Weekly Market Update (Issue 496) – 27th April, 2018
27th April 2018, 2.00pm
It was an interesting week, in which all our long-term investment themes continued to play out like slow-rolling lava.
Rising bond yields, ongoing Australian Bank sector underperformance, a falling Australian Dollar and with that outperformance by foreign equity markets, were all notable in their impact this week.
Australia’s economic outlook looking less assured
U.S 10-year bond yields pushed up through 3.00% during the week, their equal highest level since 2011.
Much has been made of the slow grind higher in global bond yields, but perhaps this week what was noticeable was the outperformance of Australian bond markets, which has seen the nominal spread or carry on Australian risk-free assets fall to its lowest level since the late 1990’s.
The reason for the outperformance, and the collapse in spread differentials is simply down to the relative growth arguments for each of the two economies, and the market’s increasing observation that Australia’s 12-month outlook is darkening by the day in the wake of the recent Banking sector Royal Commission.
To recap, Australia’s household indebtedness has long been highlighted as the sword of Damocles, perilously hanging over what has been an otherwise robust economic progression. In the past 12 months, banks have significantly reined in credit to housing investors and the government has necessarily tightened foreign ownership restrictions.
Housing finance has slowed to a trickle, and taken the steam out of 4+ years of house price inflation.
Australian Banks go lower
But what has worsened the outlook, and made several well-regarded economists now fearful of an imminent domestic credit crunch, are the likely measures to be forced on bank lending departments in the wake of this year’s Royal Commission.
In simple terms, many loans have been issued in recent years, into an ever-inflating local housing market, that otherwise would never have been made had the banks followed more closely the Responsible Lending terms outlined in the National Credit Act. The rules will soon be more strictly applied, effectively constricting credit into an already weakening market.
The sins of the past now look set to be born on the present, and there is every likelihood that we see a more rapid decline in Australian house prices as we head into the Spring selling season.
Having spoken at length for 18 months now on Australian housing and its risk to Australian banks, it sadly feels like it is all coming home to roost, and arguably in a worse fashion than I had previously felt.
The rug is being pulled out from under the Australian bank sector, and is best typified by the downgrade on Westpac Bank (WBC) to SELL on Thursday by Australia’s top-rated bank sector analyst Jonathan Mott at UBS, even in spite of the fact the stock was already sitting at a 5-year low.
He is no mug.
It might feel hard selling Australian mortgage banks here now on their lows and ahead of some dividend respite next month, but I can assure you these shares are unlikely to do anything but underperform over the coming 6-12 months as earnings pressures bite from the litany of headwinds facing them.
Next week we get ANZ (ANZ), National Australia (NAB) & Macquarie Bank (MQG) results, followed by Westpac (WBC) and Commonwealth (CBA) the following week, and it won’t be pretty reading.
Our preference remains for MQG, but we freely admit it is looking fully priced up here.
Bank Hybrid space continues to look a little sketchy
For all the reasons cited above we would again highlight the need to be ‘appropriately’ positioned in Australian bank hybrid securities, and by that I mean to ensure you don’t rely on hybrids as the majority of your portfolio’s defensive asset allocation.
We have made remarks in recent years, and notably last month again in the wake of Labor’s proposed tax changes to imputation credits, that bank hybrid securities looked less and less attractive as a source of defensive income.
Our discretionarily managed portfolios have reduced bank hybrid securities down to ~20% of all defensive positions, which means under 10% of a typical balanced portfolio.
Healthscope (HSO) – some positive news
We were pleasantly surprised, but not euphoric, of the reports confirming an unsolicited indicative bid by private equity players for HSO this week.
The bid is entirely opportunistic (cheeky frankly) and low-balled, but strategically clever given the woes HSO has faced in recent years.
At $2.36, the indicative bid is well below our assessment of intrinsic value ($3.00+ in 2yrs), but such is the market’s impatience with HSO and the combined strength of the bidding group, that a deal will likely be done in the $2.50 range.
For the time being please hold onto your hats. A deal will surely be done, and at a level above the initial level pitched.
Aged Care sector could benefit from renewed interest
As an aside, I wouldn’t be surprised to see the aged care space catch a small bid on account of this HSO interest simply because it seems apparent part of the attraction in HSO to private equity is the securitization of its significant property holdings.
We have been long-suffering in Regis Healthcare (REG), but would note that it and the sector have significant property exposures that have the potential to be realized.
Oil continues to push higher, and could keep climbing in the short term
We have been impressed by the ongoing climb in global oil prices this past 12mths, and the outperformance of our oil bets Oil Search (OSH) and Woodside (WPL). That said, both OSH and WPL have lagged their peer group frustratingly, hobbled by a loss of production associated with the PNG earthquake in the case of OSH, and by the surprise $2.5bn rights issue announced by WPL.
The jump in oil prices however seems set to continue, with the French President suggesting President Trump was likely to walk away from the Iran nuclear deal, which would likely impact Iranian oil exports to the tune of 500,000 barrels a day. Coupled with ongoing hostilities in the region (Saudi Arabia and Yemen/Qatar), it seems like oil might just hold in their longer, and it is our hope that this continues to push OSH and WPL further toward our target prices for both (10%+ higher).
Incidentally on oil, Australian national retail prices for petrol this week jumped to their highest level in 4 years, further sticking the boot into domestic Australian household budgets!
Snippets from the week
IOOF (IFL) reported quarterly fund flows to their investment management and platform divisions, and encouragingly in the face of all the Royal Commission headlines, it is business as usual for them.
There is no doubt that IFL will bear some impact from the RC findings – it would be impossible to think not – but the group have confirmed they are indemnified by ANZ on any issues emerging from within the ANZ planning business they recently purchased.
In the low $9’s it looks great buying for the medium-term, yield conscious investor.
The L1 Capital Long/Short fund (LSF) listed this week.
Vocus Group (VOC) announced it was shelving plans for the sale of its NZ business, and instead seeking to renegotiate covenants over its not inconsiderable debt.
Though the failure to attract a decent bid is moderately disappointing, we like the decision to pull the sale process and reject the unsatisfactory bids. The stock fell -5% on the news, but has rallied over +10% in the interim, and we think this price action is highly demonstrative that the investor base is now warming to the potential underlying value in VOC under $2.30.
I would again encourage you to take a look at the stock and add it to local Australian portfolio’s.
Lastly, we trimmed positions in both APN Outdoor (APO) and Macquarie Group (MQG) in our discretionary Australian equity accounts this week with a view to raising weights again at lower levels.
Jono & Guy
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Australian Market Index
Friday 10am values
|S&P / ASX 200||5911||+30||+0.5|
|Property Trust Index||1328||+15||+1.1|
Key Dates: Australian Companies
|Mon April 30rd||N/A|
|Tue May 1st||Results – ANZ (ANZ)|
|Wed May 2nd||N/A|
|Thu May 3rd||Results – National Australia (NAB)|
|Fri May 4th||Results – Macquarie Bank (MQG)|
International Market Index
Thursday Closing Values
|U.S. S&P 500||2667||-26||-1.0|
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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.