Weekly market review
Written and accurate as at: Mar 13, 2018 Current Stats & Facts
The Australian share market gained +0.6% in what was a relatively quiet week on the stock-specific front, although there were two macro developments which we think have material implications for markets over the medium-term.
The first was strong jobs data out of the US, with February payrolls well ahead of expectations – and also ahead of the revised January figure which triggered the sharp sell-off early last month. This time, there was no wobble in response. The mix of new jobs continues to favour lower-paid roles, which means that average hourly earnings is not changing at the same rate as other indications of employment health. Nevertheless, the strong pace of job creation suggests the combined effect of deregulation and tax cuts is encouraging businesses to hire and invest. While this continues, it provides a supportive backdrop for equity markets.
At this point, we do not believe this environment is under threat from a trade war in response to President Trump’s tariffs on steel and aluminium. As discussed last week, the direct effect of these sanctions on China is minimal, given the small volumes China exports to the US, meaning any response is likely to be symbolic. The European Union, emerging from the post-GFC mire after a decade, are unlikely to endanger their revival via serious escalation of protectionism. They too are likely to confine their response to symbolic but largely immaterial measures – such as the tariffs they have threatened to impose upon Harley-Davidson motorcycles.
The second development was news that China’s National People’s Congress had approved Xi Jinping’s proposal to abolish the two term limit on the Presidency. There is still some speculation over the ultimate rationale behind the move, given Xi’s grip upon the two other roles he fills as General Secretary of the Chinese Communist Party and Chairman of the Central Military Commission (neither of which is subject to a term limit) is the effective source of his power. Nevertheless, the term limit abolition does serve to remove some of the policy uncertainty that goes with a change in leadership. It will also aid with the provincial execution of policy, as local leaders are less likely to prevaricate on difficult policies in the hope that the next leader may reverse them.
The implication is that we have a better line of sight on medium-term policy, including the strategic supply side reform (SSSR) that has seen huge cuts in capacity and production in a range of traditionally state-owned enterprises (SOEs) including steel and aluminium. This has been successful on two fronts. First, it has seen a drastic cut in pollution, with the usual winter spike in pollution failing to materialise. This is a demonstrable improvement on the quality of life which can help underpin the leadership’s legitimacy. Second, it has restored SOE sector profitability to the point where it can service its huge pile of debt, thereby relieving stress upon the financial system. Gearing levels in heavy industry have rolled over for the first time in a decade, but remain high at ~65% – and we would argue that profitability needs to remain in place for another 4-5 years to restore debt to more reasonable levels.
At the same time, the government has been clamping down on the shadow banking system while ensuring sufficient liquidity remains in the system to support their growth target of 6.5%. Ongoing evidence of accelerating wage growth and strength in the small business sector suggests this policy is working, which allows the authorities to de-emphasise the role that heavy fixed-asset investment has played in driving economic growth.
The ultimate observation is that we are likely to see policies remain in place which underpin commodity prices at a decent level and allow China to maintain steady growth, albeit at lower levels than in the past. This is a positive backdrop for Australian resources companies and other China-related plays.
China’s return from the Lunar New Year holiday did see the iron ore price correct -7% last week from ~US$77 a tonne, as production came back on line, dragging on the S&P/ASX 300 Metals & Mining index (-2.8%) as BHP (BHP) (-4.4%) and Rio Tinto (RIO) (-2.6%) lost ground. We believe iron ore is likely to remain in the US$60s over the medium term. Anything below this starts to put pressure on the ability of low-grade ore producers to turn a profit, eliciting a supply response. Consensus forecasts still imply an iron ore price in the $50s, so the miners remains cum-upgrade and hugely cash-generative even as the ore price has slipped away from its recent highs. Elsewhere in resources, oil-sensitive stocks such as Origin Energy (ORG) (-2.4%) were down as the oil price weakened – although Brent crude bounced back in overnight trading on Friday to end the week up.
The steel price also softened on the end to the Chinese New Year, and BlueScope Steel (BSL) (-4.0%) gave back some of the tariff-related gains it made in the previous week.
Several of the weakest stocks from reporting season staged a bounce last week, as investors ‘bought the dip’ in an indication of the still abundant liquidity searching for an entry point. Vocus Group (VOC) was up +9.7%, while Domino’s Pizza (DMP) (+9.1%), Star Entertainment (SGR) (+5.0%) and Healthscope (HSO) (+6.8%) were also strong. There was also movement among the growth stocks, both in technology (REA Group (REA) (+6.1%), Seek (SEK) (+4.2%) and health care (Cochlear (COH) (+4.7%), ResMed (RMD) (+4.2%).