside.

Woolworths (WOW) shares continue to defy gravity, trading at near enough to their all-time high as investors continue to place a ridiculously high premium on the stock for its perceived earnings certainty.

• The shares are almost certain to see downside in 2020 as the group de-merge the Endeavour Drinks business from the wider WOW group – WOW shares currently trade on an eye-wateringly high 26x future earnings and a 65% premium to the local market.
• The P/E of 26x makes the stock as highly valued as it was in the lead-up to the GFC and is far from justified given its barely single digit earnings growth nor <3% dividend yield.
• As investors recognize that the $10bn demerger of Endeavour Drinks will surely see Endeavour trading on at best a mid-to-high-teens P/E multiple given the maturity of its business its and exposure to hotels and gaming, that will leave the remaining WOW supermarket operation on near 30x earnings for precious little underlying growth.
• WOW shares look incredibly overvalued at current levels and shareholders would do well to take advantage and SELL them here.

What’s interesting?

Australian national auction clearance rates have rebounded back to be in the 75% range, not far off their peak recorded during the house price boom of 2015-2017.

Whilst current volume is significantly lower than in that period, the rising clearance rate augers well for rising house prices and with that, a turn in domestic construction markets.

The chart below shows the national auction clearance rate in RED and the national house price index in WHITE and suggests we should again expect to see house price growth push back up through +10% annualized in the 2H of 2019.

We remain optimistic that Australia’s economy will improve as we enter 2020 and that it will be led by, at first, a stabilization in building activity and then a bounce in residential construction volumes.

We do believe Boral (BLD) will significantly benefit from the improvement and hold it as a key equity position.

Auction Clearance Rates lead house prices

Looking ahead

• Tuesday – US Dallas Fed Manufacturing survey (Oct), US Consumer Confidence (Oct)
• Wednesday – AU CPI (Q3), US ADP Employment (Oct), US GDP (Q3), US FOMC Meeting
• Thursday – AU ANZ Bank (ANZ) FY19 results, AU Building Approvals (Sep), AU Private Sector Credit (Sep), US Employment Cost Index (Sep), US Chicago Fed PMI (Oct)
• Friday – AU Macquarie Bank (MQG) 1H FY20 results, AU AIG Manufacturing survey (Oct), AU CBA Manufacturing survey (Oct), US Employment (Oct)

Beyond ANZ and MQG’s results this week locally, markets will focus on results in the US from Alphabet (GOOG) tonight and then Apple (AAPL) and Facebook (FB) on Wednesday night.

Next week Westpac (WBC) will report on Monday, Pendal (PDL) on Wednesday, NAB (NAB) on Thursday and AMCOR (AMC) on Friday.

Regards,

Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Securities mentioned this week

• Nufarm (NUF), Downer (DOW), Westpac (WBC), BWX (BWX)

Key market themes

Slowing global growth >

• U.S. Manufacturing sector activity fell to a 10-year low and U.S. Service sector activity fell to a 3-year low last week, causing rightful concern that the 18-month long trade war between China and the U.S. had finally begun to bite on U.S. business confidence.

Trade tensions >

• China’s Vice Premier Liu He will return for the next round of talks this Thursday in the U.S. but press reports over the weekend suggest the Chinese will not be willing to discuss changes to China’s policy of government subsidies to the private economy nor reforms to their treatment of intellectual property.
• This would indicate a hardening in China’s negotiating position, perhaps feeling emboldened by President Trump’s domestic pressures.
• Given the tariff war was kicked off precisely because of the United States’ perceived injustice at these two key Chinese policies, this is hardly an encouraging sign.
• Both countries need a win, but it seems like any win of substance that sees the Chinese take a backward step on the Made in China 2025 or the U.S. removing tariffs already implemented is as far off as it has been.
• Given that it is the uncertainty surrounding tariff policy that has rattled global business confidence and industrial demand, it seems any interim deal that fails to address this issue, will similarly fail to bolster the rapidly waning global business outlook.

Economic data released

Australian Building Approvals for August showed little sign of recovery, falling month on month in absolute terms for both new houses and apartments.

• Building Approvals remain down -20% annually, and though we feel confident these numbers will begin to look prettier by early 2020, the lack of liquidity in the local economy remains a major factor.
• Last month’s bank lending for owner occupiers showed its slowest annual rate of growth since 2013, rising at just over +4.5%.

Private Sector credit for August rose at its slowest annual rate since 2011 and Australian broad money growth collapsed back to near its lowest level since the 1990’s recession also.

• Private sector credit grew at +2.9% and Australian M3 money supply a measly +1.9% in the 12 months to August, highlighting that even in spite of the multiple interest rate cuts, domestic money supply remains significantly constrained.

Observations from the past week

Australian Banks came under heavy selling pressure last week following the RBA’s decision to further cut interest rates to a record low of 0.75%.

It would seem a given that domestic rates fall again, perhaps before year end, to 0.50%.

Remember of course that the RBA is cutting domestic interest rates in large part to avoid any unnecessary upward pressure on the Australian Dollar, but that it is rapidly losing firepower, particularly as it seems increasingly likely that the U.S. Federal Reserve could be forced into a more aggressive rate-cutting cycle than it currently indicates.

Though all of the major banks failed to pass the full RBA rate cut, bank profitability is being rapidly eroded both by lower rates, but also by the increasing exodus of consumer deposits from banks as households chase higher returns elsewhere.

Australian retail bank business models are premised on cheap deposit funding from households and with collapsing domestic rates, profit margins are being hit on both the asset and liability side.

Only as interest rate hedges begin to roll off in the coming 2-3 years will we see the real impact on bank profitability, but as we have highlighted before, the top-rated analysts on the sector are looking for future earnings declines and future dividend cuts from Australia’s major banks.

We remain significantly underweight in our recommended weighting to Australian major banks.

Looking ahead

• Monday – AU Australian Industry Group Construction survey (Sep)
• Tuesday – AU ANZ Job Advertisements (Sep), AU NAB Business Confidence (Sep), U.S. NFIB Small Business Confidence (Sep)
• Wednesday – AU Westpac Consumer Confidence (Sep), U.S. Job Openings (Aug)
• Thursday – U.S. Federal Reserve meeting minutes, U.S. CPI (Sep)
• Friday –U.S. Michigan Consumer Confidence (Oct)

Regards, Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Securities mentioned this week

• IOOF (IFL), Challenger (CGF), Afterpay (APT), Boral (BLD), BHP (BHP), Rio Tinto (RIO)

Key market themes

Trade tensions >

• It was a quiet week on the trade front albeit the Chinese government have said they would expect the US to roll back existing tariffs for them to be able to commit to the type of agricultural buying quantities President Trump had alluded to at last week’s supposed agreement.
• This issue will again likely escalate as we get closer to the next planned tariff implementation date by the United States, being the 15^th of December 2019.

Economic data released

Australian September employment figures remained surprisingly strong, with 26,200 new full-time jobs created and an unemployment rate of 5.2%.

The data continues to defy the weakness seen in job advertising – skilled vacancies are -6% on last year and the wider ANZ job advertisement figures are down -11% on 2018.

Early October manufacturing data in the US seems to have stabilised with the Empire (New York) manufacturing sentiment bouncing modestly this month

Chinese Q3 GDP grew at an annualised rate of 6% which is the lowest figure since the data series started nearly 30 years ago in 1992.

China’s economy continues to soften as the impact of US tariff’s on US$360bn of Chinese exports to the US weighs, though we would expect to see continued, measured fiscal and monetary stimulus afforded by authorities to mitigate the significant slowing.

US housing sector trends remain positive with the October NAHB Housing Market Index jumping again in October and just shy of the record optimism we saw in the sector back at the start of 2018.

Falling mortgage interest rates continue to generate strong homebuilding activity and September Housing Starts and Building Permits rare up +12% and +8% on the previous year respectively.

Observations from the past week

IOOF (IFL) confirmed our expectations and announced last week that they were set to complete the ANZ Wealth transaction and at discounted price.

• Having announced the planned acquisition of ANZ Wealth for $975m as far back as November 2017, the two groups finally confirmed the transaction would go ahead last week, and at a nicely discounted price of $825m.
• IFL’s shares jumped +18% on the week and the stock is now up over 40% for the year-to-date.
• We think the shares will settle above $8+ before the year ends now that the corporate uncertainty is beginning to lift.
• In a highly fragmented industry where the landscape is awash with the opportunity to consolidate and rationalize cost, we think 11x 2021 earnings is simply way too cheap for a company with the industry positioning and strength of cashflows that IFL has.
• This stock will continue higher in the years ahead.

Challenger (CGF) reported a resilient first quarter in the face of falling interest rates and the stock bounced accordingly.

• The stock bounced over +10% last week after surprising investors with strong net annuity sales growth in the Q1, albeit via the lower margin wholesale channel and via higher risk guaranteed income products.
• The company re-affirmed their 2020 normalized net profit target of $500-550m.
• The market response demonstrates that investor expectations are very low for CGF and that should we see an improvement in the domestic retail channel as the post-Royal Commission advice disruption settles, then CGF shares can go a lot higher.

Afterpay (APT) shares were one of the worst performers during the week, falling -17% after UBS initiated coverage of the stock with a contrarian SELL rating.

• The prevailing issue raised in the report was APT’s ‘no surcharge’ clause which prevents merchants from passing on the cost of APT’s platform back to the consumer in a manner such as that done by the likes of Mastercard, American Express and Visa.
• The suggestion being that if merchants were in the position to do this, potentially the Afterpay platform might lose its appeal with customers.
• The RBA announced last week it would conduct a review into the ‘buy now, pay later’ sector to determine whether retailers required help recovering the costs.
• We think its quite likely that this issue will prove to be as impactful on APT as investor fears were over the Senate and ACCC reviews of predatory lending and the more recent AUSTRAC investigation of APT over money laundering issues.
• Our recommended positions on APT have been significantly reduced in recent months as we felt the stock was beginning to price in much of the blue-sky opportunity, however we remain committed to the long-term growth story and retain a recommended holding.
• Weakness like that seen last week opens up the opportunity in time to potentially add to holdings again.

Boral (BLD) was the subject of M&A chatter during the week with The Australian publishing an article suggesting US private equity giant, Lone Star, could be considering a bid for the company.

• The stock bounced modestly but not with the vigour that might imply investors thought a bid was soon to arrive.
• That said, BLD’s business is widely disparate and has the makings of a break-up for any financial or corporate bidder willing to undertake the task.
• We think the underlying demand picture for US residential construction is strong and that expectations on BLD earnings are now quite low, which makes us feel like the risk/reward offered by BLD shares at current levels under $5 look particularly attractive.

What’s interesting?

We note, with some modest trepidation, that though the Australian share-market is +18% year-to-date and within 3% of its high, that the Australian mining sector has not only foregone its sector leadership, but in fact underperformed quite materially over the last 3 months.

As the chart below shows, the Australian mining sector does a very good job of pre-empting the performance of the wider market.

As the leading edge of the market in a cyclical earnings sense, investor appetite for miners tends to offer an early look at future risk appetite across the wider market.

In red is the ‘relative’ performance of the Australian material sector against the ASX200 benchmark, and the white line is the ASX200 share price index lagged by 6 weeks.

The underperformance of Australian miners since Q2 seems set to presage consolidation in the wider market in the weeks and months ahead.

The slowing Chinese economy is the main culprit for recent weakening in iron ore prices from their July highs at $110/ton to todays level at a touch over $80/ton.

BHP (BHP) and Rio Tinto (RIO) share prices have underperformed the market by almost -20% since their peak in April, although Fortescue (FMG) has fared marginally better.

Mining sector relative performance (in red) regularly leads the wider ASX200 index (in white)

Looking ahead

• Monday – N/A
• Tuesday – N/A
• Wednesday – AU US Richmond Fed manufacturing (Oct)
• Thursday – AU CBA Manufacturing & Service sector PMI’s (Oct), US Markit Manufacturing & Service sector PMI’s (Oct)
• Friday – US Michigan Consumer sentiment (Oct)

Major corporate results in the US this week will come from Microsoft (MSFT) and Amazon (AMZN), and then the following week will see Apple (AAPL), Google (GOOG) and Facebook (FB) all report.

In Australia, the major banks and Pendal (PDL) will report September year end results in 2-3 weeks.

Regards,

Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Securities mentioned this week

• Pendal (PDL), Australian major banks

Key market themes

Slowing global growth >

• U.S. Small Business Confidence eased back to be just above a 3-year low last month, and within the release hiring and employee compensation plans also stumbled.
• The U.S jobs market has definitely peaked with job opening numbers also falling last month, and now at an 18-month low

Trade tensions

• It was hard to miss the headlines from Friday night that signaled the prospect of a near-term truce between the U.S and China on trade, but the reality is far less encouraging
• Yes, China has agreed to purchase $40-50bn of agricultural product from the U.S, and yes, the U.S have agreed not to increase tariffs in mid-October, but beyond that, the headlines made far less compelling reading
• No progress has been made on U.S concerns for Chinese intellectual property theft nor on their desire to halt Chinese subsidies to major state-owned groups and nor does there seem to be much hope of progress in the near future
• The tariff hikes slated for October and again mid-December could still be brought into play should the U.S perceive that China is dragging their feet on any number of issues, and that simply means that the pall of uncertainty that has been cast over the global economy, and specifically business capex intentions, has yet to lift

Economic data released

• Australian NAB Business Confidence figures lolled around at a 5-year low last month
• Australian Westpac Consumer Confidence collapsed to a 4-year low last month, with households concerned on future family finances

Observations from the past week

Pendal (PDL) on Friday posted another disappointing quarter of fund-flows from both its domestic (ex-Westpac) franchise and from its growth engine, global equity fund manager, J O Hambro.

• The September quarter marked the 8^th in a row of outflow and we would note that much of the J O Hambro funds continue to trade under their high watermark, and hence are ineligible for performance fees.
• Analysts cut earnings back between 0% and 5%.
• We weren’t surprised by the release and acknowledge that much of J O Hambro’s core European and global equity franchise continues to trail their peer group on recent year performance.
• However, we believe that PDL is now being valued with scant expectation for a turnaround in their fund performance, meaning that any improvements have the ability to positively surprise in a highly meaningful way.
• We would remind investors that only 2 years ago, investors were questioning Magellan’s (MFG) global equity performance and lauding that of the J O Hambro stable of funds, and that it was PDL trading on the premium rating and MFG on the discounted multiple.
• On 12.5x earnings with significant net cash and investments ($200-300m) on its balance sheet, we think PDL is a bargain.
• The 7% dividend yield (partially franked) should offer support on the stock at current levels.

This morning the Federal Treasurer tasked the competition authority to investigate the major banks and their inability to pass on the full 0.75% of RBA rate cuts made in the past 12 months.

• The major banks passed on approximately 0.57% of the 3x 0.25% cuts.
• Whilst we don’t think this inquiry will yield any major headlines of collusion nor fines of any substance, we do think this again highlights the business and regulatory pressure the sector remains under and that any easing in recent scrutiny is still some time off.
• Three of the four major banks (excluding Commonwealth) will report full year profit figures in the coming month, with ANZ (ANZ) kicking things off on the 30^th October and Westpac (WBC) and NAB (NAB) following suit in the following 10 days.
• Earnings are unlikely to be anything but downbeat and we think, as is widely expected, that WBC will cut its annual dividend from $1.88 per share to around $1.60 or $1.70.
• Our recommended Australian bank weightings are around 50% of their current ASX200 index weights.

Observations from the past week

Falling U.S. interest rates are having the desired effect on U.S housing markets with last month posting a spike in both building permits and housing starts to their highest level since pre-GFC (see chart below).

U.S. average 30-year mortgage rates have fallen from 4.7% to 3.7% in the last year and this has seen a wave refinancing and new purchase activity which has fueled domestic consumption and new housing activity.

Core portfolio holdings in Boral (BLD) and Reliance Worldwide (RWC) should benefit from the rising activity with both groups making around 60% of their total earnings from North American construction markets.

RWC has bounced well after its recent downgrade, but we feel BLD has significant upside potential as there remains a major mismatch between company targets for their disappointing Headwaters fly-ash acquisition and market estimates.

U.S. Housing Markets strengthening – building permits (white) and housing starts (red) at their highest level since the GFC

Looking ahead

• Monday – N/A
• Tuesday – AU RBA Meeting minutes, US Empire Manufacturing (Oct)
• Wednesday – AU Westpac Leading Index (Sep), US Retail Sales (Sep), NAHB Housing Index (Oct)
• Thursday – AU Employment (Sep), US Building Permits/Housing Starts (Sep), Philadelphia Fed Business Outlook (Oct)
• Friday – N/A

U.S. Q3 corporate reporting commences in volume this week with many of the major banks due to report (Goldman Sachs, Citigroup, Wells Fargo, Bank of America) and industrial (Honeywell, CSX) and technology (Netflix, IBM, Microsoft) companies also.

Next week and the week after sees results from the major U.S technology platforms Alphabet, Amazon, Facebook and Apple.

Regards,

Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

Portfolio Objective

To achieve capital growth with moderate tax-effective income via franked dividends through investment in listed Australian securities.

The Model Portfolio is managed by selecting primarily those securities with moderate growth potential but robust cash-generating capacity. These securities are expected to deliver an above-market average income yield, together with a relatively moderate level of capital growth. The portfolio benchmark is the S&P/ASX200 Accumulation Index.

Portfolio Commentary & Positioning

Global equity markets were weaker in August as represented by the MSCI World Index which fell -2.2%.

Volatility was again the flavour of the month with the Volatility Index (VIX) rising to its highest level since January.

US equities dropped -1.8% as the US imposed 10% tariffs on the remaining $300bn of imports from China. Fears of a recession rose as the yield curve on 2 and 10-year Treasury notes inverted for the first time since 2007.

China was weaker falling -1.6% as the ongoing Trade War continues to negatively impact business sentiment. China responded to the US by halting purchases of US agricultural products.

UK equities were heavily hit falling -5% as UK PM Boris Johnson shut down Parliament in an attempt to block MPs from blocking a no-deal Brexit.

Locally, the ASX200 Accumulation Index was weaker, falling -2.4% as corporate earnings season got into full swing.

The RBA left the cash rate unchanged at 1% instead opting to wait for the Federal Reserve to meet next month before taking action.

Australian bond yields tightened further with 10-year Government bonds yielding 0.88% at August 31.

Oil was weaker during August with Brent oil falling -8% and WTI falling -5% to trade $59/barrel and $55/barrel respectively. Oil prices have now fallen -20% since a 2019 peak in April, hit by concerns the Trade War would erode demand.

The iron ore price experienced its biggest monthly drop in eight years falling -28% to US$86/tonne as shipments increased to China sparking supply pressures.

Contributors to performance were BWX (BWX) and Afterpay (APT) which added 50% and 16% respectively. Both companies reported full-year results to the market with BWX guiding to 30% EBITDA growth in 2020 whilst also relaunching its Mineral Fusion brand. Afterpay continues to grow reporting underlying sales figures of $5.2bn whilst adding 12,500 new customers per day, far exceeding analyst expectations.

Detractors were Boral (BLD) which fell -18% and IOOF (IFL) which fell -13%. Boral posted disappointing 2020 guidance flagging a -5% to -15% fall in earnings and its fly-ash acquisition Headwaters also missed earnings estimates. Whilst disappointing BLD trades on 11x earnings and generates ~$500m in free cash flow per annum so we believe it remains cheap at these levels. IFLs total funds under management reached $150bn so despite the selloff we believe business activity remains strong. The next catalyst for IFL will be an update on Federal Court proceedings and the ANZ OnePath deal.

The Growth SMA reduced BWX, added to IFL, exited our position in VAS and established a new position in Webjet (WEB) in August. The Diversified Income, Defensive Income and International Growth SMAs went unchanged. On a risk profile performance basis our 5-year numbers continue to perform well against their respective benchmarks.

RISK PROFILE PERFORMANCE FIGURES
As at 31 August 2019
Pre-Franking Credits

SMA—MODEL PORTFOLIO PERFORMANCE FIGURES
As at 31 August 2019
Pre-Franking Credits

What is a Separately Managed Account (SMA)?

What’s the benefit of a Separately Managed Account (SMA) to a Managed Fund?

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.

Securities mentioned this week

• Nufarm (NUF), Downer (DOW), Westpac (WBC), BWX (BWX)

Key market themes

Slowing global growth

Little to add from last week as data was mixed – some softening in US consumer confidence, but little else to report

Trade tensions

China’s Vice Premier Liu He is reported as planning to visit the United States for the next round of trade talks next week on October 10^th.

Over the weekend the Trump Administration floated the idea that they could enforce restrictions on portfolio investment flows by US firms into China and potentially even restrict access to US capital markets for Chinese-controlled entities.

Whilst any imposition of such restrictions was said to be a long way off, the suggestion was enough to cause a significant scare to investors who marked down the share price of major NASDAQ-listed Chinese stocks on Friday night – Alibaba (BABA) was down -5% as an example.

DE-RISKING (a new theme)

We’d highlight increasing evidence of local investors reducing share-market risk and how we have begun to similarly move to higher cash holdings after the ASX200’s stellar year-to-date rise

In the past fortnight we have reduced exposures to Westpac (WBC) and BWX (BWX) after their strong respective rises.

We fear WBC is likely to cut its dividend come results in November, and in the case of BWX, the share price has doubled in under 2 months.

Beyond our own moves, it is worth noting that recent market high flyers such as Clinuvel (CUV), Appen (APX), Pro-Medicus (PME) and Nearmap (NEA) are down some -30% to -40% in barely a few months and on no news – indicative of a market in which investors are locking in speculative gains.

Economic data released

Chinese September manufacturing data was flat on last month with little worth mentioning.

Australian Private Sector credit for August rose at its slowest annual rate since 2011 and Australian broad money growth collapsed back to near its lowest level since the 1990’s recession also.

Private sector credit grew at +2.9% and Australian M3 money supply a measly +1.9% in the 12 months to August, highlighting that even in spite of the multiple interest rate cuts, domestic money supply remains significantly constrained.

Observations from the past week

Nufarm (NUF) this morning positively surprised the market with a left-field announcement it had sold its profitable Latin American crop protection business to major shareholder Sumitomo Chemical for almost $1.2bn.

• As I type, the shares are +27% having opened +50% higher initially.
• Understandably the news is extremely positive in that it alleviates NUF’s balance sheet issue in one fell swoop, but also that it involves the sale of a major business unit on roughly 2x the multiple the wider group had been previously trading on in market.
• Whilst there are swings and roundabouts in terms of the impact on NUF going forward, the significantly de-geared nature of the business following this sale trump’s any earnings dilution felt, particularly since investors will soon begin focusing on the potential earnings growth from NUF’s omega-3 infused canola seed that today the company confirmed would begin contributing to profit in 2021.
• The shares today stand at around 10-11x forward earnings, but on an infinitely healthier balance sheet and with material prospect for improving earnings from its seed’s operation and from the recent European patent acquisitions made in 2018.

Downer (DOW) was in the press last week with suggestions it could put the Spotless Laundries business up for sale.

• Considering that it is widely expected to sell its contract mining business in the coming year, the additional sale of Spotless Laundries could take the potential total asset sale proceeds for DOW to well over $1bn and a likely share buyback of substance.
• We think momentum in DOW remains strong and that the stock is well placed to push towards $9 in the coming year.

What’s interesting?

All investors should be paying close attention to US Presidential election issues even in spite of the fact the election itself is not until November next year.

This is because its impact will be felt in markets well before then, and likely as early Q1 2020 when the initial Democrat caucuses commence (Iowa is February 3^rd and New Hampshire a week later).

The reason we are focused on the Democrats is because two of the leading candidates to face off against President Trump, Senators Elizabeth Warren and Bernie Sanders, support policy in favour of greater government regulation, expanded national healthcare, free college tuition and higher taxes on wealthy individuals.

With an economy and share-market hugely attuned and linked to low regulation and the significant corporate profitability this has engendered, any prospect that either of Senator Warren or Sanders could usurp President Trump will be extremely closely monitored by investors.

In fact, the surge by Elizabeth Warren in the polls over the past few months, should have investors paying attention (see the chart below from Predictit.org) as a Warren presidency would likely cause not only a significant share-market fall, but potentially even a medium term sell off in government bond markets as well.

Senator Warren is running on a platform that promises to levy a 2% ‘wealth tax’ on those whose net worth is over US$50m and to spend these funds on providing free college tuition and a concept, as yet undefined, of nationalized healthcare.

She is a fierce consumer advocate and a supporter of increased corporate regulation and is also promising to provide increased distance between vested interests (corporate lobbyists) and US policymaking.

U.S. Democratic Candidate ‘market movements’ – Warren surging ahead of Biden

Looking ahead

• Monday – AU Private Sector Credit (Aug), CH Manufacturing & Non-Manufacturing PMI (Sep), US MNI Chicago PMI (Sep)
• Tuesday – AU Australian Industry Group Manufacturing survey (Sep), AU CBA Manufacturing survey (Sep), AU Building Approvals (Aug), AU RBA Meeting, US ISM (Sep)
• Wednesday – US ADP Employment (Sep)
• Thursday – AU Australian Industry Group Services survey (Sep), AU CBA Services survey, AU Trade Balance (Aug), US Markit Services PMI (Sep)
• Friday – AU Retail Sales (Aug), US Employment (Sep)

Regards, Jono

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.