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Weekly Equities note

Written and accurate as at: Mar 28, 2017 Current Stats & Facts

The euphoria which drove markets up in the wake of President Trump’s election continued to dissipate which, when combined with some softer data from the US, saw the S&P/ASX 300 fall -0.8% last week. The sense of stalled momentum will only be exacerbated by the withdrawal of the President’s legislation to repeal Obamacare, in the face of stubborn opposition from a cadre within his own party, as some conclude that this indicates that the tax and regulatory reforms which had the market so excited may not eventuate. There is a contrary view that Obamacare, for all the rhetoric of the election campaign, was not the Trump Administration’s primary focus and that having tried and failed to achieve change, it will now be placed to one side and allow them to focus on economic reforms.  Regardless of which view ultimately proves true, there is no doubt that the market is now expressing concerns over President Trump’s famed ability to execute a deal.

This doubt is driving rotation within the market, as well as dragging on it more broadly, with bond-sensitives continuing to outperform cyclicals. Hence infrastructure stocks such as Transurban (TCL) (+2.3%), Macquarie Atlas (MQA) (+1.8%) and Sydney Airport (SYD) (+1.4%) all did relatively well, while resources underperformed, with BHP Billiton (BHP) down -2.3%, Rio Tinto (RIO) -4.5% and Fortescue Metals (FMG) off -6.6%. A wobble in Chinese financials as funding issues at a small bank saw a spike in the Shanghai Interbank Offered Rate (SHIBOR), prompting a reduction in interbank liquidity, also weighed on sentiment regarding China-related stocks. The People’s Bank of China (PBOC) intervened quickly enough to calm markets, but it serves as a reminder that there are structural issues in the Chinese financial sector.

In this vein, there were a number of interesting observations from our research trip to China last week. Given the upcoming 19th Party Congress in late October/early November, we are unlikely to see much disruption or surprise in the short term. The Congress normally sees that significantly shuffling of personnel throughout the party leadership and structure and the possibility of securing a plum job will encourage officials at all levels to meet their targets and toe the party line. While there are indications that Xi Jinping, having bolstered his power base through the recent anti-corruption purge, might break with recent tradition and decline to nominate his successor, there is some speculation that the current Premier, Li Keqiang, might be replaced with the current Secretary of the Central Commission for Discipline Inspection, Wang Qishan. As the driving force behind the recent purges, Wang is a close ally of Xi. He is also regarded as an economic rationalist and his appointment could signal more aggressive reforms.

Outside of politics, there were several other observations with significant implications for the resource sector. First, while there have been measures to tighten the property market these have largely been directed at Tier 1 cities, which account for 10-15% of the Chinese property market, and have been aimed at cooling inflation rather than driving prices down. At the same time, it appears that a lot of the money borrowed in recent years to fund infrastructure projects has not yet been spent, but that it should start to be deployed in 2017. Both sectors should provide support for resources demand over the short to medium term.

All indications suggest that the policy of structural supply-side reform (SSSR) will continue apace. It is important to understand that this goes beyond the traditional areas of steel and coal. The Chinese system almost guarantees overcapacity as provinces all compete to participate in any industry seen as having structural growth opportunities, be it in resources or anything through to high end technology hardware, with each championing its own local companies via subsidies. It is a useful reminder that China has the capacity to disrupt supply in almost any high-growth industry. The supply side reform has come with capacity cuts – although in some instances this is little more than window-dressing – but also with cartel-like behaviour among providers to increase revenue and boost profitability. This, in turn, can lead to more problems down the road, however in the short term it alleviates the debt burden and relieves pressure on the financial sector.

Risks remain, with the surge in opaque retail lending products and the fall in forex reserves in proportion to the total financial asset base both posing potential longer term problems. However the upshot is that the Chinese economy looks unlikely to offer any significant surprise in the near term, which should serve to support commodity prices and resource stocks. Weakness in the latter is also offering some opportunities from current levels.

Coincidentally, Li Keqiang visited Australia last week and brought the olive branch of loosened restrictions on nutritional and health products with him. This saw Bellamy’s Australia (BAL) (+21.0%), Blackmores (BKL) (+19.0%) and A2 Milk Company (A2M) (+7.4%) among the best performing stocks for the week. Other outperformers include Seek (SEK) (+6.2%), Metcash (MTS) (+4.9%) and Qantas (QAN) (+2.6%). Nine Entertainment (NEC) also did well, gaining +5.9% as Married at First Sight proves a hit with audiences.

Downer EDI (DOW) fell -21.1% on the news of its bid for Spotless Group (SPO) (+46.2%). In this instance the market has disregarded any potential earnings accretion and instead focused on the 60% premium offered for what is seen as a lower quality asset. The capital raising to fund the acquisition has not been well supported. This highlights the fact that a company’s capital allocation is a key driver of valuation in the current low-growth environment.

Elsewhere, the banks and insurers underperformed as expectations of US deregulation and improved growth wavered. Telstra (TLS) (-3.6%) too was weaker on concerns that an upcoming regulatory review could declare their rural mobile network as a public asset and open it up to competition. We believe it is unlikely that TLS would be so punished for having invested in this service and believe that it is at oversold levels following its recent decline.

 

 

 

 

 

 

 

 

 

 

This document has been preparedby BT Investment Management (Fund Services) Limited (BTIM) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at 27 March 2017. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This document is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information in this document may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this document is complete and correct, to the maximum extent permitted by law neither BTIM nor any company in the BTIM Group accepts any responsibility or liability for the accuracy or completeness of this information. BT® is a registered trade mark of BT Financial Group Pty Ltd and is used under licence.

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