Weekly market review
Written and accurate as at: Feb 06, 2018 Current Stats & Facts
The S&P/ASX 300 gained 1.1% last week, finally making some headway after a muted start to the year. That said, the fall in US equities on Friday has seen a volatile start to the week here in Australia.
Official US wage growth edged free of its long-held trading band – coming in at 2.9% annualised versus the 2.5% trend of recent times. This prompted a bout of volatility in both bond yields and equities as people extrapolated an expectation of more aggressive Fed tightening in 2019. While a spike in volatility in the US – from extraordinarily low levels – will have an effect here, at this point we do not believe this heralds the arrival of a sustained bear market in Australian equities. There are several points to consider in this vein.
First, it is important to remember that Australian equities have not enjoyed the same surge as other developed markets over the year-to-date or, indeed, over the last year. For example, the S&P/ASX 300 is up +9.1% for the preceding 12 months – versus +20.2% for the S&P 500, even after Friday’s move. This partly reflects the more defensive nature of the ASX and the different market composition, with technology stocks – which have outpaced the rest of the US market on valuation re-rating – comprising a much lower proportion of the local bourse.
The Australian market’s aggregate valuation, while slightly above its long-term average, is entirely consistent with where we would expect it to be given our low interest rates. With little to suggest that the RBA is likely to start raising aggressively, we are relatively comfortable with the market’s valuation level.
There are also currency effects to consider. The AUD has strengthened against the USD in recent months, reaching 80c last week, before falling back near 79c on Friday’s risk-off trade. Should we see further rotation to the USD on greater risk aversion, the currency benefit for Australian companies can provide an offset to any valuation de-rating.
We remain mindful of the risks in the local market. We consider roughly 30% of the S&P/ASX 300 to be significantly sensitive to bond yields; a sustained pick up in yields could see these stocks drag on the market as a whole. There is also a significant cyclical exposure – particularly through resources – which may be vulnerable if US rates go up faster than anticipated. That said, it is worth remembering that in recent years the US economy has displayed a meaningful sensitivity to bond yields. The strength of US business confidence and persistence of benefits from recent tax reform may allow a greater proportional rise in yields than in recent years, but we must be mindful that if yields continue to rise – and temper the US expansion as a result – then there is every chance that the Fed will not accelerate rate hikes which could see the bullish sentiment reverse again.
We will monitor yield-driven factors in the market, however our more immediate focus as we head into reporting season is that it feels like the market is already positioned for the more obvious results. The risk here is that many of the stocks expected to deliver good results have already outperformed and may actually underperform post report, in a case of “buy the rumour, sell the fact.” This also leaves scope for the market’s most recent unloved – including index heavyweights such as the banks and Telstra – to do better than has been the case in recent months.
There is little evidence of the complacency normally associated with the top of bull markets, with market media coverage generally striking a cautious, almost worried tone. It seems as if people have been searching for the trigger to prompt higher yields and Australian bond sensitives have been underperforming in anticipation. Last week the S&P/ASX 200 AREIT index was down -0.8%, with the fall exacerbated in the residential-related names such as Mirvac (MGR) (-3.2%) and Stockland (SGP) (-2.1%) on concerns over a slowdown in apartment sales. Infrastructure stocks also suffered, with Transurban (TCL) down -1.1%, Sydney Airport (SYD) -2.2% and Macquarie Atlas (MQA) -4.9%.
Resources also underperformed. The large diversified miners edged lower BHP (BHP) (-0.1%), Rio Tinto (RIO) (-0.7%)) while Pilbara iron ore miner Fortescue Metals (FMG) was down -2.2% following its quarterly production update. A historically wide discount for lower grade iron ore has challenged FMG in recent months and, while their update was probably a bit better than expected and initially received well, concerns over the outlook for their realised price were ultimately reasserted. There is some unconfirmed speculation that Hebei province in northern China may extend its steel production capacity restrictions, which could continue to support high steel margins and encourage mills to use high-grade ore, thereby curbing pollution. Outside of the base metals, gold miner Northern Star (NST) fell -5.6% following a disappointing quarterly, while indications of better zircon pricing saw rare-earth producer Iluka Resources (+7.3%) outperform following its quarterly update.
Financials had a good week. The Big Four banks all rose, led by Commonwealth Bank’s (CBA) +2.7% gain as the announcement of its new CEO removed an element of uncertainty. The key question is now the extent to which he uses this week’s earnings report to re-base expectations. This is a lower risk under an internal candidate, however given the current environment of lower volume growth, the move to digital and likely regulatory fines, there is the potential for a significant one off charge in the upcoming result. This outcome is reinforced by the current political environment, with enormous scrutiny on bank profitability. Westpac (WBC) gained +2.5%, with ANZ (ANZ) (+1.6%) and National Australia Bank (NAB) (+1.7%) just behind.
Medibank Private (MPL) (-1.8%) bucked the trend of broad gains across financials. Recently announced annual gains in private health fund prices, while lower than in recent years, were not as bad as many investors feared. That said, the stock reacted to statements from the Federal Labor party targeting private health fund premiums as an area of concern. Fund manager Janus Henderson (JHG) (-4.4%) was also down on some concerns that their flows may disappoint market expectations.
Outside of financials, Sirtex Medical (SRX) (+48.9%) was among the market’s best performers, surging on an all-cash takeover offer from US-based Varian Medical Systems. James Hardie (JHX) (+11.2%) was also strong, following its half-yearly result. The company has had to increase spending in recent quarters to rectify its loss in North American market share due to previous production issues. This result suggests that they have improved share faster than many expected, while a favourable product mix saw margins surprise on the upside.