Weekly market update - 29th of October 2018
Written and accurate as at: Oct 29, 2018 Current Stats & Facts
Last week’s -4.6% fall in the S&P/ASX 300, on top of the previous week’s decline, renders October’s -8.8% the market’s worst monthly fall since the GFC. It is now down -10.8% from its August high. The swift spike in volatility comes on the back of several factors including fears of overly-aggressive tightening from the US Fed, the fear of deteriorating US-China trade and signs of higher input costs, particularly in the US.
Thus far we have seen a valuation de-rating – the S&P/ASX 300 has fallen from 15.5x next-12-month (NTM) price/earnings (P/E) to around 14x – but we have not seen earnings expectations shift materially. The latter is important as we consider the key question: have we just seen the market relieve some pressure, or are we in the early stages of a more sustained bear market typically associated with a major global slowdown?
Notably, the US economy remains in good shape and we are not seeing signs of recession. In this vein, it has been interesting to note that the pressure of the last two weeks has not been reflected to the same degree in credit spreads, suggesting that this is more about equity market sentiment than broader economic deterioration.
The oil price came off, however energy stocks fell further and were among the market’s weakest as cyclical sectors came under pressure, reflecting fears over the possible effects of heightened trade friction. Woodside (WPL) was down -8.1%, Santos (STO) -6.6% and Origin Energy (ORG) -12.0%. ORG’s fall was exacerbated by the ongoing uncertainty around government energy policy, where suggestions that the government may legislate the right to force asset sales spooked a market which is already suffering from underinvestment. Defensive yield sectors such as REITs (S&P/ASX 300 A-REITS -1.2%) and infrastructure tended to outperform, as did gold miners. It is interesting to note that REITs are now performing in line with energy stocks over the year-to-date, even as the latter has benefited from a significant oil price increase. Outside the defensive sectors, private hospital group Healthscope (HSO, +17.5%) was a notably outperformer as it continues to attract takeover interest.
AMP (AMP, -26.5%) managed to steal the show in an already volatile weak. Management announced the sale of its life insurance and mature business divisions – a move which had been looked for to unlock shareholder value – but the market was very disappointed with the price and a lack of clarity in the messaging around an admittedly complex deal. The price for the mature business looks reasonable, however there is a sense that management have rushed the sale of the life insurance business - which has deteriorated in recent halves. The disappointing price, in tandem with some uncertainties over a hit to earnings and additional costs from the sale which were not well explained by management, took a heavy toll on the stock price. There is no doubt that the deal is value destructive, however we estimate this to be in the order of 12%, with the rest of the fall in response to broader market weakness and the ambiguity arising from poor communication around the deal. The deal does provide a cleaner, simpler company for the new CEO, however we are in something of a vacuum in terms of his strategy for turning around the business and for the likely use of the proceeds from the asset sales.
Elsewhere Worley Parsons (WOR, -15.8%) announced the proposed acquisition of the energy, chemicals and resources division of Jacobs Engineering. This is the latest in a string of deals which, while accretive at an EPS level, have not particularly well received. In the current environment it is not enough for management to use a higher P/E or some leverage to make superficially accretive acquisitions – they must also make a compelling case around return-on-capital and the strategic logic for a deal to gain market approval. Other cyclical names such as Whitehaven Coal (WHC, -11.7%) and Bluescope Steel (BSL, -11.5%) also got hard hit. Meanwhile the growth names, which had already fallen in the previous week, continued to underperform: Aristocrat (ALL) was down -10.8%, with Wisetech (WTC) -10.8%, Xero (XRO) -9.2% and Treasury Wine (TWE) -8.2%.
Qantas (QAN, -6.4%) updated the market. People have been worried about the QAN fuel bill in an environment of high oil prices – as flagged by management at their results – and while this has continued to climb it has been more than offset by stronger-than-expected revenues.