Weekly market update
Written and accurate as at: Aug 20, 2018 Current Stats & Facts
The local market added a further +1.3% in a week which saw the trend of growth stock outperformance persist despite their already lofty valuations. This was helped by a continued rotation out of resources, where fears over trade sanctions have weighed on commodity prices. This trend has been particularly interesting to observe in the context of reporting season: in several instances resource stocks have been punished despite posting decent results. At the same time, some high growth stocks have surged despite posting relatively uninspiring report; with Seek (SEK, +10.8%), REA Group (REA, +6.0%), Domino’s Pizza (DMP, +6.0%) and Treasury Wine (TWE, +5.4%) providing cases in point.
This suggests that investors continue to be focused on the geopolitical aspect of the resource sector and are worried about the escalation of rhetoric. In this vein, China’s decision to send a trade delegation to the US later this month may serve to calm fears. The second observation is that there is still plenty of liquidity in the equity market and, with both resources and financials under pressure, investors have thrown more money after already expensive defensive industrials.
Mineral sands producer Iluka Resources (ILU, -12.5%) was among the worst performing resource stocks. While its recent updates and result revealed that it continues to benefit from higher contract prices for zircon, news that the spot price (which is well above contract) has rolled over prompted some concern and a material amount of hedge fund shorting. At the same time, the cost estimates for expansion of its rutile mining development in Sierra Leone have been increased. The company continues to address its previous issues of high inventory and has reduced net debt by 81% in the last half. The stock’s fall feels like an over-reaction, but it is important to remember that that is the nature of midcap resource stocks. Most other resource companies also fell, with gold stocks such as Northern Star (NST, -8.5%) hit hard as the gold price continues to fall. BlueScope Steel (BSL, -4.3%) delivered a good result and a big stock buyback, however the market was focused on the possibility of trade détente between Europe and the US, which may be a negative for the steel maker.
Power company Origin Energy’s (ORG, -8.4%) LNG division continues to do well, however the power generation/retailing business was hit by a change in the way which it accounted for its hedging, which effectively knocked 6% off profits. ORG has also had to wear a margin hit as the government has effectively blocked it from passing on increased power costs to consumers. Division and uncertainty over the government’s energy policy is a stiff headwind for the power sector and yet another example of regulatory and political intervention disrupting several sectors in the domestic economy.
Challenger (CGF, -7.5%) continued to grow its annuity book, but is failing to achieve earnings leverage as falling investment returns and new business has crimped its margins. Elsewhere in financials Insurance Australia Group (IAG, -6.4%) delivered a reasonable underlying result but tempered the market’s enthusiasm on their outlook. Fellow insurer QBE (QBE, +8.4%) was at the other end of the spectrum, re-rating on the back of a result which was modest but did not contain the bad news that many people feared.
JB Hi-Fi (JBH, +11.4%) was another company which defied expectations of bad news, continuing to deliver sales growth and seeing the return of some earnings leverage after larger than expected costs in the first half. The result was in line with guidance and there were some signs of improvement in the Good Guys franchise, where margin weakness has weighed in recent times. Telstra (TLS, +8.5%) too was rewarded for a lack of further bad news, with some suggestions emerging that it might be reaching its nadir of earnings pressure in 2019, with some runway of recovery beyond as NBN costs decline and the benefit of cost cutting in other areas begins to flow through.
Finally, in REITs Goodman Group (GMG, +7.1%) delivered a strong result, albeit in line with expectations. Dexus (DXS, +4.8%) also did well, benefiting from some supply constraints in the office market. Like the broader market, the flows chasing GMG suggest there is plenty of liquidity in the AREIT market however it is avoiding the heavyweight retail sector and is instead beating a smaller niche of the market to an even greater valuation premium.