Weekly Market Update (Issue 536) – 22 Feb 2019
The ASX200 is up a little more than 1% again this week, and believe it or not, its within 3% of its highs seen back in September last year.
ASX200 +9% year-to-date, but underlying business conditions worsening
At the headline level optimism prevails, but under the surface, the foundations for this rally are becoming progressively weaker.
A multitude of large companies spoke this week of the subdued or worsening consumer environment domestically, notably Woolworths (WOW), Coles (COL), Flight Centre (FLT) and Crown Resorts (CWN).
All of these stocks saw net analyst downgrades to forecast earnings numbers, as did BHP (BHP) which still managed to reach a 5-year share price high, and Wesfarmers (WES) whose stock bounced strongly on announcing its intention to return $1bn of capital to shareholders.
Beyond the consumer sector, QUBE (QUB) posted excellent first half profits, but failed to upgrade full-year guidance because of the subdued trade outlook (container volumes notably, and motor-vehicle imports specifically).
Bingo (BIN) was smashed after cutting earnings forecasts for 2019 on account of the impact of slower construction on their demolitions and collections business.
Net earnings forecasts are falling.
More well known and regarded commentators are now openly discussing the prospect of an Australian recession and the likely need for Australian interest rate cuts, including Gerard Minack (former Morgan Stanley economist/strategist), Brett Gillespie (Ellerston), Bill Evans (Westpac’s senior economist, Bill is now calling for 2 x 0.25% rate cuts in Q4 2019) and Shane Oliver (AMP).
Personally, I think it is inevitable to think we expect interest rate cuts, and if the RBA are serious about hedging against the emerging deterioration, they should move in larger size (in other words, by 0.50%) and in faster time than most expect.
Employment trends at peak – expect to worsen
Forget the strong employment figures reported this week, employment trends are worsening, with ANZ Job Advertisement figures falling -3.7% year-on-year and the Federal Government’s own Department of Employment and Workplace Relations leading indicator of employment reaching a 7-year low this month.
We should expect to see the Australian unemployment rate weaken back to the 5.5% to 6% range by the end of 2019 from its current level of 5%.
The deteriorating employment backdrop will prove negative for wages and negative for economic activity, and have ramifications across the board for equity markets, but particularly Australian bank and consumer shares.
A dose of reality, but a gilt-edged opportunity
The slowing economic backdrop should be a cause for concern.
Household indebtedness is a huge factor and falling household wealth on account of house price falls will continue to bite deeper into consumer spending.
Australian savings ratio’s have already fallen to 10-year lows, and require economic growth to replenish, let alone sustain current economic activity.
The Federal Election is surely a handicap to near term business spending, and should Labor prevail, a future negative for domestic asset values.
Banks seem highly unlikely to loosen the credit purse strings anytime soon, which then begs the question – what saves the day for us, and helps Australia avoid its first technical recession in 30 years?
Sadly, I can’t see the panacea.
However, the positive news is that Australian share prices are within 3% of a 10-year high.
Australian banking shares are +10% off their lows, ANZ (ANZ) is even +20% from its low.
On top of that, Australian shares relative to their offshore peer group have largely matched performance in the past 12 months.
So despite the increasingly cloudy domestic economic backdrop, large swathes of Australian’s retirement portfolios are actually performing reasonably well and yet to see the impact from our rolling slowdown.
But they will, and this is precisely why, right now, is an acutely good time to be making changes to your portfolio if indeed you are concerned about the dual-risks of a slowing Australian economy and a future Labor Government on your retirement portfolio.
This is as good an opportunity as any, to diversify away from Australian franked income, be that to domestic, unfranked income sources, or in the growth component of your portfolio, to international equity exposures (we favour Asia and both long/short or value strategies offered by the likes of Platinum, VGI Partners, Orbis and Antipodes).
Even more than this, this is a terrific time to raise cash levels again.
Corporate Results update – the fast money round…
- We were thrilled with the +20% jump in the IOOF (IFL) share price. Results were OK, with some margin pressure in the fund administration business, but the driver of the share price was IFL’s remark that they had yet to see reason for a significant revision higher in remediation charges. We think IFL can reach $7 ahead of the late June vote by custodians of ANZ’s Onepath business as to the sale of that business to IFL. Famous last words, but we think IFL is through the worst.
- Another rebound from a poor performer is the +30% rise in BWX (BWX) Just like IFL, BWX had been way oversold, so some of this bounce corrects that. It would seem the core brands are tracking in line with growth expectations, inventory has normalized and the ridiculous operational performance under previous management has largely been excised. BWX at $2.10 trades on no more than 10x the annualized low end of their current guidance, which makes me think that continued delivery to plan sees this stock back above $3.00 by the end of 2019.
- Woolworths (WOW), Wesfarmers (WES) and Coles (COL) all saw net downgrades, but WES shares are up +5% on the week, whilst COL is -10% and WOW is -5%. WES promised a $1bn capital return, and Bunnings posted a still impressive +4% like-for-like sales growth, but in the end WES will certainly see earnings risks emerge in 2019 as housing’s downturn bites on the DIY market.
- WES are however in the enviable position of having as much as $10bn in balance sheet firepower with which to make acquisitions, at a time when the value and prospects of many businesses are set to weaken. Both COL and WOW face pressures in their core supermarkets business from potential trading down (see Costa Group’s weak sales figures on high-end fruits such as avocado and berries) and from wage costs, whilst their discount department businesses are right in the line of fire from an embattled consumer. Both stocks ought go to lower and are far from cheap.
- BHP (BHP) went up despite the weaker profit figure and the falling iron ore price this week. The stock reached a 7-year high here this week, and now looks much more fairly valued against a long-term iron ore price of US$65/t to US$70/t. It’s hard to expect much more from BHP or RIO near term I feel.
- QUBE (QUB) – good figures but no upgrade to guidance because the group flagged a softening in container volume expectations (in other words a slowing economy). We have loved QUB and still think it’s a wonderful business, but at $2.85+ it does feel very fully valued in the current economy.
Next week and the week after (important) …
Afterpay (APT), SEEK (SEK) and Costa Group (CGC) all report next week.
On Friday it is the deadline for a China/U.S. trade deal, though most now expect that timeline to pass by way of extension.
I would see that as a negative.
The following week please note that we get Australia’s Q4 GDP figure.
Ordinarily I wouldn’t pay much attention to such a backward-looking figure, however I expect it to be a negative headline, and to catalyze calls for a domestic rate cut and a likely significant fall in the Australian Dollar.
Watch this space.
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