Weekly Market Update – 11 October 2021

Markets flat amid increased volatility

Global equity markets fell slightly last week. The MSCI World Index fell -0.1% in AUD terms and was driven lower by a stronger AUD (+0.7%).

Volatility was once again the flavour of the week with risk as represented by the VIX (volatility index) climbing sharply on Monday before trailing off throughout the rest of the week.

Primary factors behind the movement in volatility were concerns over the US debt ceiling and the possibility of a default, the outage that impacted Facebook and Instagram and further gains in the oil price (+4%) that continue to raise upside inflationary risks.

Fears over a US default on its debt ceiling eased somewhat throughout the back half of the week with equities rallying after Republicans agreed to increase Treasury’s borrowing capacity by almost USD$500b in the US Senate. This enables the Federal Government to meet payment obligations through to December.

Momentum in markets shifted again on Friday with September’s US jobs report disappointing. The US economy created 194,000 jobs, less than half the 500,000-consensus forecast. The overall unemployment rate dropped to 4.8%, but with nearly 200,000 people ceasing to look for work this was a clear ‘miss’.

We believe the weak jobs report may drive the Federal Reserve to delay the planned tapering of its asset purchases from November to December. Looking ahead, Q3 corporate earnings kick off this week with the major banks all set to release profit numbers.

Locally, the RBA kept its weekly bond purchasing program in place at $4b and left rates unchanged. The RBA governor has predicted that the Australian economy could return to its pre-Delta growth trajectory next year. If this was to occur, the timeline of an interest rate hike would likely be brought forward.

Interestingly, the Reserve Bank of New Zealand became the second major bank (after Norway) to raise rates last week. The move serves to combat rising inflation and cool an overheating housing market.

APRA lifts mortgage serviceability buffer

The Australian Prudential Regulation Authority (APRA) announced it will increase the mortgage serviceability buffer by +0.5% to 3% in total.

The buffer which is used to assess loans is expected to reduce the maximum borrowing capacity for the average borrower by around 5%.

In opting to raise the buffer compared to the serviceability floor, we believe APRA is targeting a small pool of more-leveraged investors rather than owner occupiers. With owner occupier credit growth currently 4x higher than that of investor credit growth we believe the changes will have little impact on credit growth.

Without a material change in credit growth, we do not see elevated risks for a slowing in house price momentum and given less than 10% of borrowers typically borrow at their full capacity we expect the changes will have little impact on borrowing capacity.

We think APRA’s changes will have little impact on the banks and currently retain our overweight position in Westpac Bank (WBC) and our market-weight position in Commonwealth Bank (CBA).

Constructing a Quality portfolio

We construct the PRIME Australian Equity Growth SMA adopting a ‘Quality at a Reasonable Price’ methodology.

We define quality not through the lens of a single metric but rather as a holistic concept. In answering the question of what quality is, we are interested in understanding:

1. Earnings Quality. Good earnings quality means the ability to deliver consistency of earnings through the cycle. Operating margins need to be sustainable indicating the ability to grow over the long term whilst the composition of earnings must also show the ability to grow organically, not just through M&A.

The business must also be able to consistently deliver and generate positive free cash flows from earnings. A signal of deteriorating/high accruals tells us less cash flow equals more risk.

Finally, the representation of business earnings is critical. We look at the magnitude and frequency of non-recurring items to determine whether one-offs are driving performance. Changes in earnings quality provide insight into the future trends in earnings momentum and we prefer ‘consistent’ earners over ‘one-offs’.

2. Balance Sheet Quality. We prefer a strong Balance Sheet. For industrial companies Net Debt/EBITDA <2.5x and banks capital position must be ‘unquestionably strong’ relative to regulatory capital requirements. A strong balance sheet provides optionality to execute.

3. Returns Quality. We prefer a high returning business. This ensures that benefits of growth create value for shareholders and returns are a form of the business’s earnings ‘quality check’. The golden rule is to avoid companies where returns are unsustainable.

4. Industry Quality. This means a large potential market opportunity and growing industry. Industry returns, market share, barriers to entry and regulatory environments are all indicators of industry quality.

5. ESG Quality. Industry leaders need to be leaders in ESG (Environmental, Social and Governance). Corporate Governance ensures that benefits flow to shareholders/stakeholders not management.

6. Valuation Quality – Quality at a Reasonable Price (QARP) valuation is fair to good when there is a margin of safety. We utilise a combination of measurement tools including capitalisation models, discount cash flow models and sum-of-the-parts models.

To measure quality, we use multiple sources of data: Annual reports, independent company reports, broker reports, independent industry analysis and proprietary PRIME Financial Group company research reports for each portfolio stock and watchlist stock.

ASX Weekly Wrap

The ASX200 outperformed last week rising +1.9% and posted its first weekly gain since the beginning of September.

Large caps anchored the market climbing +2%, whilst mid-caps rallied +1.6% and small caps +1.2%.

Having spent much of the past three months writing about the remarkable gains in the iron ore price and the impact this was having on a weekly basis to the mining sector, attention has now fully shifted to the energy sector. The sustained increase in the price of oil continues to see energy stocks re-rate higher.

Energy stocks climbed +4.6% last week (+20% since the end of August) on the back of +4% gains in the price of oil. Brent Crude is currently trading at 82/barrel whilst WTI is likewise closing in on the $80/barrel level.

Importantly for oil stocks, OPEC+ continues to ratify only slow and gradual increases to production and last week’s 400,000 barrel per day supply hike was evident of this. Oil, natural gas and coal stocks continue to surge from this rally.

Health care stocks were the weakest part of the market last week falling -0.1%. The sector was dragged lower by medical supplier Fisher & Paykel (FPH) which fell -5.9%. Despite announcing it new Evora Full sleep apnoea mask, a broker released a note claiming shares remain elevated at current levels.

Perhaps that segment of the market was unexplainably weaker last week as respiratory care and sleep apnoea provider ResMed (RMD) also fell close to -4% on little news.

We continue to view the landscape for health care stocks favourably in the current market believing their defensive characteristics are more likely to generate alpha in a market that is looking more full from a valuation perspective than it has in the past year and a half.

Current preferences in the health care space remain CSL (CSL), Healius (HLS) and Ramsay Healthcare (RHC).

The best performing stock in the PRIME Australian Growth SMA last week was recent new addition Bega Cheese (BGA) which rallied +7.4%, closely followed by Santos (STO) which added +6% on the back of oil and gas price strength.

BGA was consistently stronger every day last week rising over 1% on four out of the five trading days. An analyst note suggesting it could make strategic sense for BGA to acquire Fonterra Australia (FSF) in an effort to extract synergies and buy back its naming rights was behind the share price momentum.

Other developments in the portfolio last week included the ACCC investigation into QUB’s $90m acquisition of the Newcastle Agri Terminal. The ACCC concerns relate to the vertically integrated position that QUB will hold in the supply chain for delivery of bulk grain to the Port of Newcastle, and the potential for QUB to engage in anti-competitive bundling of storage, handling, and transport with terminal services.

Given the size of the acquisition relative to QUB’s market capitalisation ($6.2b) we consider this to be largely immaterial.

The $6b CBA off-market buy-back completed last week. The final buy-back discount was announced at 14% and participants were scaled back by around 80% as expected. Despite the strong demand, investors in pension phase generated around a +13% return inclusive of franking credits which we viewed favourably.

Looking ahead

Monday 11th October 2021 – Friday 15th October 2021

  • Monday: N/A
  • Tuesday: AU NAB Business Confidence (SEP), UK Unemployment Rate (AUG)
  • Wednesday: CN Balance of Trade (SEP), UK Balance of Trade (AUG), US Inflation rate (SEP)
  • Thursday: AU Westpac Consumer Confidence (OCT), Unemployment Rate (SEP), CN Inflation Rate (SEP)
  • Friday: US Retail Sales (SEP)

Friday 8th October, 5pm values

 IndexChange%
All Ordinaries 7617 +130 +1.7%
S&P / ASX 200 7320 +134 +1.9%
Property Trust Index 1590 +17 +1.1%
Utilities Index 6258 +177 +2.9%
Financials Index 6790 +216 +3.3%
Materials Index 14909 +292 +2.0%

Friday 8th October, closing values

 IndexChange%
U.S. S&P 500 4391 +34 +0.8%
London’s FTSE 7096 +69 +1.0%
Japan’s Nikkei 28049 -722 -2.5%
Hang Seng 24838 +262 +1.1%
China’s Shanghai 3592 +24 +0.7%

Key dividends

Monday 11th October 2021 – Friday 15th October 2021

  • Monday: Div Pay-Date – Orora Limited (ORA)
  • Tuesday: Div Pay Date – Chorus Limited (CNU)
  • Wednesday: Div Pay-Date – BlueScope Steel Limited (BSL), News Corporation (NWS)
  • Thursday: Div Pay-Date – Brambles Limited (BXB)
  • Friday: Div Ex-Date – Harvey Norman Holdings Limited (HVN)
    Div Pay-Date – Qualitas Real Estate Income Fund (QRI)

Contact

Mark Johnson – Chairman of Investment Committee(03) 8825 4738
Guy Silbert – Investment Manager(03) 8825 4750

If you would like to discuss your situation, please speak to your adviser or email clientservices@primefinancial.com.au

Mark JohnsonT: (03) 8825 4738Cameron MorcherT: (03) 8825 4737
Livio Caiolfa T: (03) 8825 4748Michelle BromleyT: (03) 8825 4751
Marcus AingerT: (02) 9134 6292Nicole LewisT: (03) 8825 4734
Dylan CresswellT: (03) 8825 4707Nicholas Miller T: (03) 8825 4722
Jarrod Rodda T: (03) 8825 4729Gina McIntoshT: (07) 3557 2557

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 (www.primefinancial.com.au/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.

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