In a sign of the times in which we live, markets globally have swung from extreme greed in late September 2018, to extreme fear in December, and now back to knocking on the door of extreme greed again as recently as this week (CNN Fear & Greed index).
The ASX200 is up +8% year-to-date, and a surge of optimism overtook investors in recent days as the RBA Governor tempered his economic outlook, conceding the domestic interest rate policy to be ‘more evenly balanced’ than before.
Investors cheered the dovish remarks never mind the fact they were in large part motivated by a significant deceleration in domestic data over our summer – NAB Business Conditions and Australian Service sector activity collapsed to their lowest levels in 4-years.
Further grounds for investor optimism stemmed from the Banking Royal Commission where investors cheered the absence of major structural reforms or incremental penalties.
As a result, Australian shares led their global peers this week, rising +4%.
Weird huh, but don’t believe the hype.
This is the time to make some sales.
Rate cuts coming, but won’t push shares higher
Make no mistake, Australian interest rates will be cut in 2019 – in fact, I think there are grounds to go pre-Federal Election – but the cut to rates will be a rear-guard action designed to protect business confidence in the wake of construction weakness and political uncertainty associated with a likely Federal Labor Government.
On Friday the RBA themselves cut their FY2019 GDP forecast significantly from 3.25% to 2.5% (remember we are already 7mths into the year).
The rate cut will be welcome news, but it is the finger in the dyke, not the accelerant to the fire.
This surge in investor buying will all be in vain, as Australia’s domestic economic outlook is now firmly in rapid retreat and likely to lead to ongoing corporate profit downgrades as 2019 progresses.
Where we advocated for buying the dip in late October and again in December, we are now firmly of the mindset to be TAKING PROFITS in certain Australian equity positions after this phenomenal bounce back.
In fact, local investor optimism seems to be coming precisely before the housing slowdown truly impacts employment and certainly comes with little concern for the negative impact on local asset prices (in the near term at least) associated with a likely Labor Government.
It’s a little perplexing to be sure but remember too that we did start the year on a very negative footing, so this rebound might indeed be a similarly aggressive snap-back to counterbalance last year’s pessimism.
Either way, I fully expect the enthusiasm to peter out, and for those of you looking to build cash war-chests, now is the perfect time.
Miners – perfect opportunity to TAKE PROFIT
The tragic dam collapse in Brazil that has forced Brazilian iron ore major Vale (VALE5) to suspend shipments, helped Australian mining shares to reach record highs this week.
Rio Tinto (RIO) shares surged to a 10-year high above $90, and BHP (BHP) too rose to a 4-year high.
In response to Brazilian shipment issues, iron ore futures have spiked to over $90/ton from the low $70’s only a fortnight ago and a range of $65-70/ton during much of Q4 2018.
RIO is now +30% since early December, BHP is +20% and Fortescue (FMG) is +50%.
In both BHP and RIO’s instance, the stocks are now trading at or near long-term asset valuations and at around 14x a normalized profit which assumes iron ore prices returning to a long-term average of around $65/ton).
Since this recent commodity price spike is likely to be short-term in nature, and since we feel very convinced in the likely decline in Chinese steel production in 2019 and 2020 and the subsequent iron ore surplus that is set to emerge, it seems an ideal opportunity for those investors fortunate enough to have ridden these miners up, to book some profits.
The opportunity to TAKE PROFIT here is a good one.
Global Growth – European woes continue
We rarely speak of the economic situation in Europe in this column in large part because its rarely worth mentioning, however it was notable on Thursday night to see the European Commission slash their 2019 forecast for economic growth from 1.9% to 1.3%.
Notably, the EC dropped their assumption on Italian economic growth from 1.2% to 0.2% and on the UK from 1.7% to 1.2%.
These cuts are significant in size, but also of note given the enormity of Europe’s sovereign debt.
Without growth, debt won’t be repaid, and the prospect of an escalation in intra-European haggling over financing seems assured.
Overnight the French Ambassador to Italy was recalled, taking relations between Europe’s 2nd and 3rd biggest economies to their lowest ebb since WW2.
Whilst much of our focus has been on the trade war in recent months, the structural issues facing Europe remain enormous and it wouldn’t be a surprise to see a negative curve-ball emerge out of Europe in 2019.
Downer Group (DOW) – mixed results but remains a key holding
DOW results were a little light against forecasts as a couple of problem contracts hampered the group’s excellent exposure to Australia’s east coast infrastructure boom.
The Spotless acquisition missed earnings figures moderately, but cash conversion continues to improve, which is good news.
DOW has outperformed the market significantly in recent months, so perhaps it was due a pause, however we feel like the momentum remains strong for the group and on 14x earnings, it is far from expensive given end-markets remain so good for their key transport, rail and engineering assets.
Result dates for corporate earnings are filed in the table below, but we are particularly interested in results from AMCOR (AMC), Telstra (TLS) and Challenger (CGF).
It will be good to get an update from AMC on merger plans, but also to see if the fall in key polyethylene input prices had done a good job at counteracting continued volume softness in the group’s North American rigid plastics business.
On TLS, we think numbers will be sound and the market will continue to warm to an improving backdrop for the company.
I repeat the idea that TLS will outperform in 2019 and likely trade towards $3.50 on the optimism surrounding a more benign environment for mobile competition, and the likelihood of an NBN write-down by Labor soon after their May Federal Election win (this should spur great profitability for NBN resellers like VOC, TPG and TLS).
On CGF, though we have already seen the downgrade, we are interested to get more details on the composition of the miss, and to ascertain industry volumes currently and expectantly ahead of favourable new legislation due on July 1st this year.
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