Rudi's View | Jun 20 2019
In this week's Weekly Insights (published in two parts):
-A Confirmation From Aussie Banks
-What's There To Worry?
-Morphic Explains Shorts For CCL, Woolies
-Rudi On Tour
[Non-highlighted parts will appear in Part Two on Friday]
By Rudi Filapek-Vandyck, Editor FNArena
A Confirmation From Aussie Banks
A pullback in most equity markets around the globe in May, while Australian equities continued to march onwards and upwards, have turned the Australian share market into one of the best performers all around in 2019.
But strategists and analysts are not so confident the local market can hold its own simply on the promise of more RBA rate cuts and, on the back of this, a potential recovery in domestic housing. Is the Australian share market now too expensive?
Let's find out whether my personal market indicator can shine any light on the issue.
Traditionally, I focus on share prices of the Big Four banks, and more specifically on the gap between these four share prices and FNArena's consensus price targets, to gauge the status for local sentiment in the share market.
Today, Tuesday 18th June 2019, Stock Analysis on the FNArena website shows CommBank ((CBA)) shares are trading well above target (to the tune of 13%), while Westpac ((WBC)) is also above target, as is ANZ Bank ((ANZ)), while the sector laggard National Australia Bank ((NAB)) still has a minor gap to fill (0.6%).
All else remaining equal, this seems to suggest investor sentiment is running red hot and there is not much room left, if any, to rally a lot higher from here, which shortens the odds for a pullback in the not too distant future.
The fact major commodity producers BHP Group ((BHP)) and Rio Tinto ((RIO)) are equally trading above their respective consensus target, while the next rally in both Woodside Petroleum ((WPL)) and Santos ((STO)) will put the major energy producers in the same position, only reinforces the idea that the local share market is trying to defy gravity in June.
Hence, in the short term, my banking stocks sentiment indicator confirms it's probably best to be a little more cautious for investors.
When using this market indicator, and every other gauge I hasten to add, investors should always question whether there are specific circumstances that can potentially make its apparent signal invalid. This is not always easy and one of the key reasons my advice to investors is to never rely on just one indicator or signal.
In this particular case, there are times when banks share prices are dominated by sector-specific dynamics that are not necessarily representative for the Australian economy or share market as a whole. Think last year's Royal Commission, for instance. It goes without saying during such times whatever happens to bank share prices cannot be used to measure risk appetite in general.
Which begs the question: are we back to normal?
I suspect the answer is yes. See BHP and Rio Tinto above. A number of other indicators is equally suggesting more upside might just be a stretch too far, and not long lasting given the ongoing declining trend in earnings forecasts outside of iron ore producers in Australia.
This need not be the end of the road for the local share market. After all, share markets are forward looking and in less than two months we'll have the August reporting season to take note and update our general outlook for the year ahead.
One of the key reasons as to why Australian bank shares have recovered so swiftly this year is because investors can once again see profit growth on the horizon, after having succumbed to the view there won't be any growth for longer for the sector.
This change in outlook explains the upgrade CommBank received from Bell Potter this week.
Apart from lifting the rating to Buy from Hold, Bell Potter's price target for the year ahead lifted to $86 from $80 essentially on the belief CBA's Net Interest Margin (NIM) will prove resilient (no meaningful further decline) and dividends look even more solid, expected to remain at 431c per annum for years to follow (for a yield of circa 5.4% ex-franking)..
Now, I agree, one swallow does not a summer make and to date not one of the eight stockbrokers monitored daily by FNArena has set a target that comes even near Bell Potter's, but the update illustrates the changed market perception towards the sector, and what is likely to follow next.
Note also, Bell Potter's updated forecasts are not assuming CommBank is about to grow cash EPS by double digit percentage again, as in the pre-GFC golden era for the sector.
It is simply based upon the assumption that negative or no growth will be replaced by some growth. Little things can have a significant impact in the share market and this is one such example.
Some commentators elsewhere have suggested one key driver for the strong performance in bank share prices has been short covering following the surprise outcome in the federal election in May, which seems but plausible, but certainly not the full picture.
Other factors in play include:
-local funds managers lifting their portfolio exposures to banks, having been underweight the sector for a long time
-cash rate cut by the RBA with firm hints the bias remains in favour of more cuts, fueling expectations the local housing market down-cycle might be near its trough and things should brighten for housing related activity, consumer spending and the Australian economy in general
-the rally in government bonds globally has once again ignited a search for yield and large cap stocks in Australia, banks in particular, quickly landed on foreign investors' buy list
-a rising realisation the Aussie dollar is most likely to weaken, which makes owning Australian shares extra-attractive for foreign investors
Last but not necessarily least, I also suspect Labor's failed election campaign has highlighted dividend yields and franking among retirees and pensioners across the country, creating an extra source of demand post Coalition re-election.
There are more shades of grey in this than I can possibly sum up here, but most question marks that surround banking shares today equally apply to the broader Australian share market: will the RBA deliver, and will it have the anticipated impact? Is the government otherwise ready and prepared to join in?
As such, and with obvious nuances, the outlook for shares in Lendlease ((LLC)), Stockland ((SGP)), GUD Holdings ((GUD)), FlexiGroup ((FXL)), Accent Group ((AX1)) and others shall remain closely intertwined with the outlook for Australian banks.
As such, I think we can safely say the banks are back in their traditional role as a general indicator for momentum and health in the Australian economy; they also look valuation-stretched in the immediate term.
What's There To Worry?
One of the oddest observations I came across in the week past is the fact that, according to Citi's Panic-Euphoria indicator, global investor sentiment is now near Panic while one would have thought fully blossoming Euphoria seems more likely, in particular with Australian indices closing in, finally, on their pre-GFC all-time high.
While I have no deeper insights into the methodology behind Citi's indicator, I do know over the past two decades or so (most likely much longer), determining whether global sentiment reflected "Euphoria" or "Panic" has been quite reliable at turnaround points for equities either way.
Usually, when sentiment gets so bad that "Panic" applies, investors are best off by putting money into equities, as was the case late last year and in early 2016, and when the indicator is showing sentiment has ventured deeply into Euphoria, it's time to start worrying about potential downside, as was the case in late 2017 and again in 2018.
Historically, Panic appears when shares are down and Euphoria tends to show up when equities are rallying, so what is different this time?
I suspect what makes this time different is that the global investment community has remained overwhelmingly cautious in the face of USA-China tension, as well as the need for central banks to again provide support for deflating economic momentum and the staunch resistance in price inflation to finally become a positive problem.
As such, money has kept flowing into government bonds and into defensive assets in share markets. Witness, for example, how sectors healthcare, telecommunication and industrials in Australia have been among the best performers this year. The latter sector includes stocks like Sydney Airport and Transurban, usually aligned with a more cautious investment approach, at least when bond yields are not the driving force.
And that latter point might be essential for understanding why Citi's indicator is flashing "Panic" rather than "Euphoria"; equity markets have risen on the "bad news is good news" mantra, and this is reflected in global funds flows having mostly preferred the safety of bonds and the luxury of bond proxies in the share market.
Time to highlight what I believe are the key risks/question marks for equity markets, as these will be on the minds of professional asset managers the world around.
In the US, forward indicators continue flashing weakness lays ahead. The leading indicator from the OECD is a case in point.
Globally, momentum remains negative, including for the US economy with the OECD leading indicator for the number one economy in the world now showing a negative reading of -1.6% year-on-year; its worst reading since August 2009.
This suggests momentum was already losing its oomph well before tensions rose firmly between China and Washington. An outbreak in hostilities, or even a continuation of the current impasse are only adding to the weakening outlook.
Thus far US markets have remained remarkably resilient, with many a commentator suggesting investors simply refuse to believe there won't be an agreement, in some form, between the two protagonists, at some point.
I think a lot of confidence also rides on the back of the Federal Reserve possibly reversing back into stimulus mode through renewed interest rate cuts.
If everything goes according to plan, the US economy and corporate profits in America are facing two weak quarters ahead, but by the final quarter of 2019 momentum for both is expected to accelerate noticeably.
I remain of the view that as long as this prospect remains alive, and many believe it remains feasible enough to rely upon, equity markets can remain firmer for longer – but watch out if confidence falters.
In Australia, the situation is slightly different. The RBA is cutting the cash rate, while others such as APRA are trying to loosen financial conditions on top of these cuts.
RBA Governor Philip Lowe is communicating at the best of his abilities that interest rates will be lower in the months ahead. Economists are now fiercely debating how low the domestic cash rate might go.
Is the RBA going to stop at 1% (one more cut)? Will it be 0.75% (two more cuts)? Or is 0.50% the bottom (three more cuts)?
Irrespective, while equities gain on the initial support from central bank cash rate reductions, the support for housing related sectors and consumer spending has to show up in concrete numbers at some point, or sentiment will turn negative.
While this is a tangible risk when indices are posting post-GFC highs and approaching the all-time peak from late 2007, it seems too early to bicker about the effectiveness of a lower RBA cash rate just yet.
The RBA is going to cut its cash rate further. The minutes released on Tuesday repeated that message unambiguously. For now, that's all the local market wants to hear and read.
The April update for the OECD leading indicators also suggests the downturn in economic momentum in few countries including China and Australia might be stalling, which makes for yet another data input to remain optimistic about what awaits on the medium-term horizon.
Audio interview on Wednesday about what is happening in the share market:
On Monday I participated in Episode 5 of Switzer TV (I appear 8 minutes in for about 10 minutes):
Rudi On Tour In 2019
-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1
(This story was written on Monday and Tuesday 17-18th June 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part two follows on Friday).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
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(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)