Markets went onward and upward again last week, and it wasn’t just equities.
Oil jumped +10%, gold rallied to its highest level in 6-years and bond investors sent yields further lower across the world.
‘Anything but cash’ seems to the mantra of investors at the moment, with asset markets surging ahead on support from global central banks all outwardly willing and able to further stimulate demand in the latter half of 2019.
And its on this front that I have to acknowledge, with more than a little surprise and disappointment, that I have been far too cautious on risk assets for the last couple of months.
Central Banks prolong the party
The willingness of both the Federal Reserve and European Central Bank to ride to the rescue of investors, and the reciprocated faith that investors have placed in monetary authorities to successfully elongate this economic cycle has surprised me.
Markets have been significantly stronger than I have expected, and my caution has been misplaced.
Last week the Federal Reserve intimated a willingness to cut interest rates in the near term, but perhaps of more significance, the European Central Bank promised they were willing and able to further lower European interest rates from their already negative -0.40% rate.
The RBA too, unsurprisingly, gave markets a wink and a nod to expect further local rate cuts.
As the largest contributor to the global monetary stimulus this past decade, that the ECB stood ready to further lower domestic interest rates was perhaps the biggest catalyst for equity investors and seems to signal no fatigue from central banks on their willingness to commit ever more liquidity into the global economy to bolster demand.
German 10-year bond yields fell to a record low of MINUS -0.30% and for the first time ever, French 10-year government bond yields now offer ZERO yield to investors.
Australian 10-year bond yields are at a record low of 1.28% as we speak.
That we are now needing to cut rates further from an already negative rate in Europe, a cycle peak of 2.5% in the United States and following an unprecedented cut in corporate and personal tax rates in the United States under President Trump is astounding, and surely suggests that the incremental impact of this stimulus on the real economy is waning ever more.
That we continue to double-down on this policy, rapidly inflating the value of financial assets, only further escalates the risk that when it all comes a cropper, it does so in a major way.
But in the here and now, investors are being encouraged to continue taking risk, and as the markets last week showed, they are happy to do so.
This means that momentum continues to work.
Momentum takes another leg higher
In Australia, that means healthcare stocks continue to lead the market, alongside REIT’s, infrastructure and miners.
Where Australia’s equity market started the year looking good value against its long-term earnings, after its near +20% rally, the ASX200 is now at a 10-year valuation high and the likes of Cochlear (COH), RESMED (RMD), CSL (CSL), Transurban (TCL), Woolworths (WOW), Coles (COL), Medibank (MPL) and property REIT’s all trade at record valuations.
Whilst we are unprepared to play in many of these themes so deep into the rally for multiple reasons, knowing when this momentum peters out is also a difficult call to make.
Construction exposure looking more attractive
We do however believe that the collapse in Australian interest rates and the significant rally in U.S long-bond yields in anticipation of falling rates there auger well for construction and house-building, which means that we think there are increasing opportunities available from companies exposed to this theme.
We have already recommended Boral (BLD) and would willingly add again under $5, but we also think that exposures such as Adelaide Brighton (ABC), James Hardie (JHX) or Reliance Worldwide (RWC) could potentially be suitable for portfolios in time too.
Lastly, it’s quite possible that our improving outlook for Australia’s domestic economy leads us to take a more optimistic view of small-caps given they have lagged the blue-chips in this rally and are often far more cyclically exposed than their larger peer group.
Again, watch this space.
Earnings Season is due
The upcoming annual reporting season stands every chance of being even more volatile than normal when it kicks off in early August.
Last week saw the start of confessions season, with several Australian companies being forced to lower guidance for profits due to a disappointing end to the financial year.
Soft furnishings retailer Adairs (ADH) cut profit guidance by around -15% after blaming a drop off in sales in the first 3 weeks of June – this despite the rate cut and the Federal Election boost to consumer sentiment that was expected.
Petrol retailers and refiners CALTEX (CTX) and Viva Energy (VEA) both lowered guidance citing the slowing economy is a factor, whilst Metcash (MTS) today lowered guidance for a variety of reasons, but one of which was the impact of slowing construction on the group’s hardware business, Home Timber and Hardware.
Whilst Wesfarmers (WES) cut guidance for its Kmart department stores a fortnight back, they didn’t lower guidance for Bunnings for 2019, however it wouldn’t surprise to see WES offer a softer outlook for that division into 2020.
There will be more of these to come in the coming month as we lead in to results season.
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