Weekly Market Update (Issue 495) – 20th April 2018

20th April 2018, 2.00pm

This was an important week for markets and investors, and I hope everyone takes 5-minutes out of their day to quickly read through my simple thoughts.

The week was important for two simple reasons:

  • firstly, real interest rates continue to rise and this week reached their highest level since 2010;
  • Second, the Australian financial sector (dominated by the big-4 banks) traded to a 6-year low against the broader ASX200.

‘So what’, you say?

Well, these two observations provide wonderful long-term context for Australian investors and their portfolio composition.

Rising Interest Rates – stealing equity market oxygen

On rising nominal and real interest rates, investors should be aware that since all asset classes trade relative to one another, a rising ‘risk-free’ rate simply makes all other asset classes increasingly less attractive.

In a nutshell, if you can invest profitably with less risk, why would you do anything else?

This week, US 5-year inflation adjusted bond returns jumped up to their highest rate since 2010. US government 5-year bond yields which drive this return jumped through 2.75% and US 10-year bond yields pushed up to 2.91%

Economic strength is one driver of higher rates for sure, but so too is the recent surge in US treasury issuance to pay for Trump’s massive tax plan. On top of that, our primary concern remains the progressive withdrawal of liquidity by the US Federal Reserve, which will only escalate as the year drags on.

In simple supply/demand parlance, the supply of US liquidity is being tightened by the US Federal Reserve whilst at the same time the demand for that liquidity in the very near term is escalating because the US Federal Government are issuing all this debt to pay for the tax cuts.

This remains a primary concern of ours, as it has been for well over 6 months. The constriction of money supply growth is only likely to rise further, and it is precisely this point that is really acting to cap out the otherwise optimistic outlook for corporate earnings, the economy and ultimately the share-market.

Australian Banks, the Royal Commission & the impact of higher rates

This week saw the Australian financial sector plumb a 6-year low relative to the market. Banks and insurers have been sent into a tailspin by the ongoing Hayne Commission revelations, and it seems highly unlikely investors should expect respite anytime soon.

Some context around the significance of this if I may.

Australian banks still comprise far and away the largest part of Australian investment portfolios. By a mile.

Looking through our client holdings this week, the 4 largest Australian banks excluding Macquarie (MQG) still make up around 15% OF ALL INVESTMENTS, which is a whopping 5x the recommended bank weight in our model portfolios. So even in spite of our ongoing pessimism towards Australian banks for the better part of 5 years, the evidence seems to suggest that we haven’t nearly had the success we would have liked in getting portfolio’s more diversified away from their reliance on old-school habits.

The reason I am harping on this again, is put simply, things remain pretty grim if you’re an Australian banker.

There is virtually no loan growth in residential lending at the moment because of the tightening in APRA regulations around investment lending and margins are being squeezed by rising funding costs (see my points above about rising interest rates).

The Bank of Queensland (BOQ) this week demonstrated precisely this in its results reported this week and analysts were forced to downgrade earnings by around 5-6%, and that in spite of reasonably benign credit quality (a good thing).

More worrisome is the future earnings outlook, which has taken a turn for the worse following the recent Royal Commission testimonials from the banks. It seems entirely reasonable to expect that bank lending will FURTHER TIGHTEN in the coming 12 months as regulators and legislators force the industry to adhere more closely to the Responsible Lending laws outlined in the National Credit Act.

It is about to get EVEN HARDER to get a loan folks, and if that’s the case, then Australian house prices are only going further south.

This matters for the future direction of the economy and bank share prices since so much of our recent national wealth accumulation has come from a debt-financed house price boom.

It is starting to get a little gnarly, and yet we already at a 6-year sector low against the market.

There is no time like the present, so once again I would implore everybody to consider these words in the context of their portfolio and to work out a plan with the help of your advisor. Waiting things out hasn’t worked for the last 6 years, and it won’t in the coming six.

Our portfolio & market views in this context remain the same

In light of my remarks above I would stress the following, and all of these thoughts are completely current –

  1. The share-market upside remains capped by rising global interest rates, and volatility as per the February swoon is an ever increasing prospect
  2. We have shifted our TACTICAL ASSET ALLOCATIONS MORE CAUTIOUSLY on account of this and other factors
  3. Australian Banks remain in the dog-house, and investors should consider other forms of income if they are looking to deliver a total portfolio return (capital growth + income) that is competitive – we have made mention of MCP Master Income Trust (MXT), Latrobe Financial – 12mth Australian Credit Fund, IOOF (IFL) and BT Investment Management (BTT) as alternative income generators
  4. Even after 30% outperformance, MQG remains our preferred bank for the medium to long term, however it is looking rather fully priced in an absolute sense at $105, so we would prefer to be buying again nearer to $90-95
  5. Small & mid-cap stocks + international equity funds will deliver capital growth well in excess of Australian big-cap stocks, as they already have done so – international equity markets delivered over +10% more in returns in the 12 months to end March

Snippets for next week

The L1 Capital Long/Short (LSF) fund lists next Tuesday. We think this fund is a ripper, and no doubt in the lead up to its listing you will see some good press reported in the weekend papers.

Vocus (VOC) and  Afterpay (APT) and MHOR Australian Small Cap fund have to be up for consideration for any portfolio seeking capital growth over the coming few years.

Take my remarks about the share-market and banks above, and put the VOC, APT and MHOR remarks in their rightful context. VOC and APT I think have the ability to rise 30% or more in the coming 18 months, and in the case of MHOR, we value their abilities to pick small-cap stocks in a diversified fund and to contribute outperformance relative to not only the ASX200 but their own Small Ordinaries benchmark.

Jono & Guy

Interest Rate Commentary & Update

For full interest rate commentary and updates please click here

Term Deposit Rates

For to view the latest term deposit rates click here

Australian Market Index

Friday 10am values

IndexChange%
All Ordinaries 5976 +65 +1.1
S&P / ASX 200 5881 +65 +1.1
Property Trust Index 1313 +6 +0.5
Utilities Index 7391 +37 +0.5
Financials Index 6041 -58 -1.0
Materials Index 11933 +531 +4.7
Energy Index 10887 +289 +2.7


Key Dates: Australian Companies

Mon April 23rd  N/A
Tue April 24th  N/A
Wed April 25th  Anzac Day
Thu April 26th  N/A
Fri April 27th  Div Pay-Date – PRIME Financial Group (PFG)

International Market Index

Thursday Closing Values

IndexChange%
U.S. S&P 500 2693 +29 +1.1
London’s FTSE 7328 +70 +1.0
Japan Nikkie 22191 +531 +2.5
Hang Seng 30708 -123 -0.4
China Shanghai 3117 -63 -2.0

Financial Services Guide Update

Our Financial Services Guide has been updated, please click here to download the most recent version.

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.

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.

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