June 2019 Half Recovery
The ASX All Ordinaries (500) index closed today, 24th July at a record high of 6862, beating the previous record it reached in November 2007 (6853).
As discussed in the June blog ‘A tale of Two Halves’, the Australian equities market was down 10% in the 6 months to Christmas Eve 2018. The market rallied in the second half to 30 June 2019 so that for the full year the S+P/ASX 200 was up 8.27% (13.02% with dividends).
Burrell have begun the process of reviewing portfolio returns. It is evident that the majority of portfolios fell by less than the market fall at Christmas Eve, but have enjoyed much of the upside since. We often say that Burrell portfolios are lower risk, but risk measures are few and far between. One of the key reasons portfolios were off by less than the index on Christmas Eve is the aversion to high growth stocks such as Flight Centre and Domino’s Pizza both which fell from $70’s to $40’s.
Growth stocks have shown stellar returns in the 6 month recovery to the point where a number of commentators see the growth stocks in both Australia and the USA as ripe for correction. Some Australian long/short funds i.e. investment managers that invest long but also sell those stocks they expect to fall by borrowing the stock and selling it on the market- some of these funds are selling short growth stocks and buying value stocks with sustainable dividends. There is considerable interest in the reporting season now commenced as to whether companies will disappoint with earnings reports. Companies that disappoint are likely to be dealt with harshly, as happened to Illuka today on the release of the June 2019 quarterly review. Given that Iluka had carried stock through some soft Rutile and Zircon markets, realizing that in the prior year comparatives, it may be that the market dealt with the stock a little too harshly.
The June blog included a graph showing the Australian 10 year bond rate falling from 2.75% on 9th November 2018 to 1.28% in late June 2019 and 1.3% currently. The gap between the fully franked dividend yielding companies such as Westpac and the 10 year bond has widened. The June blog forecast that this deferential would likely see the market gallop ahead to be within cooee of the 2007 high. This was achieved today. The dividend yield driver has not finished its work, with several of our
advisors seeing the market continuing to the 7000 level. Others have coined the term TINA, meaning ‘There Is No Alternative’. Suncorp is currently issuing a 4 year bond at a coupon of 1.9%.
While the dividend yield driver is positive for the banking sector, regulatory issues including remediation are negative and analysts are forecasting a cut in bank dividend payments. It will be interesting to see how the market reacts to a reduction in bank dividends as CBA results are announced this reporting season and the other banks at the end of the September quarter. NAB received positive news with the appointment of CEO Ross McEwan to complement Chronichan as competent chair. One research analyst forecast NAB’s dividend to fall from $1.98 to $1.66, representing a 6.2% yield and a P/E of 12.6x. This highlights the yin and the yang. The positive being the dividend yield gap over the 10 year bond i.e. TINA, the negative being compressed margins in a lower interest rate environment together with regulatory and other business issues leading to lower profits and lower dividends. A conclusion is to continue the investment strategy of broadening beyond banks and resources so that portfolios have broader shoulders to stand upon.
The major energy stocks are of interest at current levels with Santos quarterly production exceeding that of Woodside for the first time in many years. Santos is embarking on an aggressive growth trajectory and announced during June a target of 100 million barrels of oil equivalent (mmbloe) by 2025. This will likely see Santos paying lower dividends and incurring higher capex than its Australian cousin Woodside. Oil Search is awaiting news from the new PNG government, which was elected on a platform of seeking higher returns from the mining and energy industry in PNG for its residents.
The telco sector continues to be disrupted by the NBN. The withdrawal of a possible fourth carrier from the market has seen Telstra firm. The negatives of high gearing of 50% and the permanent fall in earnings per share and dividends sees the Telstra metrics likely to be a dividend of 4.2% and a P/E of 17x. The market sees Telstra as the likely first mover in 5G, adding to a more rosy future.
Lendlease is expecting a poor result due to losses and write-downs in the former civil and civic construction business, portrayed for many years as a core business of Lendlease. Again we have the yin and yang with the good news being $21B, Google Silicon Valley housing project for urban regeneration. This positive announcement saw the recovery in Lendlease continue from a low of $11 in January 2019 to $15 currently.
The blog often restricts its focus to investment strategy and broader issues, but it is interesting to focus on the positive and negative factors impacting on the major Australian companies.
Another factor in this reporting season is that the 6 months to June 2019 was punctuated by the Australian federal election. TR Burrell OBE had a quote that “elections are excuses for people to do nothing”. Almost all business people have confirmed that this was in fact the case for businesses large and small. The Stockland CFO at a presentation in our offices confirmed that the election had indeed been a key change in sentiment for their business. The change in sentiment in the economy, the interest rate cuts and the income tax cuts do mean that the June half may be seen as more negative than the forthcoming December half year, when those factors should produce a positive impetus to Australian GDP.
The geopolitical issues as discussed in the June blog have continued. The election of Boris Johnson as UK PM is likely to see the UK assert its sovereignty in the Brexit discussions with the EU.
The US/China Trade War has so far shown no signs of any immediate positive resolution.
In Germany following the downgrade of the central bank from 2019 GDP growth in Germany to 0.6% and 2020 to 1.2%, Deutsche Bank announced a major curtailment of its global ambitions and refocused to a strategy which is more aligned to the ANZ bank in Australia i.e. look after your domestic customers and your international operations have a focus upon their operations overseas. There is concern around the risk of Deutsche Bank being an X Factor with a gross derivative exposure greater than European Union GDP. However the major ratings agencies including Moodys have reaffirmed the rating of Deutsche Bank, notwithstanding the new CEO has transferred $27B Euro of assets to a “bad bank” and the lack of transparency around the derivatives exposure. Deutsche Bank today posted a second quarter loss of $3.51B including major restructuring costs. Deutsche’s woes peaked with $7.2B US fine in 2017 for its role in the mortgage market crisis (GFC). Fortunately Deutsche Bank in Australia was profitable and well regarded, so the shutdown of their equities trading business should proceed in Australia in an orderly fashion.
In summary, low fixed interest yields will force investors to consider the Australian stock market and sectors of the commercial property market as providing satisfactory risk adjusted returns. Care should be taken with the growth stocks that have performed well in the past period in both Australia and the US, but now screen as overvalued. A number of leading Australian companies have some negative business aspects which may offset the dividend yield driver, such that the current reporting season will require ongoing careful consideration by Burrell research and advisors.
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Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.